Thursday, 31 July 2014
Last updated 5 hours ago
Feb 9 2012 | 6:46am ET
David Baran, an equities and equity derivatives proprietary trading vet of Lehman Brothers, Goldman Sachs and Barclays Capital, co-founded Symphony Financial Partners in 2000 with Kazuhiko Shibata, formerly of Nomura Securities. The two serve as co-CEOs of the Tokyo and Singapore-based investment manager that specializes in event driven hedge funds and has over $200 million in AUM. SFP operates both the SFP Value Realization Fund, a Japan-focused equities value fund launched in 2003, which gained between, 6.8% and 8.9% last year, depending on share class, and the $21+ million, pan-Asia multi-strategy Sinfonietta Fund, which was launched in June 2008 and last year returned 28.8%.
Baran spoke with FINalternatives’ Senior Reporter Mary Campbell recently on a wide range of issues, from what to look for in a Japanese company to how to avoid investing in the next Sino-Forest, and many topics in between.
Symphony Financial Partners operates both the Sinfonietta Fund and the SFP Value Realization Fund, can you tell me something about them?
The SFP Value Realization Fund [is] focused on Japanese deep-value companies and works with management to improve share price valuations. It’s a unique approach to what is a malignant problem in Japan—companies trading at huge discounts to intrinsic or break-up value. But they’re good companies—it’s not like you have malfeasance or mismanagement—these are very good companies that are solid both operationally and financially but have been overlooked, either because they’ve got low liquidity, low market cap, etc. The equity market in Japan is just different from other advanced economies, and once you learn to operate within this unique environment, there are unbelievably huge opportunities available.
The Sinfonietta Fund was set up differently. It’s a trading vehicle originally established to manage partners’ assets in a transparent way. We don’t want anyone trading in their personal accounts, but we didn’t want to prohibit people taking advantage of the opportunities here in Asia. This is the genesis of Sinfonietta. It can transact in basically any asset class in Asia credit, currencies, REITs, obviously equities. It doesn’t own physical assets, just securities. It’s designed to take advantage of market anomalies or trends that we’re seeing. We apply our decades and decades of experience in the markets to managing the assets.
The Sinfonietta Fund was set up in 2008, right in the teeth of the GFC [global financial crisis]…so 2008 wasn’t a great year. We got a lot of things wrong. Mostly a trial by fire, but since then everything has been fine, three good years; 2010 was only marginally positive but we’ve been happy both with the execution of our investment strategy for that fund and the reception we’re getting for it now that we’ve decided to open it up to external investors.
You founded the SFP Value Realization Fund in 2003 so you’ve been in the Japanese market for some time, how does that experience help you in the current market?
I’ve been trading Japanese equities since 1990, so I’ve seen it all twice [laughs]…
I think [it’s influenced] our views on how the world is going to look as a result of, not just the current sovereign debt crisis in Europe, but the entire cycle of over-leveraging in the world and the shifting to an almost perpetual low interest rate, low growth scenario. We’ve lived it in Japan already—we know what it’s like, we know what it does to asset prices, we know you’re going to get attractive bull market runs but you’re still going to be in a long-term bear market. Being able to look back at our own experiences of having dealt with that in Japan gives us a completely different perspective, I think, from other managers who would be relatively new to the market—by relatively new, I mean, they’ve got 10 years experience—and they’ve only seen bull markets with some deep corrections that are reversed by policy.
I don’t think there’s a policy solution for what we have now. You’ve got to get rid of all the debt. The global debt overhang is huge, it’s historic. The amount of unfunded liability in the U.S. can cripple the country. And you have that situation amplified in Europe with fewer policy tools to rectify the problem.
Now, fortunately, we’re in Asia and…the Asian economies have grown their GDP so much during the past decade and they have so [many] more resources that you don’t have the overleveraging problem. I would argue that China has a lot more leverage in its economy than it’s ‘fessing up to but they also have a lot more money. I know a lot of people worry about Japan, but if you think about it, the arguments that global investors have been making against Japan and how an implosion is imminent, well, those arguments have been the same for two decades.
What are you looking for when you’re evaluating investments for the Japan fund?
For the Japan fund…we’re focused on two things: valuation and management. You would be shocked to learn that approximately 200 companies in Japan trade at 100% or more net cash to market cap. Forget about price-to-book, it’s irrelevant—everything is at a discount to book…We look at things like, does the company have more cash on its balance sheet, net of debt, than its market cap?
There [are] so many companies trading at unbelievable prices. The question is not how much of a premium to market do you need to pay, it’s how much of a discount can you get it at? But, the other thing that we look at, which probably makes us somewhat unique is, what is management like? What is management’s position on raising the valuation of the company? Do they have a sense of responsibility towards shareholders? Do they care about share price? Would they buy back their company? Would they do a privatization? Would they do M&A? or anything to stimulate the share price?
You say there is now an M&A and MBO market in Japan where there wasn’t before, why is that?
MBOs [management buyouts] first came to prominence in Japan in 2006 with the Skylark MBO. This caused corporate Japan to first sit up and take notice that this was a possible road that management could take. At the same time, there began a series of changes to Japanese corporate governance that aimed to increased corporate disclosure and increase transparency. The most recent of these came out in 2010 and included requirements for director/statutory auditor independence, disclosure of executive compensation, and explanations for cross shareholdings. All of these are hard to swallow for many Japanese companies. In addition, with all these new rules, including IFRS accounting rules that will soon be introduced, the costs of being a listed company was getting high. Too high particularly for smaller cap companies for whom these costs were now of a material size relative to earnings. It is no coincidence that we have seen a steady increase in MBO activity in Japan, with 2011 on track to be the highest in five years.
It seems strange to me that in time of instant communication and easy travel there could be so much misunderstanding about a market the size of Japan.
It’s cultural. Investors don’t want to spend the time that’s necessary to understand what can and can’t be done. It’s not solely people who don’t understand Japan—I know people who understand Japan, who’ve lived here, who’ve been in the market for decades and they come up with financially logical investment ideas and I say, ‘What are you talking about? You can’t do that in the market. It’s not going to happen. You cannot go and buy that company and break it up because it’s trading at this valuation—the last 1,000 shares traded at that price but you can’t acquire the company at that valuation. You can’t even acquire the company at two times that price.’ But someone else might be able to.
Investors—and I use this kind of euphemistically for Western investors— who have an understanding of U.S. and European markets, which are broad and developed , where there’s a body of law on M&A, they expect what they’re used to in their home markets because Japan is a big, deep market. Or they expect US-level corporate governance from companies in mainland China. Their assumptions about how markets operate are flawed.
How activist an investor are you?
We are not activists. The whole activist approach doesn’t work in Japan. It probably works better in the U.S. because the shareholder base is more diversified and economically motivated. Shareholders in Japan may not necessarily use the same formula. The activists who tried a hostile approach here before, and this is where the cultural biases come in, they never had the ability to force management to do anything because they never had control. So they were requesting management to do something but doing it in such a way that management would just turn their back on them and say, ‘Well, we don’t even really need to talk to you,’ and the other shareholders really didn’t care, and would side with management.
We take a much more cooperative approach with management…We’ll act more as their counsel, their consigliere, guys they can talk to about things as opposed to the squeaky wheel. We’re not interested in being the squeaky wheel.
You’ve said in your market commentaries that Asian stocks look cheap but investors should be cautious, why is that?
Basically, we’re saying we’ve seen cheap stocks getting progressively cheaper for a long time in Japan. Sometimes being cheap just means you’re using old metrics. That’s a risk for investors now that I don’t think they fully appreciate. For example [stocks] may be cheap based on a given P/E multiple you think is appropriate for that company—well, have you considered all the factors leading to multiple expansion or contraction?
I think Asian equity markets are entering a new cycle. With interest rates going to be 1%-2% for a very long time, you have to think, ‘Where are the investment opportunities? Why isn’t the S&P 15% higher? Earnings look pretty good. Maybe people don’t want to invest in equities at this point’…I would guess that a lot of people are scared of the equity market right now. I would guess that their marginal dollar…is not going into buying stocks, or TVs or…whatever, it’s going to go into paying down debt. So, if it’s not going into the market, people are going to invest in equities less that means valuations can come down…
What Asian countries do you find most interesting right now?
There’s still abundant opportunity in China. There’s so much going on, good and bad. We think Singapore’s a great place to invest and it will end up being a Switzerland-type equivalent within Asia, over time. Malaysia [is] growing strongly and the markets are getting more mature. Korea, outside of the Samsungs which have done an incredible job, is going to find itself battling with Chinese companies more in the future than they have. They’ve done an excellent job of getting exposure and infiltrating the Chinese company supply chains, but they’re still bit too accepting of Chinese ways of doing business…The Japanese…have been much more effective at protecting their intellectual property. I don’t think the Koreans have been that good at it. Down the road the Chinese will be competing with the Koreans for the same customers.
What effect has the whole Sino-Forest scandal had on investors looking at China? Is it something that will hang over the country like a cloud?
Well it should hang over the country like a cloud, a black cloud...Sino-Forest in and of itself, it’s a pinprick in terms of China overall but it should alert people that…[although] a company may be listed in the U.S. or Canada, you’re investing in a different set of managers. Whatever transpired at Sino-Forest, true or not, there are different rules of engagement and you need to be conscious of that.
Actually, I don’t think Sino-Forest is the real problem. The big problem, the real fundamental problem is business culture. When company founders are disappearing in the night because their company debt burden is too big you have a fundamental problem with governance. We are talking about a breach of trust, a breach of social contract. This is starting to become a recurring issue…[These are] local businessmen who gear up their businesses, but when things turn down and they can’t meet their debt obligations, they run away. They just leave. They just walk away from the factory. Employees are shut out, the factory is shut down, banks are like, ‘Well, what do we do?’ And these are Chinese banks. You’re dealing with a different mindset. No financial model will help you here.
So how do you do it? What’s the secret?
I don’t think it’s a secret, certainly not anymore. You have to be extremely cautious with everyone and be highly vigilant about due diligence. Particularly in Asia, due diligence is not just reading the annual and quarterlies and having a perfunctory meeting with management. It requires real legwork and vigilance.
How long does due diligence process take?
For Japan it can take three months, it can take three years. You may find a good company, but it may not be ready. You don’t want to be stuck in a value trap, you don’t want to be stuck in something where management doesn’t really care. You need to be able to confirm not only that it is cheap, but that there is a culture within the company that will facilitate some form of share-price appreciation.
How long do you hold onto a stock?
It really varies. It can be a year, it can be five years. These things can take some time to come to fruition, but because we’re buying so well, we’re comfortable hanging on.
How did the recent catastrophic events in Japan affect your business?
We were in Shanghai March 9 to see the expansion of a factory of one of our Japanese portfolio companies…after which I flew to Hong Kong to talk to investors. I was on the tarmac ready to fly back to Tokyo Friday March 11, when the earthquake hit. When I got back we focused all our efforts on our Japanese portfolio companies.
We spent the next few months helping them, making sure that everything was 100% back to normal, no concerns. Really, it didn’t take long to set ourselves at ease, because of the strong relationships we have with senior management at our portfolio companies. On Monday evening on March 14, we knew the situation at all of our portfolio companies…which in turn made it very easy to transact in the marketplace for both funds that week when things were crazy. We understood what the situation was, we understood which companies were in trouble and which companies were going to benefit. And…this is why having a cool head and experience doing this pays off during a crisis. The markets were absolutely in freefall on Tuesday afternoon and we were trading very actively. There were so many things trading at the wrong price, it was hard to keep up. It was our access to corporate Japan and trading experience that contributed to the strong performance for both funds in March.
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