Manager views

James Morton travels the world to find the
upside in troubled companies

Many portfolio managers invest in brand-name companies trading on major indexes. James Morton takes another approach. As the manager of the Mackenzie Cundill Recovery Fund, he travels the world - from Russia to Germany and China – looking for companies that are recovering from a crisis. And the global recession has produced no shortage of potential companies to invest in. As the story and chart below illustrate, it’s a strategy that has produced solid returns over time.

When Mackenzie Cundill Recovery Fund was launched in October 1998, the markets had collapsed in the wake of the Asian currency sell-off that toppled banks and pushed countries to the edge of bankruptcy. The landscape was strewn with wrecked companies, but to James Morton, manager of the new fund (with a mandate to buy companies emerging from a crisis) the landscape was actually littered with opportunity. Today, Morton is again travelling the world looking for companies that are recovering from the financial crisis. So far, the fiscal health of many of the companies in the fund has been improving – sometimes dramatically. The fund was up 60.3% in 2009. “Although the markets were dreadful at times last year,” recalls Morton. “It turned out to be a once-in-a-lifetime opportunity.”

While a few well-known multinationals are now held in the Recovery Fund, one strategy unique to the fund still dominates, and that is Morton’s ability to invest in regions and companies where investors would normally fear to tread – countries like Russia and Ukraine, where political winds can change abruptly. In fact, he made one of his biggest gains in 2009 investing in Sibir PLC a small Russian oil producer, that was bought out by the country’s energy giant Gazprom. And at the depth of the financial crisis in February 2009 Morton also met in Moscow with officials from Sberbank RF, the country’s largest bank, which operates a vast branch network. He invested in the bank, tripled his investment and then sold – albeit too soon. “It was too tempting not to take a profit,” says Morton. “That is the risk with value investing. You tend to get in early and get out too soon, leaving quite a bit on the table. But we’ve been booking profits and reinvesting in cheaper securities than the ones we sold.”

With Cundill Recovery 35% in cash last winter, Morton decided to re-enter the markets just as they lifted off into a 10-month rally – one of the longest in history. Morton’s mandate is find battered companies with turnaround potential. Whereas in the Asian currency sell-off, many of his investments were in financial companies located in that region, the latest financial tsunami was international in scope, leaving few companies, sectors or countries untouched. And while many companies in the Recovery Fund are small to mid-size, with a market capitalization of less than a $1 billion, the crisis allowed Morton to cast his net globally for companies, including blue-chip multinationals that had fallen into the Recovery Fund’s unique mandate.

And, Germany, where the fund holds a number of firms with a global reach, now has an 11.9% weighting in the fund. “This is a first for the Recovery Fund,” says Morton. “We’re finding cheap companies in Germany, which is showing the first signs of coming out of the recession. The country should outperform.”

The extent of the crisis also allowed Morton, who also manages Mackenzie Cundill Emerging Markets Value Class, to position the Recovery Fund in front of a potential global economic recovery. For example, at close to 9%, the fund now has a high weighting in building and construction materials, something it has never had before. The sector collapsed in the months leading up to the financial crisis, but with governments around the world continuing to spend massively on infrastructure, Morton believes it will inevitably bounce back. Among others in the group, he purchased Germany’s HeidelbergCement AG, one of the world’s leading producers of building materials, and Praktiker Bau-und Heimwerkerm, a German building products retailer operating in eight European countries. “We should see a recovery in share prices in the building materials sector some time in 2010 and 2011 as the stimulus packages and infrastructure-related activity kick in,” predicts Morton. “We’ve already started to see that in China.”

The financial crisis that leveled economies in the West, combined with continuing strength in large emerging markets like China, have also presented Morton with a unique arbitrage opportunity. For example, Morton bought German vehicle manufacturer Volkswagen, which was battered along with the rest of the auto-manufacturing sector. Morton believes it will do well, in part because almost 100% of the company’s 2009 profits were generated by sales in China, with more to come in the future. So in effect, adds Morton, “You’ve got a mature market leader in Germany’s Volkswagen paired with emerging market growth in China.”

Still, finding new deep-value names has become more difficult with the almost year-long run-up in world indexes, which Morton believes have generally reached fair value. He bases his analysis on a number of barometers, including the Q ratio, which among other things, measures asset replacement costs going back to 1900, and the CAPE or Cyclically Adjusted PE Ratio, looking back over 130 years. “These readings are saying we’re in fair value territory now, neither high nor low,” explains Morton. “This is not a bad thing, because it means stock picking is going to be more important. And it could mean actively managed funds will outperform index funds.”

Southeast Asian countries, including the Philippines, Indonesia, China, Hong Kong and Singapore, are among those where Morton believes he can still find deep-value investments. The fund holds diverse assets across the region, including a paper products company in Indonesia and an electrical component manufacturer in Taiwan. He particularly likes the real estate market in Singapore, an island nation with a rapidly-growing population. When he visited there, he discovered that Singapore’s real estate market had been drastically oversold. On his return to his home base in London, he immediately acquired CapitaCommercial Trust, a real estate investment trust with 11 buildings in prime locations in central Singapore. Explains Morton: “The Singapore property market is limited because it’s a small island and goes through very extreme and regular cycles, which makes it a perfect asset category for the Recovery Fund.”

Morton also believes the economy of Southeast Asia, including China, will continue to do well in 2010. In fact, Hong Kong and China have a combined weighting of 20% in the fund. Morton’s optimism is reflected in earnings forecasts, which have risen by 13% for major listed companies across the region for 2010. And, as Asia-ex Japan continues its growth trajectory, its weighting in the MSCI World Index continues to expand – from 3% twelve years ago, to 9% in late 2009. “There are huge surpluses at the corporate and government levels in China that have to be deployed, so I would expect more stimulus spending and mergers and acquisitions,” says Morton. “If you can find value stocks in that space, I’d rather be there.”

There have been concerns expressed that China’s massive infrastructure spending program has led to overbuilding and the inflating of a “bubble” in the real estate market. But as he travels through China, Morton says most of the company executives he meets are very positive about the future. “They’re hugely optimistic,” adds Morton. “It’s just a pleasure to be out there because they all assume the future is going to be a lot better than the past.”