BR Research recently met the top management of Tundra Fonder - a Swedish mutual fund investing in frontier markets including Pakistan. Tundra's CEO Jon Scheiber, its co-founder and partner, Johan Elmquist and Shamoon Tariq, portfolio manager and partner, attended the meeting. Below are edited transcripts.
BR Research: What attracted you to Pakistan?
Johan: What we, all the founders of Tundra, have in common is that we have a very long track record with emerging markets. Mattias Martinsson, who runs the Frontier Fund and Pakistan Fund, came to Pakistan in 2008. At that time he was running a hedge fund. When he went back, he couldn't find an ETF or get any exposure to the Pakistani market. Later on, when the idea of Tundra surfaced, he said the precondition to going forward is having a dedicated Pakistan Fund.
We visited Pakistan in 2011 and met CEOs and owners. We didn't have a license, didn't have any money. The analyst travelling with us told me it has been six months since any foreign investor came to Pakistan. So, back in 2011, we were pretty alone here. We came here because of the potential Mattias saw and as of now, we have six people on the ground here and $135 million in the dedicated Pakistan fund. We have 40,000 Swedish retail investors investing in the Pakistan fund. We started with our own money - it was less than $1 million.
Jon: There is a strong culture among Swedish retail investors to have an interest in new emerging markets, which started with investing in Russia in mid-1990s up until the recent crisis. There is a lot of perception and hope that these new emerging markets, including Pakistan, could become a new Russia story.
Our total assets under management across our six funds are around $215 million. From that, the dedicated Pakistan fund is the largest - about $135 million. If you include Pakistan's share in our sustainable fund, our total investment in the country crosses $150 million.
One of the interesting things is that analyst coverage in Pakistan and in markets like Vietnam, Sri Lanka and some African countries is very limited compared to traditional emerging markets and developed markets. There are very few sell-side analysts covering each stock. It's actually a good thing because it provides a lot of opportunities for people early on the ground. You can find those hidden gems.
BRR: What are some of your most preferred sectors here?
Shamoon: Primarily, there is a tilt towards the consumerism story given the rising income per capita and recovering macro economic situation in the country. That's true in all the frontier markets. Then there is infrastructure (and power) sectors with CPEC coming in - where out of $46 billion, $35 billion will be in the power sector. We are here for the long-run, so we are banking on the sectors that will aid the middle class the most. The main themes that we think we should play on are consumerism and infrastructure.
BRR: Outside of a few stocks, most consumer stocks are very ill-floated - there is limited supply. As far as CPEC is concerned, what makes you guys so confident on the CPEC when there is so little that we know about it?
Shamoon: Consumer stocks include healthcare, beverages, FMCGs among other things. So that gives us around 20 stocks. Illiquidity is not an issue for us when we say we are long-term investors, we are not liquidating our portfolios in the next couple of years.
In terms of CPEC, there is a paradigm shift - there is a thing that would happen around the globe and you can't change that. Just to give you a perspective, everyone is shifting their businesses to Vietnam because the cost of production is one-third that of China. So, even if the Planning Commission does not disclose its cards about CPEC, we still know that Gwadar is strategic. They are creating a 2500 km road because there is economic benefit to China. We know that given the geopolitical situation of the region, China has to look for options here.
Jon: Also, a lot of the new emerging markets including Pakistan are following the same macroeconomic dynamics that we have seen in the big countries over the past two decades. Pakistan is still behind, but it is coming up in a big way. And we never see countries develop without the development of its infrastructure. There will be hiccups; that's natural, but in the long term we are very bullish.
BRR: Recent data shows that there has been a consistent outflow of foreign investment from Pakistan in the last few months. What is your take on that?
Jon: This is a global trend we are seeing at the moment. People don't want to own volatility - they are afraid of the first Fed rate hike. There is a global de-risking phase. People in Europe do not want risk; they want alternative investments - safe and secure returns. That is the mood at the moment, which can shift very quickly - it can take days, it can take months.
BRR: Do you think that frontier markets or Pakistan in particular, has priced in the US interest rate hike speculation yet, or will we see that happening in the near future?
Jon: The general view of Pakistani market outside is that people haven't invested much here, and that is why it trades at very attractive multiples. Go across the border to India, and the market trades at 18-20x earnings and has, to some extent, the same dynamics as Pakistan - of course it's a bigger economy and a bigger population. With similar dynamics driving this economy, Pakistani market trades at only 8.5-9x. So there is very little room for (further) discount here.
BRR: Since you are pretty optimistic about Pakistan, why not open a local AMC here?
Jon: If and when a right opportunity arises, for instance, finding a good partner to work with - that is when we would definitely consider it.
BRR: If things go well, KSE will launch a SME counter in 6-7 months. Would the firms listed on that counter fall under your 'finding gems' theme?
Shamoon: There are already nearly 600 companies listed on the KSE and we know that only a fraction trade actively. It's about investors being comfortable trading in these sorts of stocks. At KSE, we have good knowledge about the top 50 companies, but for the remaining ones, we don't even know what the management is doing. That said transparency is good for companies. If they want higher valuations, they need to open up more.
BRR: There are different models of financing. The Anglo-Saxon model is tilted towards raising money from capital markets, while the Northern European style dictates more institutional investments. In Pakistan as well, the percentage of financing raised from the stock market is way low. What's your take on it?
Johan: The problem is that valuations are too low. In order for an entrepreneur to be attracted to the market, you need to get a decent price for the company. The market is not paying good enough and that's why we see only a few IPOs. For this, the market needs to attract more money.
In Russia, we saw more than 30 IPOs in a good year. It's all about valuations. When the valuation is high, you can attract a lot of capital, and now, when the valuation is very low, there are no IPOs. I would link it a hundred percent to the valuations. The market is too cheap.
Three years down the line, Pakistan will see the valuation gap shrink against India, where the valuation is more than a hundred percent higher compared to Pakistan.
BRR: Tell us about your sustainable fund?
Jon: We launched a new fund in August this year, called the Tundra Sustainable Frontier Fund. This is a global frontier market fund, investing in many frontier markets, including Pakistan. We have seen a shift in sentiment, particularly among institutional investors in US and Europe - a rapidly rising demand for ESG or sustainable investments that incorporates environment, social aspects and corporate governance.
Such products are outgrowing the demand for traditional investment products. We think, if the European investors are to invest here, they will demand similar ESG products. So far the demand for sustainability financial products in Europe has been primarily within the institutional segment. But that's gradually shifting as the young population is growing up and investing more. Young population is much keener to express their views through their investments.
The current size of this fund is $12 million. But sustainability is going to go mainstream and at some point, all asset managers will have to incorporate this aspect. The world's largest mutual fund manager, Black Rock, believes the sustainability front is not a niche; it is something integrated in all their products.
BRR: How many Pakistani firms do you have in that sustainable fund?
Jon: We screened 80-90 companies for the sustainability fund and around one-third or quarter belong to Pakistan. The criterion was strict so there were a handful of companies that did not qualify. There are two camps; some companies have very high standards (in terms of ESG), and some have no clue.
The investment process for this new sustainable product incorporates two different components - traditional financial analysis, the discounted cash flow models etc, and research on the sustainability front. One way is to look at the turnover. If turnover from tobacco, alcohol, pornography and gambling exceeds a certain ratio - five or ten percent depending on the sector, we don't invest. That's a quantitative screening method that we use.
The second aspect is that we exclude companies that have had breaches of the UN Global Compact. There can be instances of child labour, slavery and so on. We don't just exclude these companies; we first start a dialogue with them that we like your business model and would like to invest but cannot accept these violations. We highlight some aspects where changes are needed for us to invest.
BRR: What are you views on the economy? Around the same time next year, we have IMF repayments. Then there are Paris Club repayments. The CSF flows may start drying out whereas Sukuk and Eurobond repayments will also form a queue around the same time.
Shamoon: The quality of FX reserves is really questionable - I would see it as a threat. But at the same time, the oil price slump, which resulted in $6-7 billion annual saving, has helped. Last year, at the same time, our current account deficit was $1.9 billion; right now it is $532 million. We have actually saved $1.4 billion. The balance-of-payment risk is mitigated by the lower oil prices and lower imports.
At the same time, our textile segment hasn't performed well. Low cotton prices, recession in European Union and the emergence of Vietnam have affected us. If you look at Vietnam, it has signed three free trade agreements, with Russia, EU and now with TPP. For exports, they have a 17 percent tax rebate. We have strong competition in textile exports, and don't see our companies being able to compete with them.
Foreign companies would rather prefer buying from Vietnam rather than Pakistan because of quality and perception. So, we have to come up with different strategies - good quality standards and better lobbying perhaps. There is certainly a BoP risk that for now has been mitigated by the low oil prices.
If you look at the last ten years, earnings growth in Pakistan - in dollar terms - has beaten every country in the world. And in that period, we had army rule, terrorism, energy crisis, five years of bad governance - basically the worst case scenario has already happened. That is the sort of figure no one mentions.
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