- Direct EM plays increasingly the preferred vehicle to play the emerging market story.
- Still, try to be as close as possible to either the operating asset or the controlling shareholder.
- 'Sort of' arbitrage opportunities in select plays.
For several weeks now I have been advocating that long-term investors should seriously look at emerging markets again. A few years ago, when EM were all the rage, I believed that a better way to play them was generally through key developed market companies whose valuations did not reflect their exposure to higher growth emerging markets. As EM equities have generally been significant laggards in recent years, compelling long-term entry points have emerged.
I have recently argued that EM should always be an integral part of diversified global equity portfolios. Their current meaningful valuation discount simply implies that global investors who do not yet have direct EM exposure should use current market levels to participate in the outstanding long-term potential of the emerging world.
I plan to continue evaluating and unveiling what I believe to be particularly intriguing opportunities in coming months. Today I want to focus on certain 'arbitrage' opportunities. Alright, I am using the term quite loosely, as the ideas I will discuss do not really constitute pure arbitrage by any means. However, they do generally entail ways to get access to certain assets in what I perceive to be more attractive ways than through alternative listed equities. A general principle I have traditionally followed is to be as close to the operating assets as possible. Holding company structures and other complex approaches that controlling shareholders use to own certain assets often result in more than one way for smaller shareholders to buy access to a particular operating company.
The further a 'minority' investor is to the way the controlling shareholder owns a certain operating asset, the higher the risk of conflicts of interest getting in the way of the average (minority) shareholder deriving comparable benefits from the operating asset's cash flows.
Corporate governance issues create additional challenges for minority shareholders (I use the term minority investor to refer to what most of us are when we buy listed equity in a company where there is a control group or individual which owns the majority of the voting stock). Thus, whenever possible, I like to own the same class of stock that controlling shareholders prefer. This is obviously often difficult if not impossible. Alternatively, I try to purchase the stock that gets me as close as possible to the operating asset. All that said, there are times or situations where specific conditions or compelling entry points motivate me to deviate from these general preferences.
In this note I will discuss several pairs of securities where I have a preference for one over the other. It is by no means a recommendation for pair trades (I would not advocate a long position in one at the expense of the other, and thus in fact quite far from arbitrage opportunities). Rather, they are generally cases where I like a certain operating asset, and would prefer to gain access to it through one alternative over the other. Still, because I like the operating asset, for individuals who want to gain exposure to it and cannot for some reason buy one of the securities in the pair, I would still advocate the long-term purchase of the less preferred of the pair. In other words, it is just a matter of preferring one versus the other, but both being long-term desirable.
I have already recommended BABA as a key component of a Chinese Internet basket. Yahoo is an additional way to gain exposure to the asset. The US Internet company will spin off its BABA holdings. When one subtracts the value of YHOO's holdings in BABA and Yahoo Japan, one is getting the US operating asset either at a very low valuation or free. Some more optimistic analysts argue that an investor buying YHOO now is actually being paid for taking on the US asset!
This is a particularly tricky one. Long-term, one is probably better off being closer to the controlling shareholders and thus owning the more global asset, BUD. I currently own only BUD, and have long advocated that investors gain access to ABEV through its parent company. However, Brazil is so out of favor and the outperformance of BUD has been such that one can currently buy ABEV at a rare discount to BUD. ABEV obviously is the more direct EM play.
Google Inc Class A (NASDAQ:GOOGL) and Google Inc Class C (NASDAQ:GOOG)
This is a somewhat different situation, and more of a corporate governance issue. Here, my clear long (as well as intermediate and short) term preference is for GOOGL over GOOG. GOOGL is one of my top picks for 2015. In the interest of full disclosure, while I have long liked the Google story, at the time of the 'stock dividend' in which similar to a stock split shareholders got one GOOG and one GOOGL share for each share of Google they owned, I sold all my GOOG shares in order to subsequently replace them only with GOOGL.
Those of you more familiar with my work know that corporate governance and culture are very important to me. Google is one of the exceptions that proves the rule, and I very much like the story as a whole despite the fact that I hate its corporate governance. The GOOG/GOOGL split was a particularly reproachable action. Still, while I do not approve of their corporate governance practices, I understand the controlling shareholders' motivation and reasoning. Moreover, I trust their vision and capabilities enough to be willing to sacrifice voting rights to them. Still the GOOG/GOOGL split went a bit too far, and I wanted no part of the GOOG class of stock (preferring GOOGL instead).