Indirect Plays on Emerging Markets

McDevitt: Anne is the portfolio manager on PIMCO Pathfinder. Anne has been with the fund since April of 2010, but before that you were, of course, with Mutual Series for a number of years.

I want to jump right in and just ask you a few questions about your portfolio and your positioning. One of the things I find interesting is you don’t have a lot of direct emerging-markets exposure in the portfolio, but it seems like you do have a fair number of indirect plays. Could you talk about some of the ways you are getting that indirect exposure to emerging markets?

Gudefin: It’s correct. We prefer to have indirect plays because we are value investors; we have strict value criteria, so we tend to find more value in some of the multinationals listed in the developed world, and we also care about corporate governance, and corporate governance is definitely better in the developed world.

So, for instance the way we play emerging market is through a company listed in Copenhagen, Denmark, called Carlsberg. They have over 50% of their earnings just coming from Russia, and 10%-plus also coming from Asia. But if we focus on Russia, they own Baltika, which is the main brewer in Russia, and the good thing about having a brewer in Russia is that you benefit directly from what the government is trying to do. You have a major problem in Russia in the sense of demographics. The population is declining, and one big reason for that is life expectancy is declining, especially for men. It went from 65 to 55 years. Why? Because people are drinking too much vodka, so the government is taxing very heavily vodka, which has benefit impact on the consumption of beer, and you know that’s a simple idea, but it works, and that’s what we like in the fund.

McDevitt: And ... there are other companies out there too that are getting ... a large percentage of their revenues from emerging markets. Are there any other examples along those lines?

Gudefin: Sure there are a plenty of them. We own a company like Danone ... 100% of their products are healthy, and they also have 50% of their EBIT coming from emerging markets, Russia, China and so on. There are plenty of [others]. We own Pernod Ricard, which is major beneficiary of consumption of Scotch whiskey and cognac in China for instance.

McDevitt: One of the things I think sets your fund apart and is very different about your approach is, in addition to just owning equities, you also will own distressed debt in your fund, and you also have taken advantage of merger arbitrage in the past. And with M&A activity picking up in recent months, recent quarters, I am wondering if you've found more merger-arbitration opportunities out there, and if you may give a few examples of those.

Gudefin: You know what we like about merger arbitrage is that we can have equity-like returns but with a much lower level of correlation to the overall equity market, so it improves the overall picture of the fund.

Having said that, the way we practice merger arbitrage is a very conservative manner, because we only participate in the announced deals, and we don't use leverage.

I would give you sort of a recent example of what we own. We have been a shareholder of Pride for a long time, because we thought the company would be taken over and a bid from Ensco came, and we looked at it and we thought that it was an attractive risk-reward, because the deal was going to be completed, and we could get an attractive return. Then we looked at the new company, Ensco, and thought it was a very cheap company, trading at less than 9 times P/E on next year earnings. It's a 2.6% dividend yield, and it's going to be one of the positions we're going to hold on to, because we think there is more upside. And that's quite representative of the way we invest.

McDevitt: Another good example of that, and I think you've mentioned before, you have very much of a deep value contrarian approach. You opened a position in BP last summer, almost exactly a year ago, June 2010. If you could maybe walk through what your thought process was then when you're buying BP, and what you felt like you were seeing that the market was not appreciating?

Gudefin: We bought BP in the second quarter, especially in June, not over the summer, because then the stock had started to rebound. But what we really liked about BP is that the US assets were valued at about $100 billion, and at one stage the market cap destruction on BP was $100 billion. So really what the market was assuming is that Obama was going to be [like] Chavez and would nationalise all the assets of BP and give nothing to BP in compensation. So we thought it was overdone.

That's very representative of the contrarian style we have and that's the reason why we were among the courageous investors probably who could buy BP. We have a long-term investment horizon when we're making investments, so we saw that either BP would get a new CEO who would sort out the situation, or someone in the industry would come and bid for BP, because it would not be much cheaper to buy the BP assets than to drill for some new oil.

McDevitt: One interesting thing about that, though--that was very much of a deep-value contrarian play. A parallel to that could be the tragedy that we’ve had recently in Japan. And after that happened--and this is, of course, outside of the tragedy itself--you had a lot of value-oriented managers saying that they found Japan very attractive, that they felt the market had overreacted to the disaster in terms of the economics of the situation.

But it seems like you have not been adding to Japan. Why is that? Why are you not finding opportunities there?

Gudefin: I said we’re long-term investors, but in Japan it’s even more long-term; you’re talking 10 years, and we're probably not that patient to see changes happening.

The other thing about Japan is that, you have many companies where you have a lot of cash, a lot of real estate .... You think, wow, that’s a fantastic investment, but what happened is a lot of management destroyed value by reinvesting the cash in nonprofitable manners. So you have your NAV coming down, not the stock price moving up. And historically, we've found more value, for instance, in countries like South Korea. One investment I made recently is a South Korean company called GS Home Shopping. Over 70% of the market cap is in cash, so you’re paying less than three times for earnings that are growing, and I think that you have more likelihood of some corporate changes over the coming years, and I think it’s a better option.

McDevitt: OK. Last question is, I have to ask about GLD, and I know you have very much of a bottom-up stock-picking process. But I thought it was interesting to see GLD at the top of your holdings list. What’s your rationale, what’s your thesis behind owning GLD?

Gudefin: Well, the reason why we like gold is that we look at supply-demand. And you look at supply: Basically, the production coming out of mines is about the same as 10 years ago. What you're seeing is you have sustained industrial demand, demand coming also from the jewellery sector. You know that in countries in India, it's a traditional form of savings.

China is catching up quite quickly on that. You look at gold consumption in China for the last 10 years, it has increased by about 15% per annum. And historically central banks have been big sellers of gold, but this has inversed and now you see central banks, most notably central banks from emerging markets being buyers of gold. So, think it's a favourable outlook. And on top of that, you look at the balance sheet of a number of countries, especially in the developed world, that are extending, and we think gold could be a really good investment in that kind of environment as well.

McDevitt: It's somewhat ironic, because I think a lot of the central banks were sellers in early 2000s, weren't they? At least I think, perhaps, in Britain and the US, they were sellers at that time.

Gudefin: Well, you have many people who sell assets when they are very cheap and that's what we like looking at--trying to be on the other side of the equation.

McDevitt: Right. In terms of buying GLD directly, I'm curious if you have had any interest in the mining stocks, as well?

Gudefin: Well, we could be looking at mining stocks, but I think it would fall more into the category of investments where we see a number of catalysts happening. You might have gold mines, especially in South Africa, that have a discount owing to the country, but if we would break up the company, then it could be more interesting because you could have the value being realised for shareholders, so that would be sort of the angle. But keep in mind that historically, the correlation between the price of a commodity and the price of the corresponding stocks have not been very high, and that's the reason why we prefer the commodity.

McDevitt: OK, excellent. Anne, thank you so much for your time.

Gudefin: Thank you Kevin for having me.