Aberdeen Emerging Markets Fund - Aberdeen Asset Management

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Aberdeen Emerging Markets Fund - Aberdeen Asset Management

Aberdeen Emerging Markets FundTable of contentsSectionPageInvestment philosophy and process................................................................................................................... 2Competitive advantage ...................................................................................................................................... 6Page 1 of 6


Aberdeen Emerging Markets FundINVESTMENT PHILOSOPHY AND PROCESSInvestment philosophyWe believe, given the inefficiency of markets, that superior long-term returns are achieved by identifyinggood quality stocks at a reasonable price and holding for the long term. Sound fundamentals drive stockprices over time. We identify good companies from first-hand research, and add value from activemanagement, which constitutes intensive and ongoing scrutiny at the company level.We hold absolute return to be more important over the long term than index-relative. We do not see indicesas providing meaningful guidance to the prospects of a company or its inherent worth. Neither marketcapitalisation nor index membership is a guarantee of quality either. As such, we do not use indices as astarting point for building a portfolio, preferring to rely on common sense checks and the principles ofdiversification. We are comfortable taking decisive positions away from the benchmark, underpinned byconvictions from proprietary analysis. We do not equate risk with divergence from benchmark, but ratherwith investing in companies that do not deliver.Investment processWe follow a bottom-up process based on a disciplined evaluation of companies through direct visits. Stockselection is the major source of alpha. No stock is bought without our managers having first metmanagement, and detailed notes then written. We estimate a company’s worth in two stages, quality thenprice. Quality is defined in reference to management, business focus, balance sheet and corporategovernance. Price is calculated relative to key financial ratios, market, peer group and business prospects.Top-down factors are secondary in portfolio construction, with diversification rather than formal controlsguiding geographical and sector weights. Aberdeen portfolios are generally conservatively run, with anemphasis on traditional buy-and-hold, with top-slicing/topping up preferred to outright trades, resulting inlow turnover. Typically they have higher return on equity/assets and lower debt to equity than marketaverage.Portfolios are managed on a team basis, with investment managers doing their own research and analysis.Desks operate independently but each has a model portfolio that contains its best ideas, and forms the basisfor portfolios, be they retail or institutional. All ideas are shared via formal committees and commondatabases, with desk heads and the CIO enforcing consistency across the Group.Page 2 of 6


Aberdeen Emerging Markets FundInvestment process diagramCompany visit noteRisk controlsStep 1 Step 2 Step 3QualityAberdeenuniversePricePortfolioconstruction• Use model portfolio• Filter for mandatePass or fail?c400 stocksCheap orexpensive?• Refine weightings• Compliance checksPotentialrevisitWatchlist/reviewc160 stocksMonitorResearchAberdeen does not employ separate research analysts. Instead, our investment managers combine the role ofanalyst with that of portfolio manager. Each member of the team has sector and portfolio responsibilitiessuch as day-to-day monitoring of liquidity. (Note that managers do not take investment decisionsunilaterally). The overall result of this matrix approach is a high degree of cross-coverage, leading to adeeper understanding of our holdings.Ninety percent of research is in-house, rather than externally generated. The objective is to control and avoidunnecessary risks at the security level. Quality earnings growth and market liquidity provide the upside. Ourlimited use of external research, principally received from both local and global brokers, is at the initial stageof our investment process when we are identifying which companies we wish to research more fully, andoccasionally as an additional source of information and comparison to our own analysis. We never rely onbroker research when making an investment decision.Our contention is that one of the most effective ways of protecting against downside risk is to know yourcounterpart, and therefore we have a strict rule of never investing in a company without having first met itsmanagement. We aim to visit companies in our core portfolios at least once a year, and in practice oftentwice, while those on our Watch/Revisit list are visited at least once annually.Investment universeOur theoretical universe is all listed stocks within Emerging Markets since we do not have any limits interms of market capitalization or any other rigid filters that automatically exclude certain stocks. In practiceit is very much smaller; after having visited the vast majority of the stocks in the MSCI Emerging Marketsuniverse over the past decade, we have eliminated a vast proportion. Typically stocks have been excluded forPage 3 of 6


Aberdeen Emerging Markets Fundreasons of size, business quality or ownership (e.g. too small a float or because of political links). Our‘working’ universe today is around 400 stocks.Stock selectionOur stock selection process contains two filters:Primary filter: “Quality”When filtering for quality, we look at the following:i. Core franchiseii.iii.iv.Recurring earnings growth from the underlying core business, excluding extraordinary earningsQuality of management team (at both the policy making and executive level)Strong balance sheet (clarity and transparency)v. Past treatment of minority shareholdersThe purpose of the above is ask whether the company is a business that has good growth prospects and hasthe balance sheet to support expansion, and whether it is run in the interests of all shareholders.Secondary filter: “Price”Companies that pass the ‘quality’ filter are then assessed for value by reference to standard financial ratios.We also estimate the value of a company relative to its market price and to valuations of similar companieswithin a relevant universe (which may be within a single country, or if appropriate, regional or even global inscope) to ascertain if downside risk is sufficiently reflected at prevailing price levels. One of the keydisciplines in our process is to avoid over-paying. Given our long-term approach, we can be patient.Portfolio constructionPortfolios are constructed to maximise their level of exposure to the most attractive companies filtered fromthe stock selection process. We run a representative or ‘model’ unconstrained portfolio that contains around50-60 stocks at any one time. Each new stock is the subject of a company note which gets discussed at biweeklymeeting to decide whether it is suitable, quality and valuations are the main criteria.Buy and sell disciplineWe introduce new stocks to the portfolio infrequently. This reflects low annual turnover and our rigorousselection criteria. Usually stocks that pass our selection criteria will be put on our Watchlist, which containsaround 5-10 names at any one time; an actual purchase will typically follow a re-visit.Any deterioration in outlook will cause us to review a company, if necessary by revisiting management.Instances of dishonesty or fraud are immediate grounds for selling (but thankfully rare). More often thetrigger is a change of personnel, loss of business direction or competition. We do not make any decisionsbased only on market forecast earnings and often in cases of downward revisions we take the long view anduse a price dip as an opportunity to top up. On the upside we typically ‘topslice’ a stock in stages once wefeel its valuation has become stretched, and will only sell the outstanding stake at the third or fourth go.Page 4 of 6


Aberdeen Emerging Markets FundRisk managementThe main risk to us is of buying a poor quality company or one that is over-priced. We therefore seek toknow our holdings thoroughly, being careful not to overpay. We view stock risk in absolute terms.Traditional diversification is the key means to control market risk.Page 5 of 6


Aberdeen Emerging Markets FundCOMPETITIVE ADVANTAGEOur competitive advantage derives mainly from the consistency of our approach, and the disciplines that weadhere to, irrespective of market conditions. We are active stockpickers and therefore good stock selection isthe main driver of alpha, along with tactical top-slicing/adding on weakness within a basic buy-and-holdstrategy.We always visit a company before investing. If we don’t like a stock, we won’t invest in it – irrespective ofindex weight.We try to differentiate ourselves by exploiting the advantages we have at the margin: i.e., better research,more cross-coverage, a culture that prefers teams to individuals (we don’t believe in ‘star managers’), andthe experience among our senior members of working for many years together, which gives us theconfidence to take a long-term view. In terms of investment process our approach begins with a few basicrules: never invest in stocks we haven't visited; never feel obliged to buy a stock because it appears weshould (for reasons of size or perceived value as a market proxy, say).What we strive to achieve, furthermore, is intellectual consistency. So we avoid businesses we don'tunderstand or ones with discriminatory shareholder structures. Working from these precepts, stocks becomealmost self-selecting (provided we have done the essential investigative work). The more difficult decision ishow much to pay. Here we place little value in ephemeral events or market 'noise' and more on factors thatwill ensure we can add value in a demonstrable and consistent way over time. In short, we focus on what wecan know, and have built our investment process around that.Please note that the information in this document may be subject to change. This document, in part, describes some of the procedures and systems ofinternal management and control of Aberdeen Asset Managers Limited (AAML) that were in place at the time of writing. These are constantly underreview, and therefore future systems of management and control within AAML may differ from those set out in this document. Opinions rendered onany particular economic scenario are solely opinions and not meant to be construed as fact. Consequently, although this document is provided in goodfaith, it is not intended to create any legal liability on the part of AAML, and does not in any way vary the terms of any relevant investmentmanagement agreement. The statements contained in this paragraph do not affect AAML's obligation to its customers under the rules of the FSPage 6 of 6

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