Thorough Research of Emerging Markets
American Beacon Emerging Markets Fund
emerging markets > >
Aug 13, 2010
52 Week HL
76.31 - $56.81
May 15, 2008
Q: Could you start with a brief overview of the company?
A : American Beacon Advisors, a wholly-owned subsidiary of AMR Corporation, was founded in 1986 to give investment advisory services to institutional and retail markets. In addition to offering a variety of mutual funds, the company also offers services of corporate cash management and separate account management. The company also manages the American Beacon Funds, a series of low-cost, no-load mutual funds open to institutional and individual investors apart from retirement accounts such as IRAs.
All the various mutual funds, including the Emerging Market Fund, are sub-advisor managed. The Emerging Market Fund was started in 2000.
Q: How many sub-advisors does the Emerging Markets Fund have?
A : We have two sub-advisors: The Boston Company Asset Management LLC and Morgan Stanley Investment Management Inc. The total assets under management as of March 31, 2010 were about $140 million.
Q: What is the investment objective in this fund?
A : The investment objective of the American Beacon Emerging Markets Fund is long-term capital appreciation, primarily from investments in emerging market stocks.
Q: When you say emerging markets, which are the countries that you actually take into consideration?
A : We take into account all the markets recognized as emerging markets in the MSCI Emerging Market Index for this fund. We benchmark ourselves against that index as well as the Lipper Emerging Markets Index.
Q: How about those growing countries that are not covered by this index?
A : We also follow the MSCI Frontier Market Index, which covers 26 countries. We allow our managers to invest up to 5% of the assets allocated to them in these markets.
Q: How do you select your managers?
A : Since we do not run the assets ourselves, we approach the selection of our managers with great precision. The current managers have managed the fund since its inception nearly 10 years ago.
It is not as if we are always looking for some new managers to replace the existing ones because, after we have selected these two, we will look for replacement only if we have a concern with the manager’s investment process, portfolio management team or the long-term performance. If assets get increased to a certain level, we may start looking for a third manager.
Every manager in the mutual fund field says that they select undervalued securities with growth catalysts. So, we utilize a model in house to determine, on an on-going basis, whether the sub-advisor is selecting attractively valued stocks with above-average growth prospects. We use this metric to assess our sub-advisors and make sure that they are still doing what we expect them to do.
In this way, by design, we select at the very basic level sub-advisors with similar goals. How they arrive at these goals eventually is left entirely to them, but we monitor their progress all along the way.
Q: Could you explain the selection process in more detail?
A : As part of our selection of managers, we focus on the three ‘P’ criteria, which are: performance, people and process.
While looking at performance, we screen managers based on their long-term track record. We look for such firms that have better than median results from their portfolios in either the latest five-year period and three-year period.
Once we have identified such managers, we look for two further requirements, which brings us to the second P, people or team. The manager must have a team that was responsible for their past performance and also have incentives in place for motivation and retention of such teams. Since we look for long-term managers we expect to see a succession plan in place for junior personnel taking over higher responsibilities in case of retirements.
Finally, the third factor that we seek to identify is the third P, or process. We spend a lot of time in getting to understand the process of the manager in constructing their portfolio that is a good fit with our objective as described earlier. When we determine that the manager’s investment process is a good fit for us, we continue to monitor their process after they are hired to insure there are no changes.
Q: What kind of securities do you generally look at in emerging markets?
A : The fund’s sub-advisors pursue equity securities of issuers that are primarily listed on the trading market of an emerging market country; are headquartered in an emerging market country; or derive at least half of their revenues from operations in an emerging market country. The fund’s investments may include common stocks, preferred stocks, securities convertible into common stocks, and depositary receipts.
Q: Do you have any guidelines for investments?
A : American Beacon provides each sub-advisor with a limit of the maximum investment allowed in each emerging market country, sector, industry, and individual stock. Within those guidelines, each sub-advisor makes stock selection decisions based on their economic, market and company analyses.
All of them select stocks that in their opinion have above-average earnings growth potential and are also selling at a discount to their market value. Even though the end goal is the same each one has their own proprietary assessment model using a combination of internal and external research along with analysis of changing economic trends.
Q: Are there any major differences in the stock selection process of your two managers?
A : Apart from having a value style of investing, each manager follows their own investment style. In the case of The Boston Company, they look at their selection process in the form of three circles. The first circle is what they term as valuation circle, or a circle which has in it all those names that are the cheapest 40% on the multiples of earnings and book value.
The second circle consists of names with good business momentum, reflected in characteristics such as increasing sales, increasing EBITDA margins, and increasing profits.
The third circle has names with strong fundamentals. As part of this, they look at debt coverage ratios, debts in the balance sheet, assets, depreciation and such balance sheet items that will give them an idea about debt refinancing requirements.
So, if some of the stocks are common to all three circles, they buy those if they are available at a discount to the market price. Essentially, this manager has a bottom-up stock selection process with a lot of research preceding the selection.
The other manager, Morgan Stanley, combines a top-down country allocation approach with bottom-up stock selection. The top-down analysis focuses on countries with improving fundamentals and attractive valuation. Security analysis is a blend of growth and value, as the focus is on companies with attractive growth characteristics at reasonable valuations.
Q: How do you keep a tab on the manager’s performance?
A : The managers are required to send us monthly reports summarizing the performance of the portfolio, attribution commentary, discussions on the market and economic conditions, and the additions and deletions of names, if any, in the portfolio. We collect such reports every month and meet with each manager in our office every quarter to discuss the performance for the quarter in detail.
We also look at the weightings by country, sector, and industry to see if they are within guideline limits. Additionally, we look at the ratios like P/E, price-to-book, price-to-cash flow, dividend yields, market cap in the portfolio, turnover in the portfolio and commission paid for the period.
As mentioned earlier, we review our in-house model, also referred to as equilibrium time analysis or qualitative analysis, which is completed every quarter and is unique to our fund. In this analysis, we arrange the stocks in four quadrants formed by P/E ratio as X-axis, and growth rate as Y-axis. We would want the vast majority of the stocks in the portfolio to be located in the upper northwest quadrant, which is the quadrant with stocks that are selling at a discount to its home market or industry and has a growth rate higher than its home country or its sector. We have been following this analysis for quite a number of years both in the company and with the manager.
Consequently, stocks that are not attractively priced with above-average growth prospects are identified and discussed with the manager at the quarterly meeting.
Q: How do you allocate assets to your managers?
A : Ideally, we would like to allocate assets equally to all our managers. We believe in all of them and expect them to deliver to the best of their ability. But, we definitely cannot say which one of them will perform better in the next quarter or the next year. Therefore, allocation depends mostly on the capacity of the manager.
Q: By having two managers in your investment process, what risk parameters are you taking out at a broader level?
A : We think value is inherently a risk control versus growth. We also mitigate the risk of underperformance by having multiple managers since they typically do not underperform at the same time.
In addition to that, we have risk controls in place for each of the sub-advisors. Once these firms are hired, we provide an identical set of guidelines to each of them in addition to what is in the prospectus. These guidelines further limit them in terms of security, industry, and sector allocations.
Q: How do these guidelines control sectors and individual weights in the fund?
A : Generally, the maximum exposure to any sector is 30%, 15% for any industry and 5% for any one name.
Q: What other advantage do you find in a multiple-manager approach?
A : We are able to offer more capacity and our funds tend to remain open longer because of the employment of multiple managers.
Q: Who should typically invest in this fund and what are your own views on this segment of market?
A : Anyone looking for long-term capital appreciation should pay attention to this fund. Except for the muted performance of emerging markets in the 1990s, it has been a segment with real growth and it will continue to be so in the near term.