James Donald Discusses the Sensitivity of Emerging Markets

over three decades. If you find the world of emerging markets remotely interesting, well then strap yourself in for a master class in emerging markets investing. We discussed everything from valuation issues to constructing a portfolio, to risk factors that exist in a M that may not exist in in developed countries. How countries go from runtier to EM and from e M two developed and some of those developed countries have gone back uh, falling back into e M uh.

This is an area I am personally fascinated in because I'm aware of the fact that U S stocks are let's just say, richly valued, European and Japanese stocks a little less richly valued. But EM is where the valuation exists. And when we look at the track record of EM and US stocks over long periods of time. It seems like the leadership goes back and forth its cycles over longer periods of time, five seven, nine years at a time.

We just finished a nearly decade long period of time where e M not just underperformed the US, but significantly underperformed the US. The gap was about as wide as it ever gets. Last year seemed to be the beginning of a change of leadership, and we could see e M stocks outperforming the United States and other developed nations UH for quite a number of years, perhaps even a

full cycle. So if you are all interested in places like China, India, Russia, Brazil, Mexico, Turkey, Greece, I keep saying Vietnam even though it's a frontier country, but I'm I'm intrigued by that part of the world, South Korea and Taiwan as em countries when really they're almost developed countries. You will find this conversation absolutely fascinating. So, with no further ado, my conversation with Lazard Asset Managements James Donald.

My special guest today is James Donald. He is the head of Emerging Markets at Lazard Asset Management, where he is also a portfolio manager and runs a variety of equity strategies in the emerging markets space. James Donald well into Bloomberg. Thank you, Barry. So you began your career back in Nree, which was a pretty good time to get into finance, the start of a long bullmarket. What

was your first job on Wall Street? Well? Um, I was born in Toronto and I actually began my first career in Toronto at a brokerage firm called Wood Gundy, where I did a training course around the firm. So you participated or helped build the trading course? Um, I participated in the trading corps in the training course, and I was involved in a whole lot of different functions in the firm, anything from operations all the way to government finance. So what what drew you to the emerging

market side? Well? I I then got a position at s G Warburg in London and UH. I went into the investment management area there and was involved in global investments. This is really pre emerging markets. Emerging markets only really developed, I would say in UM and UM So I was involved in managing global portfolios a lot of us UH holdings at that time and really learned about portfolio management at SG Warburg and the firm ultimately became Mercury Asset Management.

And in the early nineteen nineties, when Mercury was establishing it's Emerging market team, I was very interested in joining that team, and so I was one of the first members that that joined that team and was involved in managing portfolios at Mercury. What was the motivation that led you to say, So, you're in London the center, especially in the nineties of a of a fairly booming developed nation,

developed metropolis. Europe was really star to come into its own What made you say, Hey, all these developed market things are kind of interesting, but let's venture into something

a little more adventuresome. Yeah. I had done a lot of work analyzing smaller stocks in the US and looking at stock markets in Asia and back then essentially the equivalent of emerging markets places like Hong Kong and Singapore and UM Malaysia and areas like that, and so uh, I thought these markets were ones that I had had experience or not two different experiences with. And I also was very attracted by the cultures um the variety of

cultures in emerging markets. And at the end of the day, I felt that people around the world want to see their economies develop, and the capital markets are very very critical part of that. So this was long before for the era of index funds or country funds, where you could just push a button and one transaction gives you exposure to fill in the blank. Asia, Vietnam, emerging markets very different era. How was it like in those those days compared to today. It was before index funds, but

it wasn't necessarily before country funds. A lot of country funds actually developed during this time because a lot of these markets were very, very small and they don't didn't want to be overwhelmed by foreign capital flowing in and flowing out. So actually country funds were very very big part of the development of those markets. In general, the

markets were very small. A lot of the big big countries today, for instance, China, which is close to being thirty percent of the Emerging Market Index today was around one percent. And back then, places like I mean, Malaysia was a huge market. Mexico was a very big market, whereas say Brazil was relatively small or um you know, for instance, India was relatively small as well. Were there any restrictions on we know, everybody wants capital coming into

their countries. Were there any restrictions on how that money could be removed? That were they gated or any of these country funds? And I was thinking of country ETFs and indexes, but these specific country funds, if you needed to get your money out in a hurry, was that was that feasible? Well, if you go back more than twenty years, a great deal of these markets, we're not markets you could directly invest in. You had to go through those country funds. So they were fixed pools of capital.

And as a result of that, you know, the country funds values could be very different from their net asset values, and so essentially that could distort the picture very heavily. And no, no computerized arbitrage opportunities, none, none of that. Slowly these markets have opened up and UH and investors like ourselves have been able to directly invest in them. Let's get into some of the details and specifics. How do you define what is or is not an emerging market?

Is it an economic definition? Is it a political definition? Where where are the lines drawn? It's something that's changed over time. I think originally the index was based or the indices were based on economic development and and political development.

They've moved over time more towards what's easily accessible and M s c I is the biggest index provider in this area, and they're very focused on accessibility, meaning define accessibility the ability to get capital in and the ability to get capital in capital the ability to to get information on these markets without any major restrictions. So now as good a time as any to ask what is the distinction between the so called frontier markets and emerging markets? Well,

those have even less accessibility on the whole. They are much more rudimentary economies and rudimentary markets, um, and they have less liquidity in them. So uh, there are is an ongoing process by which countries have moved between frontier markets and emerging markets and even back into frontier market. It's a fuzzy line, it's not a very bright line there. There's certainly some gray in in that whole discussion. And

you mentioned earlier China is about of emerging markets. It's arguable that they're not that far off from being a developed nation. When when might that occur where China is no longer considered an em country. Yes, I I understand that I get asked that question a great deal I would say there are there are other countries that would be probably contenders, at least based on economic development before China.

Give us some examples, well, the most obvious or South Korea and Taiwan, which are actually quite developed economies, relatively wealthy economies. There are some restrictions with changing money and with investor identification that has caused them to stay in emerging markets, but in terms of overall capital market development and economic development, they're probably the leading contenders. You would think South Korea is much closer to a Japan like

economy than a China like economy. Well, China has come a long way. China has industrialized very successfully, and China is no longer a low wage country. It's actually a medium wage country. So it's not nearly as wealthy as South Korea or Taiwan on a per capita basis, but it's moved up quickly. One of the appeals of emerging markets are that within this equity half of your portfolio, they're not completely correlated with either developed markets or the

US as a particular example. But that raises the question how correlated or uncorrelated are emerging markets with the U S stock market? Well, the correlations have increased. There's no question that when the US market has big movements, we have a lot of interlinked risks around the world that cause these markets to be much more correlated than they

used to be. Over time, there are big differences between the performance of the emerging markets and the US market, But on a short term basis, the correlations are pretty high. So let's talk about those performance um metri. You look at the trailing ten years, uh, and now we're so it takes us back still through the financial crisis, US markets have done very well, emerging markets not so much.

There seem to be signs that that's changing. Now, tell us your thoughts on on the performance issue and how long these cycles last. They seem to alternate a little bit, don't they. It's hard to tell how long they last. I mean, they seem to be often seven to ten year periods that we see this. Your absolutely right, emerging

markets has underperformed the US over the last ten years. UM. I think the biggest reason for that is that we've been through a strong period where deflationary pressure has dominated markets, and the emerging markets are just more economically sensitive than the US. You know, if you think about the technology sector French, big big area. In the US, there is actually quite a big technology sector in emerging markets as well, But you have a lot of industries that are very

economy sensitive. So in that in that last decade period, that economic sensitivity has worked against the returns in emerging markets. What about the dollar I I used to think, and I'm changing my view someone on this. I used to think of emerging markets as heavily commodity dependent and therefore heavily dollar dependent. Is that still the case? And how significant is the dollar to emerging markets performance? Well, the commodity areas like energy materials are today relatively small parts

of emerging markets, around fifteen percent of our universe. How does that compare to say, years ago, well even ten years ago it was over Really that's a big change. So it's a big change. It tends to fluctuate over periods of time. Um, But I what what I would say is that emerging markets as a whole are just more dependent on economic growth than the developed world, and so when when the world has difficulties with economic growth,

emerging markets tend to be negatively affected by it. So that's an interesting contrast because I usually think of everybody dependent on economic growth. When we have a recession, people tend to spend less, less employments, profits are affected, It affects markets. But what you're really saying is more nuanced emerging markets are much more sensitive to the state of the economy than Europe, of the US, or even Japan for that matter. Is that is that a fair assessment?

I think that's fair. I think the the clear enemies of emerging market equities are negative real economic growth and or crises. So we've seen over the past year or two the US dollar we can fairly dramatically after a huge seven or nine you run and when we look at performance of emerging markets versus Europe versus US, they seem to have just edged out uh those areas on a nominal basis. But for a US investor in dollars, they had a booming year last year because of the

weakness of the dollar. How significant is the currency not to the exports of commodities, but to the net performance of e M two investors in the US well, emerging market equities tend to have a natural negative correlation to the dollar and week dollar strong EM week dollars strong EM strong dollar week E MUH. That is, that is a strong correlation, and indeed emerging markets tend to have

quite a strong correlation with commodity prices. Let's talk a little bit about some of these varied UH differences between emerging market countries in different parts of the world. When I think about e M, I tend to think about Asia and South America, and to a lesser degree UH Southern Europe places like Turkey. Um, how different are all these regions. One would imagine those three places are very, very different economically and in terms of their markets. There

is tremendous variety across emerging markets. In Asia you have large technology sectors, for instance, whereas you have a lot more of a focus on commodities in parts of Latin America and in parts of Eastern Europe like Russia or South Africa. So very different countries, very different political systems, tremendous variety. So when I think about different parts of the world, I think of the US as fully or even richly valued, Europe a little less richly valued. Emerging

markets relatively cheap compared to the other two. How do you come up with valuation metrics for different parts of the world when there's such different economies. If you're if you're looking at China or Russia, or you're looking at Brazil or Argentina. Can you apply the same sort of metrics. What do you have to develop different tools for different economies? Well,

I would, I would agree with you. I actually come at this from the perspective of thinking there are no cheap asset classes today relative to their own history, but emerging markets are relatively cheap to develop markets and to the US market. From where I stand and uh, we approach our analysis by focusing on stocks stocks that look

inexpensively valued and relatively profitable. We do a lot of accounting analysis because we have around seventy analysts at Lazard who are involved at looking at all types of different strategies, and we make adjustments for accounting distortions where relevant, and then we look forward towards the fundamentals for their businesses and we then see according to the valuations if we

think the stocks are inexpensively priced or not. And then at the end of our process will discount for certain risks that include things like political risk and macroeconomic risk and even governance risk. So so last year in the United States, I think we could fairly safely say we had one of the most politically unstable or certainly politically volatile years we've seen, and yet the stock market was utterly placid. It was very confounding to a lot of people.

Although history tells us politics and investing don't don't matter that much in the United States. Can you apply that same rule abroad or do you have genuine risk that a government gets destabilized there are capital controls that come in and suddenly the investment thesis for that country is

much more challenging than it was earlier. It's a very good question, because I also was surprised last year in the US that the market did not seem to be affected by the noise, the political noise and the economic noise out there in the world as a whole and in the US. UM. I think it varies on situations, but certainly there are political effects that we see in

emerging markets. A very good example right now is in South Africa, where um a new leader of the African National Congress, so Ramiphos, has come into power and where there seemed to be sizeable changes of what politically that are causing some quite big changes with the currency and with the market in that country. What about um some of the other countries where we've seen some either diplomatic or geopolitical issues. You mentioned Russia is Russia and investible country.

We believe it is. It certainly is a place where you have to take into account political risk because it can have big, big effects on certain corporations, and there's some degree of judgment in how we look at that. UM. It's also a place where we tend to see risks associated with governance in some companies. So those are big, big factors in Russia, but we do think that there's reasonable protection in most companies in Russia. What about India?

We talked about China earlier, and you mentioned Indian passing a giant country by population, a big technology center. What are we to make of India's perennial sense of being on the verge of of great things happening and then nothing seems to really gain any traction. Well, I think India is very exciting right now. You've got a prime minister in Mr Modi who doesn't really have to answer to anyone. Even the leaders of his own party were not in favor of him being prime minister. He appears

to be very, very courageous. Ah, he's willing to do things like um, removing the largest denominations of currencies and making big, big changes in the civil service. So um, what what is exciting is he's he's tackling the bureaucracy of that country, knowing that there's a huge young population with I think about a million people going into the workforce every month, and he needs to prepare that country for UM a much more developed type of economic system.

What are the country is sort of underappreciated or overlooked in the world of m Well, of course, I mean every country has its own issues. I mean India, for instance, is actually I wouldn't say a terribly inexpensive market. We do find opportunities there, but it in general is not

an inexpensive market. Um. The areas that that we think are are relatively underappreciated include Russia, include some stocks in Brazil, Turkey, Indonesia for instance, UM and and to some degree South Africa right now, but again we find opportunities in many many markets across the emerging markets. Let's let's talk a little bit about putting those seventy analysts to work in

the emerging market space. How important is to have the I know it's a cliche, but how important is it to physically be located in some of these countries and see firsthand what's going on. I think it's vital two

go and see activities in all of these countries. I don't think it's necessary to actually be there all the time, but I think it's very very critical to travel to get updates, to see what's changing in these markets on a very very regular basis, because if you're not seeing it fairly regularly, you're perhaps not understanding opportunities or risks that are coming up in these markets. So you're racking up a million frequent flyer miles a year or you more New York based, Uh, not a million, but a

good portion of that. And pretty much all of our analysts are traveling heavily around the emerging market world to see opportunities on an ongoing basis. So let's talk a little bit about market efficiency. You know, there's only so much any of us can do to beat large cap US stocks. It seems a ton of information is known, there are no real advantages to picking this company over that, or so it seems in the US. Do you have that same level of market efficiency in emerging markets specifically,

is information is freely available? Are there advantages that can be had from your own analysis, in your own data gathering. How does EM differ from you know, the SMP five hundred in terms of potentially producing market beating results. Well, I think indexing is a perfectly viable, tactical, and often short term solution. UM. But one of the interesting things is that in emerging markets, over longer periods of time,

the median manager tends to beat the index. And so I think informational efficiency is less good in the emerging markets, and there aren't necessarily a huge amount of analysts in emerging markets. Overall, it's nothing like the US, and so actually going and understanding these companies and utilizing certain strategies for investing UM, I think can produce good results in comparison with the index over longer term periods of time. So, um,

it's a bit more work. I think one has to be creative, but I think one can construct portfolios using perhaps different investing methodologies and emerging markets that can provide a very strong performance in the long term. So, so let's talk about constructing those portfolios and discuss a little bit of of process. Um, you manage a team that's a lot of analysts, I assume a bunch of traders, a number of other support process and I'm guessing this

investment committee on the top of that whole pyramid. What is the process like thinking about creating a new portfolio making changes to existing portfolios? Tell us how you you think about these things? Well, the way we're uh organized at Lazard is that we actually have twelve different emerging market teams, anywhere from fixed income to currencies, to fund of funds to equities. We're almost like a collection of boutiques, and all the strategies are different. So in equities, for example,

we have four different equity strategies. We have a quantitative one, we have a relative value one, which is where I spend most of my time. We have a growth at a reasonable price one, and we have a core one. So a whole lot of different things. It's almost like a menu with four different um food plates, and people can decide, based upon their objectives, what they what type of journey they would like to go on. So that's GARP, quants,

relative value, and core and core. Is there a much overlap between them or by design, they're all very by design, they're quite different portfolios. The overlap is relatively limited, and they will produce different types of results for investors over time. And you mentioned fixed income. I'm under the impression that fixed income overseas is a little bit of a challenge, and fixed income in emerging markets is a very very different animal than what we used to here in the

United States. It is very different from the US um you really have a number of different fixed income areas in emerging markets. You have hard currency debt, which which has been a very very strong area. You have local currency that until recently has been relatively weak. Uh. And then you tend to get strategies that mix the two. And you also have quite a significant corporate debt universe

as well. And you reference currencies as a group. How significant does currency hedging become when you're investing in various countries or do you not bother with currency hedging and saying eventually it all evens out in the wash? In fixed income, currency hedging happens a significant amount. I would say inequities. UM, we can hedge currencies, in practice, we don't tend to do it that much. It's it's quite expensive and it's quite easy to get the time periods wrong.

We tend to embed it in our target prices UM by analyzing what risks we think the currency or macroeconomic factors in general might mean for the actual profitability of the company. So you could reduce your expected returns in a given space thinking currency is a risk factor for this area. Correct that that that's quite intriguing you. You also mentioned you have a relative valuation funds. Let's let's talk a little bit about relative valuation in the emerging

market space. How do you think of EM valuations? Is it always relative between countries? Are you looking at the group relative to developed uh nations? Or you mentioned earlier you can look at different asset classes relative to their own history. What do you do a little bit of everything In the way we invest, we tend to look at the actual stocks and their valuations, and in a relative value world, we tend to look at it relative

to the profitability of the companies. In a growth and a reasonable price type of strategy, we tend to look at valuations relative to earnings per share growth rates. UM As a whole, will will look at the universe and will compare the universe and emerging markets to develop markets. Today, the price earnings ratio of emerging markets as a whole is at about a thirty discount to that of developed markets. That's that's pretty substantial. Do you think those will eventually converge?

I think there's a good chance with the economic scenario we're seeing now accelerating growth around the world from a very low base. That's that's usually a positive thing for emerging markets, and we're anticipating the likelihood of increasing profitability for emerging market stocks relative to develop market stocks. If those things happen, I think we could see significantly lower discounts invaluation. So take me through your process a little bit,

because there are so many moving parts here. I'm trying to get a handle on what is the decision making process like when you're is it top down as it bottoms up? Is it both? Because I sort of hearing you guys are really more specifically stock pickers in each country as opposed to Hey, from a top down view, we think Asia is attractive, but maybe South America not so much, So our tilt goes that way or am I am I just getting that wrong? No, You're exactly right.

And most of our strategies are more bottom up than top down, so we tend to start by identifying what looked like compellingly attractive stocks. Evaluation almost always plays some

sort of role, as do fundamentals. In the relative value strategy that I'm most involved with, we are attracted to stocks that are inexpensively priced and have had pretty good profitability m We then look closely at their financial statements and footnotes to see if there are distortions that are caused by that, and adjust for any distortions that we

think are material. If the stock is still compellingly attractive, well, then look into the future into the next three or four years and try and forecast the fundamentals, particularly the profitability, and derive a price target for that, and if there's

enough upside then to go onto the last step. That's where we look at some of these other type of factors like macroeconomic and political risk and governance risk as well, very important for us, and discount for those and at the end of the day, see if we have upsides

that are competitive with what we already have in our portfolio. So, since valuation drive stock pickings to such a large degree, do you ever find yourself stepping back and looking at the overall portfolio and saying, I'm gonna make up a couple of countries. But gee, we have a lot of Turkey and Vietnam stocks and we have almost no stocks from Mexico or Thailand. I'm just making these things up.

But if valuation is a key driver, can you end up with sort of a lumpy distribution of stocks by country? You can end up with quite different exposures in different countries. Um, and uh, we don't have to invest in any given country, so you have no mandate that, hey, I want to percent across the board and no more than of this country. Well, we have limits on what we can have in a given country, so we can't have. UM. You know, I think it's very unlikely we're going to have positions in

five or six countries and nowhere else. That's that's really We've never had a situation like that. We've always pretty much been invested in something like fifteen countries and emerging markets sometimes but so so we haven't really had that issue. Um, but there are times when some countries are just not attractive for us and we'll have nothing there. We have been speaking with James Donald of Lazard Asset Management. If you enjoy this conversation, be showing and stick around for

the podcast. As trus will we keep the tape rolling and continue discussing all things emerging market. Be shure and check out my daily column on Bloomberg View dot com. You can follow me on Twitter at Ridolts. We love your comments, feed back, end suggestions right to us at m IB podcast at Bloomberg dot net. I'm Barry Hults. You're listening to Master's in Business on Bloomberg Radio. Welcome to the podcast, James, Thank you so much for doing this.

This is an area I find absolutely fascinating and in in my shop. In the beginning of Seen, we changed our tilts a little more aggressively towards e M from the US, and then we did it again. Uh. In the beginning of nothing huge, just a couple of percentage points here and there. But like you, we look at valuation and think that's a key determiner of of future returns. There's a bunch of questions on value. I didn't I

didn't get to that. I want to. I want to come back to but before I do that, I have to just talk about some numbers a little bit. So when we look at at the population of the emerging market countries, it's something like half of the global people, half the global population, but in terms of market cap it's tiny, it's it's ten. Are those two eventually going

to converge? Are we going to see a greater waiting of emerging markets or as these countries or as these countries mature, some of them are going to start to move into the developed nations side of the ledger. You'll

probably see a combination of those things. I would I would guess I think it's some stage, probably not in the immediate term, but you're going to see some of these countries like South Korea and Taiwan move into the developed world UM and uh An all likelihood, I think that will be more and more companies in emerging markets, and you'll see the growth of those markets as a percentage of total market capitalization. So South Korea, Taiwan, UM.

When I think of some of the more developed emerging market countries, Turkey, Vietnam, I always want to say Australia, but I know, I know they're not technically an emerging market country. Who is the next tier below South Korea and Taiwan. Israel is another name that comes Israel is actually it actually made the move a number of years ago into the developed world. Mexico is a possibility, UM and it's it's a reasonably well developed country and market,

so that that is a possible mover. How about anyone from South America? I think it probably will take a little longer, but Chili would be definitely the contender. I think there it's been pretty successful economy and a pretty successful market. That's intriguing. UM. And we talked about valuation and e M relative to history. UM. What emerging market countries do you think are uninvestable these days? Well, that's

something we look at very very regularly. We look at what sort of protection we think there is for investors. The best example of an uninvestable emerging market has really been Venezuela, which has had terrible, terrible problems, as you know, inflation, political instability to a large degree cause by politics and UM. In two thousand five, two thousand six, basically the government said it was going to buy a lot of the public relisted stocks and just give us a value they

thought made sense. There was no real protection for investors there so they deprivatize companies effectively, and we'll tell you what we think it's worth effectively. I gave us an arbitrary value for that. So really we felt that is that is the best example of an uninvestable country. What's it going to take for them to rehabilitate that image other than a full regime change? I think, I think a full regime change is the only is the only

thing that is going to change. I mean, I spent a lot of time in Venezuela in the early nineteen nineties, and they made a lot of progress. At one point, well, there were some there were some very very well run companies, and Pitavisa, the big oil company, was always known as a company that was that had experts and was well managed. But unfortunately quite a lot of that seems to have changed now. So now let's um let me change us

up a little bit. During the European crisis, we saw accusations that a number of countries that were considered part of the EU and considered developed nations really could have been on the emerging market side of of the line. And the example that comes up time and again is Greece. Was Greece really a full developed nation and was it comparable to its other European Union colleagues. Unfortunately, the situation

that has fallen Greece has been a tragedy. It was an emerging market country, then it joined the EU and essentially got a lot of EU fiscal aid and and low rates and infinite borrowing from Germany, and that has that has really compromised the economy and the indebtedness of

the country has gone up dramatically. It's now back in emerging markets and I would say we're waiting to see if the plans, the economic plans for Greece can rehabilitate the country, particularly the banks which have very, very high non performing loans. But if if the economic plans can work, then perhaps Greece can come back. It's a very sad story.

A lot of the companies that I've seen over years have have had terrible problems through this, and in many ways it might have been a better thing if Greece had never uh put the Euro as its kind of as its currency. I was in Greece two summers ago and I'm just struck by what a beautiful country that people are lovely, But you're getting a tourists eye view, not necessarily a economists eye view, and it feels like

a European country. It feels like a developed country. You just the apparently the financial infrastructure simply isn't there compared to the rest of Europe. Well, it had excellent banks in in the period in the ninety nineties, UM, some

very very well run banks. But when indebtedness increased enormously and wasn't really kept properly in the economic pitch in in the economic figures of the country, UM, it was a big negative surprise, and of course no one, no one wanted to be involved with the country at all. Now with hindsight, looking back, it seems absurd that banks in Greece and the government of Greece could borrow at the same rate as banks in France or Germany. But I guess that's the problem with too much easy money

that I think is the problem. So we we always used to talk about the pigs Portugal, Italy, Greece and Spain. Um, are any of those other southern European countries really at risk? For where should they these countries be placed? Should they be developed nations or or emerging markets? From what I understand with those four countries, they have worked pretty hard on mending their their fiscal situations, in their economic condition, and so I don't think they will be emerging markets

um those four. Portugal is probably the closest, but I think I think they've all done a lot of very important work in the last six or seven years. I mean, it's hard to imagine Italy as an emerging market given their history and everything else. And I was just in Spain in October and I can't say enough about how delightful everything from the food to the people. But again it's a tourist side view. You're not seeing the dark

underside um. And then let's talk a little bit about China, because that is such a fascinating growth story in such a fascinating country over the past three decades. What's the line in the sand where China crosses over from e M to developed. Well, I think there's some way yet

to get to that line. One of the big changes that's happening this year is that the main indices will all have China a share some mainland traded shares in China, and the capital markets in China are increasingly converging with global capital markets. We still have quite a lot of work to do on the on the debt side in China. But this A share inclusion in the MSc I index, I think is a major major event. So to to

put to explain that a little bit. If you are a non China residents, if you're overseas, you go to Hong Kong, you're buying B shares, not A shares. There isn't the same arbitrage situation that keeps them lined up. Sometimes you're paying a premium, you're not getting the same exact thing, the same exact rights. Is that going to go away and we're all going to be able to

buy A shares? Is that the expectation as long as you have an ability to do it through the connect system in Hong Kong, you could be able to buy Shanghai or Shenzen listed A shares in that market to a large degree within those indicries. And it's worth remembering the A share market is, you know, if you take the full market, is the second biggest stock market in terms of market capitalization in the world. So our B

share is going to go away. I'm not sure if they're going to go away, but possibly over time they will. So China has been growing well for a while. It was ten percent, twelve percent. Now we're in the seven percent. Not that that's too chevy. We're hoping to grow at three percent. In the US, we'd kill for seven percent. What happens to China's economy as they mature and what

does that mean for their share market? Well, it's easier for rudimentary economies to grow rapidly because there's a catch up process with the developed world, and so over the last thirty years or so, the growth is very impressive, but it's been naturally coming down because the catch up is less and less. You're starting from such a tiny bass, it's easy to grow. But now they're almost as larger

an economy as as the US, and some measures larger. Yeah, I think it's less big than the US, but it's it's been growing much faster, and it has the potential one day to be as big as the US. Um I think. You know. The interesting thing is that last year at the Chinese Party Congress UH they didn't actually come out with the target growth rate. It had been around six and a half percent. This all has a lot to do with s Jing Ping, the president, and

consolidation of his power. UM. But the fact that they haven't got a target growth rate I think is important because perhaps it takes pressure off Jing Ping and the and the leadership to some degree. I think there's also a wish in China to have better quality of growth and not just simply higher growth. Let's get into some of the details there that that's really interesting. How do you define better quality? How do they define better quality?

What are they looking to see from their economy going forward? What areas do they want to see more growth in, and what are they leaving behind? I think they probably mean better diversified growth. I think they probably mean more technology and more modern industries and not just the big industrial old style industries. UM. They've also indicated that they would like to see less financial leverage in the economy,

in the industrial sectors of the economy as well. Now, aren't most of the major financial centers and big banks there either somewhat or partly or fully state owned. If they want less leverage, can't they just dial back their leverage? It seems sort of odd to hear that said we want less leverage, Well, you guys are in charge of it. That is correct, But on the other hand, um China has changed a great deal in the last thirty years,

but there are still old style effects from the communist period. So, for instance, state owned enterprises companies that are wholly owned or are still majority controlled by the state or different government bodies in some cases, they have a constitutional right to bank capital. H and so one of the issues in China that has been concerning investors has been, particularly in the last six or seven years, when the economy has been slowing down, quite a lot of state owned

enterprises have been in demanding capital from the bank. So they have a right to access bank capital. But what about leverage ratio? Is what about interest rates? There are lots of dials and levers that the state can pull to say if you want capital, okay, but it's going to cost you fourteen or whatever. Well, the the state owned enterprises have actual rights to have the capital, often at lower rates, and so the the amount of control the banks have or even the politicians who are in

charge of the banks is limited. That's fascinating. And so this is a process which presumably will get deregulated over time, but it's just not there at this stage. So a couple of years ago. A giant story out of China was the ghost cities, that that China seemed to be anticipating the need for big urban centers, be it for manufacturing or service jobs, and they would put up these cities of ten, twenty thirty million people seemingly overnight, and there was a bit of a frenzy to buy into

those units. And then that story kind of faded from from the headlines. What's happening with those cities, what economic purpose do they serve? And is that a good or a bad thing for China's future. Urbanization is still at the core of Chinese political thinking. This is a ten year plan, This isn't just a short term may even be longer than ten years. Yes, there's still a massive movement of people from rural areas to the cities. There over a hundred cities apparently in China that have a

million people or more. You know, a midsized city in China is probably eight million people, like New York York City, right, it's been a big city is like Shanghaire bridging at twenty million people. And but but I think urbanization is a long term process, and half the country is in

farms or is it. Is it more or less than that? UM, it's it's probably a little bit more than half the country that still is in a rural setting, but opportunities UM economic opportunities are generally far greater in urban settings. That your opportunity to go to university, be educated much greater if you're in an urban UH location. And UM. I think the government is definitely continuing to think of urbanization UM as an ongoing primary policy, so that it

seems like it accomplishes a few things. That gets people out of the rural areas, off the farms, It leads to greater education of the population, and creates a fairly sophisticated workforce that can do some of these more modern industries that that the Chinese government is pushing people for. Is that Is that a fair I think that's fair. I think it's all part of the economic development program that the Chinese government would like to see. So we

barely think beyond a quarter or two. In the United States, they're making plans ten and twenty years out. That's a real challenge to compete with that, isn't it. I think emerging countries have to think in terms of decades for

their economic development. That's that is really the best way of of of looking at things, because again, they have the visibility because they can look at a country like the US and say, maybe we don't want to be exactly like what the US is, but we we can catch up in these various areas over the course of the next ten or fifteen years. So the infrastructure spend we've seen in China right now, we're recording this in the midst of an infrastructure debate in the United States.

They have been spending tens of billions, maybe even hundreds of billions of dollars on infrastructure build out. How important is that to the country. How much longer is that going to go on? Are they going to basically create the equivalent of what the US did post war for their own country? And why aren't we doing it? Which

is the rhetorical question. Afterwards, I would probably say they've already done that, because if you go to even midsize cities in China, you'll find a beautiful new airport, you'll find expressways and highways, You'll find in many places, very very good infrastructure. And they they believe that is necessary to attract companies to to set up factories or to set up potential for employment and uh and they've they've done that, and I think they are continuing to do

that as we look ahead. Maybe maybe we're not going to see big increases, but I think we're going to see ongoing spending. And they think that gives them an competitive advantage for both building attracting capital, building factories, building companies that become world class global competitors. And I think the evidence is there. I mean, China is today in many areas, the factory of the world. And and so that that build building of infrastructure has has attracted a

lot of big companies. Someone here should take a look at what they're doing, and perhaps we can have paved roads. Also. I remember when I could drive my far on the road and not worry about losing attire um anything we skipped anything. We I didn't mention that. You want to refer what any parts of the world or any countries

as well. I think I think India is worth mentioning at this point because according to I think the the leading plans in India, something like two thirds of all infrastructure spending is planned to be built in the next fourteen years in India. In India. Now, if you've been to India, I have not. Okay, India is is. Uh is quite a different situation to China. The infrastructure is generally um relatively old, although there's been quite a lot

of infrastructure building in the last fifteen years. I've seen photos of telephone poles with thousands of wires coming off of them, summer phones, sumer Internet. It looks like it's utterly jury rigged and cobbled together. Well, I am. The plan is to change that. The plan is to build something like two thirds of the total infrastructure of the country in the next fourteen or fifteen years. And uh

that is that is with the Modi government. So it's it's a very exciting time in India, and I think it's important to highlight it because it may have a significant effect on worldwide growth. Quite interesting. Let me jump to some of my favorite questions I ask all of my guests. Let's start with what is the most important thing that people who know you don't know about your background? Well, I when I was a student, I had quite a

lot of pretty basic jobs. I was a street cleaner in London for a summer, literally pushing the room, yes, which gave me a different perspective on the world. I think, Um, and uh, it was certainly quite an interesting I worked at a pulpam paper mill in northern British Columbia one summer, which was quite a tough job, to say the least. And I worked also in a in a warehouse for

a supermarket company, unpacking box cars. UM. I would say, these these things motivated me to want to have an office job and ultimately motivated me to move into the investment world where I could be mentally stimulated. Tell us about some of your mentors who helped push your career on long and affected your philosophy. Well, I've been fortunate. My father was an asset manager. It was a portfolio manager, um, and I never had pressure to go into this area,

but he was. He was certainly someone who understood the industry and was very helpful from that point of view. And I was fortunate later to get an opportunity to to work a little bit in the industry and and then I took various exams to see if I enjoyed it more so, that was one mentor I would say. When I was at SG Warburg and Mercury asset Management, Uh, several of my senior colleagues were truly investment people and

were tremendously good mentors to me. And this is an industry that always has its challenges and you have to know how to deal with those challenges. And they were they were they were very, very important to me. How about your philosophy, What investors affected the way you look at the world of investing or in general or emerging

markets in particular. Well, this probably sounds a little bit textbook, but I would say I very clearly understand the way Warren Buffett invests um by the way people people don't realize it's an actual legal obligation of the show for that to be the answer. It's it's you could do much worse. So well, I think he's probably one of the absolute best investors of all time. I also think John Templeton was one of again one of the greatest investors of all time. Very much a global investor and

UH and very fundamental in nature. And I think I really think they were probably the two names that I would put at the top of the list. Buffet for valuation, Templeton for global and and Templeton for evaluation as well. Really interesting Let's talk a little bit about some of your favorite books. This is everybody's favorite question. Tell us what you like to read. Give us some of your

favorite books, be the finance related or not, fiction or nonfiction. Well, I m I very much enjoyed recently reading a book on the Right Brothers by David McCulloch. I thought it was a very interesting book. I enjoyed um reading The Last Spike, which is a Canadian book all about the building of the Canadian Pacific Railroad and the Last Spike, the Last Spikes. It was the last spike in the railroad when they finished that off in the Rockies. And

uh so that's that's that's a bit of my Canadian background. Um. I still think The Prince by Machiavelli is a brilliant book and and tells you a lot about interacting in difficult situations and in a very very useful book. From that point of you, those are those are three winners. What has changed since you've entered the world of emerging markets? How is it different today than it was in the

early nineties. Our universe has changed dramatically. So again, back in the places like Malaysia and Mexico were huge parts of our universe. Portugal and Greece were part of our universe back then. Very big parts has come back in but it left for a while. Today China has become the really big weighted country, but Brazil and India are also very substantial. So the universe has changed, um and there's been quite a lot of sectoral change in it.

There's been a lot more constituents of our universe, which I think is very different from the US, where I think the number of stocks has actually fallen over the last say fifteen years. The joke is the Wilshire five thousand is about thirty, right. I mean. The other thing that's really changed is that information has ballooned. So years ago, going being being based in these markets was I think much more important, whereas today I don't think you have

to be based in the markets. I think you can go and travel regularly to the markets because the information is instant. Is that a competitive disadvantage? UM At one point in time where there wasn't a lot of information and now anyone can google it and come up with some some data. I think twenty or twenty five years ago, it it could have been seen as a disadvantage so you've told us about the recent shifts over the past

three decades. What do you expect the shifts to be in the emerging market space over the next three decades? Um it, Well, it's very hard to tell. I would imagine emerging markets will develop further and and we'll see some of the frontier countries joining the emerging markets. Vietnam, for inces, is a frontier country. Perhaps it will develop its capital markets to become an emerging market. We'll see. So that that's one thing. Um you know, some perhaps

shorter term changes. We've seen a market than the last seven years where growth has been the most successful style by a long way, and at some stage I would anticipate a change of leadership more towards value. True in the US as well, that it would probably be a global effect if it happened. I think there's a high

probability of that. I also think in the emerging markets in the last five or six years, markets have been quite affected in some way, in some cases dominated by macroeconomic factors, and I would guess that they'll become more idiosyncratic, more stock focused at some point in time. Tell us about a time you failed and what you learned from

it well. When I was at University UM many many years ago, I was very involved in student politics, and I was the speaker of the University Student Council, which was actually quite a serious operation. And uh, there was an election for president of the student Council, and I think I could have been a contender, and I could have even wanted and I I decided not to go into that race. And I and I've I've lived to regret it. We always seem to regret the things we

don't do as opposed to those that we do. Tell us what you do outside of the office to either relax or stay mentally or physically fit. What do you do for fun when you're not in a suit and tie? Well, when I can, I try and do a bit of exercise. Um, not not as much as I'd like to, but I do try and do some. I read quite a lot, Um, I quite enjoy some movies. I have a cottage up in Canada, so I uh go up there and and

traveling boats and and see friends in those places. And I, even though I travel a lot for work, I do travel for pleasure as well, and go and see historical sites and and you know, place like Rome, for instance, is a wonderful place to go with incredible, incredible history, no doubt about that. Where in Canada do you have at a cottage? And what lakes are you voting? It's um in Lake Huron. It's a part of Lake Huron

called Georgian Bay in the eastern part of Kuran. And it's of course a very very big lake, and it's it's remote, very difficult to get to, and but but it's very calming place. I go fishing every summer in Maine, and we're so far north that we start to get Bell Canada showing up on there. But it's a flight in and then a floatplane and really it's just a d It's not just a hundred miles away from anywhere,

it's it's a hundred years away from anyway. Yeah. Yeah, it's very remote where I go, and and actually quite hard to get to. What sort of advice would you give to a millennial or someone just beginning their career, who were who was interested uh in getting into emerging markets or asset management or or finance. Well, this is something we have to be concerned about because there are

lots of millennials now working with us and UH. Sometimes they have different priorities from from from the way we are. But I I would say, first of all, you can combine your business interests and and other interests, your personal interests in what we do. Obviously, the type of work we do can become challenging, but you can do other things. For instance, I'm involved heavily in a charity which is makes grants to about seventy grantees around the emerging market world.

I'm involved in an educational foundation UM, and those are those are things that are very very important to me. UM. I would also encourage millennials to think long term. The asset managiment business is a long term business, particularly the long only part of it, and you can't really be evaluated properly if you're not going to be long term in in your focus. UM. Finally, I would say, learn how to evaluate yourself, learn how to two criticize yourself

in a positive framework constructive criticism UM, and UM. Understand what you do well and what you do badly. And our final question, what is it that you know about investing in emerging markets today that you wish you knew thirty years ago? Well, I I would say the great thing about investing in general, but certainly in emerging markets. It's very stimulating, it's always challenging, it's not easy. You

are always learning. Very important. You have a plan, you have a process, and I think to be in this business you have to know how to take pain, how to take pain because anyone doing what we do active investment management is going to go through challenging periods of time and you have to be mentally strong to go through that. Quite fascinating. We have been speaking with James

Donald of Lizard Asset Management. If you enjoyed this conversation, be sure and look up an Inch or down an Inch on Apple iTunes, Overcast, Bloomberg dot com, or wherever finer podcasts are sold. We love your comments, feedback and suggestions right to us at m IB podcast at Bloomberg dot net. I would be remiss if I did not thank the crack staff that helps us put together this conversation each week. Medina Parwana is my producer and audio engineer.

Taylor Riggs is our booker producer. Mike Batnick is our head of research. Attica val Bronn is our business manager. I'm Barry Reholts. You're listening to Masters in Business on Bloomberg Radio. You take take out INT