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Base Case, Upside and Downside
AMG Trilogy Emerging Markets Equity Fund
Interview with: Pablo Salas

Author: Ticker Magazine
Last Update: Nov 14, 12:44 PM EST
A broader global perspective and a highly experienced team are among the key differentiators at the AMG Trilogy Emerging Markets Equity fund. Portfolio manager Pablo Salas navigates the seas of emerging markets relying on a bottom-up approach, fundamental research, quant screens, and macro trend analysis. With risk management embedded in the process of security selection, the fund aims to invest in sustainable growth companies at a reasonable price.

“We quantify the potential downside risk at the company level and we come up with a pessimistic case scenario and price target. So, when we select the stocks, we don’t just look for better upside potential, but we evaluate the potential upside return relative to the downside risk.”
Q: Would you give us some background information on the fund?

A: We’re primarily an institutional firm; we manage money for large institutions and this fund is one of our vehicles.

I have been running the emerging market strategy with my own team since 1997. My background has been in the industry, including commercial banking in the mid 80's to the early 90's, which were the early days of emerging market debt. Then I moved to the equity side as an analyst at Principal Financial Group. In 1994, I was offered an opportunity with Lazard Freres to start the first emerging market institutional equity product as part of a team of portfolio managers.

In 1997, I started my own firm with partners, which merged with Trilogy in 2005. Ever since 1997, the strategy has been managed in the same way, with the same team, with me being the primary decision maker. So the strategy has a track record of more than 20 years.

Q: What is the mission of the fund? How does it differ from its peers?

A: Our goal is to find and invest in companies with the ability to generate attractive return on capital and above average growth. We screen the companies on a sector basis and we would invest in any sector if we find the right company.

A main differentiator of our firm is the global view and understanding. We believe that even in emerging markets, the world is moving towards companies and industries competing globally against major players. Even in primarily domestic industries, such as banks, the understanding of how the industry works globally is important.

Our process is primarily bottom-up, although the team includes people with strong track record in macro risk management and top-down views. Bill Sterling is our CIO and he founded Trilogy in 1999. He has a PHD in Economics and has worked on macroeconomic analysis his entire career. He works closely with our bottom-up analysts to incorporate any potential macro risks into the analysis of specific companies. So, we assess the downside risk in the particular companies, which could be affected by the top-down macro views.

Q: When investing in emerging markets, what are the main opportunities and challenges?

A: The main driver of opportunity is the concept of catching up with the developed economies and establishing systems and institutions. As the emerging economies catch up, the potential for higher wealth rates is created, because incomes and productivity increase as companies and markets become more efficient. In some cases, the economies become more productive because they are managed in a new way.

The other driver is rooted in the very sizable market opportunities. Some of the emerging market economies have the largest potential markets due to the size of their population. Obviously, the two markets that represent this opportunity are China and India. There are high rates of economic growth, as the economies have become more efficient and the companies have become more competitive globally. That also creates strong employment. As a result, significant part of the population has more income, and that creates opportunities.

The challenge is the lack of track record for many of the companies and the managements. In some cases, the governments are less stable. Although on a macro level they are trending towards the developed markets, they can be still volatile and with high inflation.

Sometimes leverage issues could impose a challenge. In some countries, the disclosure may not be as transparent as in the developed world. Another issue is corporate governance, because the managements don’t have experience in dealing with public shareholders and tend to prioritize the interest of the minority controlling shareholder groups. These are some of the natural challenges in the emerging markets class.

Q: What is your investment philosophy?

A: The two key elements of our philosophy are growth and valuation. First, we look for companies that can sustain attractive earnings growth. Second, the valuation has to be right in terms of upside potential relative to downside risk. That’s why our philosophy can be summarized as growth at a reasonable price, or GARP.

We believe that earnings growth is a key driver of potential stock returns. In our experience, the companies able to sustain above-average earnings growth, also have the ability to deliver attractive stock returns. Our process is structured to identify such companies.

The other GARP component, reasonable price, requires valuation and risk management. We aim to quantify risk at the individual security level, so we analyze what can go wrong and what the key risks are for each company that we own. If some of those risks materialize or turn out to be worse than expected, what would it mean for the business? What would be the impact on margins, ratings, growth, and profitability, if their competitors become more aggressive on pricing, for example?

We quantify the potential downside risk at the company level and we come up with a pessimistic case scenario and price target. So, when we select the stocks, we don’t just look for better upside potential, but we evaluate the potential upside return relative to the downside risk.

Q: How does this philosophy translate into your investment strategy and process?

A: The first step of the process is to narrow down the universe of potentially thousands of companies. We use quantitative screens to look for companies that meet specific criteria to be identified as GARP. These criteria include the company’s track record in return on equity, earnings growth, relative growth, cash generation etc. We also screen for certain metrics on the valuation side.

The other approach is our day-to-day qualitative fundamental work. We have an investment team of about 20 people, including 13 bottom-up analysts, with plenty of experience in their respective industries. Each year we conduct over 1,000 meetings with company managements all over the world, because we also run a global equity fund.

We have accumulated substantial experience in identifying and comparing companies with attractive business characteristics that are good at executing cost control, utilizing technology, etc., or companies that are poised to deliver strong earnings growth in the medium term.

So, using quantitative screening and qualitative work, we narrow down a universe of 5,000 investable companies to about 200 companies. That group of about 200 companies is the working pool of ideas for the next level, which is the due-diligence, or the fundamental analysis of the companies.

Q: What key characteristics do you look for when screening the investable universe? Could you share some examples of your quant screens?

A: As a starting point, we eliminate the companies with excessive leverage on the balance sheet, or companies with more than 60% of debt-to-capital ratio. Of course, that refers to the non-financial companies, because the threshold is different for financial companies.

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Sources: Data collected by 123jump.com and Ticker.com from company press releases, filings and corporate websites. Market data: BATS Exchange. Inc