Q1 2016 Newsletter: Seafarer's Story
The following is an excerpt from our Q1 2016 Newsletter. Below is the story of how and why we added Seafarer Overseas Growth & Income Fund to our portfolios.
The Picture of Dorian Gray is a late-19th century novel by Oscar Wilde. Dorian pledges his soul to stay forever young, rich, and beautiful. In his stead, his portrait bears the burden of age and bad behavior. After each wicked exploit, the portrait turns more grotesque. As you might expect, the story does not end well for Dorian.
Naturally, Dorian Gray came up in a discussion about emerging market currencies (the connection is obvious right?!). Andrew Foster, founder and portfolio manager of Seafarer Funds, was explaining to us his outlook when impromptu he launched into Dorian Gray.
The analogy – emerging market (EM) countries’ manipulation of exchange rates (e.g. China) to prop up their economies – is beside the point. The story symbolizes how Seafarer stands out.
Wind in Their Sails
As discussed in previous newsletters, EM stocks have been a pain point. EM is a small but important part of our portfolios. Over the long-term, we expect that EM stocks will provide strong returns amid high volatility. The past few years, our clients have experienced the latter and not much of the former.
Late last year, we reevaluated our EM strategy. Seafarer first crossed our radar a year ago due to its brief but impressive track record.
While it’s necessary to see evidence of skill, investors generally overemphasize past performance. Studies show that a dart-thrower would do better with recently underperforming funds than outperforming. Mean reversion is a fundamental law of investing that few escape.
Thus, strong past performance is a prerequisite but not sufficient. What caused outperformance? How replicable was it? Does the fund take concentrated risks or stay diversified? How are fund flows? What is the manager’s style – does he predict macro themes, focus on metrics, or evaluate individual companies?
The more we communicated with Seafarer, the more confidence we gained. Seafarer’s managers are undeniably, overwhelmingly smart. They have a deep understanding of EM investing and are serious and forthright about the risks. And as with most upper echelon managers, they leave you so impressed as to be uneasy: your impulse is to handover your last dime.
In our last newsletter, we outlined some of the fund’s characteristics that we liked: bottom-up security analysis, low fees, small asset base, and a concentrated portfolio. But due diligence goes beyond metrics. Our visit to Seafarer’s Larkspur headquarters hammered home our conviction.
An Impressively Unimpressive Setting
Many fund managers want to be seen as masters of the universe. Their offices usually have the downtown location, sweeping views, and fancy artwork to match.
Seafarer’s HQ is refreshing. Seafarer resides in a 3-story, non-descript office park in a quaint Bay-side town. There was no receptionist, flat screen TVs, or abstract paintings.
The humble setting is symbolic. Seafarer is one of the lowest fee active emerging markets managers available even though it is relatively small (firms usually lower fees as they grow).
On a variety of humdrum but important issues, Seafarer demonstrates an investor-friendly culture. It is important to see this mindset at the firm’s onset. Fund managers may pay lip service to investor issues and later blink when choosing between themselves or investors.
Intrinsic to investor friendliness is firm ownership. A publicly-owned firm owes allegiance to its shareholders. It can talk all day about putting clients first, but shareholder profit is the priority. A privately-owned firm is better able to resist short-term profits pressure.
After the grand tour, which didn’t require any walking because the whole office is visible from the middle of the room, we moved to the (very nice) conference room and learned Seafarer’s backstory.
Foster was previously the Chief Investment Officer at Matthews Asia Funds in San Francisco, where he oversaw $12 billion in assets. He has spent his whole career immersed in Asia’s development and was early to invest in China’s late 90s/early 00s ascendance.
After years of explosive growth, in 2009 Foster foresaw a Chinese structural slowdown. China could not continue growing at the same breakneck clip. China’s rise had dominated his career, so he started rethinking his future.
Foster had never invested outside of Asia. He spent his last years at Matthews researching a general EM strategy (see opposite table for non-Asia EM regions). Had Matthews been open to such a fund and/or had Matthews had an employee-owned culture (Seafarer does), then Foster would likely still be there. Instead, he left in 2011 to launch Seafarer.
A startup is an unusual move for a portfolio manager, especially for one without millions from investors queued up. Ironically for people that pride themselves on risk taking, investment managers are often by nature risk-averse. By and large, they follow a rigorous but predictable path from prestigious university to banking/analyst/consulting gig to graduate school to pedigreed investment shop where they manage millions from day one.
Granted, Foster had made enough money that the choice was Seafarer or spending his days sailing (hence “Seafarer” i.e. the life foregone). Still, he chose an uncertain path with administrative, marketing, and regulatory headaches and low expectations.
Incentives make the investing world go round. Studies show that managers’ personal investment correlates with strong performing funds. Foster has over $1 million invested in his fund. His wife, Michelle, is Seafarer’s co-founder and President. And, as a fellow small business, it gives us added confidence that Seafarer is more than a job for Foster.
Focus on the Small Picture
Managers who tell big picture stories – e.g. global commodities demand is going to be X, so invest in A, B, and C – tempt investors. They make sense of the chaotic world and give the impression that their finger is on its pulse.
Foster is not one of those managers. Ask him about which way the global winds are blowing or about unifying themes behind his success, and he punts. He and his team focus on what they know best: analyzing companies.
Seafarer’s mission is straightforward: it finds healthy companies with reasonable valuations, and then holds them until it can buy a better company. Determining which companies fit that mandate is extremely difficult. Still, we believe in that goal’s achievability more than forecasting global trends and deciding which countries, currencies, or industries to move into or out of.
Seafarer invests in China, India, Brazil, and Poland. But it would prefer to discuss its Chinese medical supplier, Indian IT consulting firm, Brazilian aluminum wheel manufacturer, and Polish bank.
Just as we do with you, fund managers communicate quarterly with investors. Many write newsletters, others publish Powerpoint slides, and some do conference calls. The broad themes are the same: provide a high-level asset class overview, highlight good moves, rationalize bad ones, and project conviction in the future.
Seafarer’s communications cover similar territory, but they are distinctly nuanced and unassuming. We encourage everyone to visit Seafarer’s website and watch one of the Quarterly Briefing videos. It’s hard to put a finger on it, but watching Foster rather than simply reading him delivers great insight.
Foster’s essays are equally poignant. After years of underperformance, Foster recently addressed mounting arguments against EM investing. While his main point was the need for investors to embrace EM dysfunction, he confessed his own doubts about EM investing and conceded some points to critics. He is also blunt with his errors (“My prediction was terribly wrong”) and with what he doesn’t know.
What May Rock the Boat
No investment comes without risks, and no manager is above nitpicking.
Foster’s business plan called for $225 million under management by early 2016. In April 2015, Seafarer had $147 million. Today, it has about eight times that. Foster’s goal is to have $5 billion under management, and he expresses no desire to balloon beyond that.
For one, it will be interesting to see how Seafarer deploys this gush of capital. Second, we are curious to see if it will be easier for him to outperform with a small fund than a large one. Smaller funds concentrate a manager’s best ideas. And some of Foster’s best ideas have been in small companies, which are harder for a larger fund to invest in effectively.
We are also curious that Foster has transitioned a growing percentage of the fund out of Asia. Much of Seafarer’s outperformance since inception has come through its Asian investments, which makes sense considering Foster’s background.
And, as with any EM manager, we’ll be watching how Foster manages the effect of fluctuating exchange rates. EM currency volatility can overwhelm companies’ bottom lines. Foster has built a currency forecasting model (this is his one attempt at macro forecasting), but he admits that it lead him astray last year.
Diversification is core to our investment philosophy. As a result, our portfolios hold a variety of funds that can seem like a mishmash of ideas.
Still, there are unifying themes. Relaying the story behind Seafarer is meant to demonstrate one: our firm and our funds must be philosophically aligned. Verifying that alignment requires comfort in the firm and manager and that we evaluate factors beyond performance.