A: Comparative analysis is only useful to a point. For instance, in the case of cement, it’s useful in trying to understand the import-export flows between countries because then there could be price arbitrages. We see if those can be arbitraged out practically or not, are there infrastructure constraints, transport costs, etc. And we’ll look at comparative costs of production and efficiency.

Q:  How do you go about building your portfolio?

A: We want companies that have rising operating leverage in our portfolio. Often, when we take a thorough look at the total portfolio, we might spot commonalities among the companies. Once the commonality is identified, we might look for opportunities with similar characteristics. For example, we have a lot of life insurance stocks. We started with Chinese companies when we bought Ping An, about two years ago. At that time half of their enterprise value (EV) of the company was under water, because they had sold policies at a time when interest rates were much higher.

Our research revealed the incremental yield they were getting was much higher than their bulk deposit yield. That negative EV part of the portfolio had a tipping point which was roughly 150 basis points above where the prevailing deposit rate was at that time. But the marginal rate they were getting was clearly much higher than that.

In our estimation the stock looked cheap to us so we bought it. We also started looking at other life insurers around the region. In addition to looking at the ones in China, such as China Life, we also look at the ones in Taiwan, Korea and India. In fact, we own nearly all the players in India.

Q:  How many stocks do you have in your portfolio?

A: When I took charge of the whole fund last April, it had 150 holdings in the portfolio. Since then the number has fallen down to about 81 holdings. I want to be able to invest down the market cap scale because many new sectors in Asia tend to be not capital intensive, service industries, and they tend to start as relatively small cap or mid cap companies. Also, I prefer not to own more than 10% of companies.

We believe that the sweet spot of Asian markets is in the $1 billion to $4 billion cap companies. We also have, for the highest conviction holdings, position sizes as much as 4%.

Regarding sector weights - Asia is a region of companies with hyper-growth and although tiny in the index, China and India are the fastest growing economies and that’s where we find most of our opportunities. Therefore, in our portfolio, we have roughly 66% in China and India. Korea is a third of the index but is much less significant to us, so we only have 16% of the portfolio there. The situation in Taiwan is very similar - where it’s 15% of the index, we have 8%. We have no investment in technology companies in the portfolio across all regions of Asia.

Q:  What is your buy and sell discipline?

A: We try to find a company where the return on capital is increasing. A company may have a reasonable earnings progression, its price-to-earnings ratio may be reasonable relative to its growth; but if there’s not a lot of operating leverage left, and the returns are stabilizing, we generally will not buy it. We prefer to buy companies where the return trajectory is rising because most analysts including our own will tend to underestimate earnings.

A classic example of this phenomenon is Bharti Telecom, a mobile telecom company in India that we had owned since it was an $800 million company and which we just sold. We bought the stock when its price was between 23 and 29 rupees. The stock trades above 800 rupees.

The company’s core strategy is to keep pushing the mobile phone penetration curve, even if it resulted in lower average revenue per user (ARPU) because their marginal costs were falling faster than marginal revenue. This is because electronics components fall in price and as the company gets bigger they can negotiate lower prices, and benefit from massive economies of scale.

Unfortunately, in India the environment is quite inflationary because of material shortages that can result in price surges. So if one-third of the equipment equation is still deflating marginally, and two-thirds of other costs are inflating, then at best, we have an equation where the marginal cost is stabilizing, while marginal revenue is still falling, which means that marginal return is actually falling.

We suspected that the company’s quality of service has been declining partially because they have been under-spending. At best, they can keep marginal costs flat. Since they were moving from high penetration urban India to semi-urban and rural areas, where the density of customers is a lot lower, the loading on the equipment and asset utilization are going to be lower because there are fewer people per square mile. So although penetration is still going up and earnings are still good for this company, at the margin, the returns are starting to decline. Consequently, the stock has stopped moving. Even when we had an all-time high in terms of net new subscribers, the stock didn’t respond anymore to good incremental news.

Q:  What is your view of risk and how do you control it?

A: If our risks are measured against the benchmark, from time to time we know we are going to have a soft period, like if tech stocks outperform or if the dollar rallies, so there’s that risk given significant deviations from the benchmark.

The other kind is specific company risk, especially if we own a large stake in a company. That is a risk in any bottom-up portfolio. We try to mitigate those risks by knowing our companies well.