Episode #187: Kevin Carter, “The Thing That’s Emerging Are The People, It’s All About The Consumer”
Guest: Kevin Carter Prior to EMQQ Kevin was the Founder & CEO of AlphaShares, an investment firm offering five Emerging Markets ETFs in partnership with Guggenheim Investments. Previously, Kevin was the Founder & CEO of Active Index Advisors acquired by Natixis in 2005 and the Founder & CEO of eInvesting acquired by ETRADE in 2000.
Date Recorded: 8/7/19
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Summary: In episode 187 we welcome our guest, Kevin Carter. Meb and Kevin start the conversation with some background on Kevin’s career, getting to know Burton Malkiel, and launching EMQQ.
Kevin offers some of his thoughts on investing in China, including his initial thoughts about the prominence of state owned enterprises. Kevin mentions that a key component to investing in emerging markets is that it’s about the consumer. He notes that emerging and frontier markets are 85% of the world’s people and almost 90% of the people under the age of 30, the GDP of those people are still growing twice as fast as the rest of the world, and their incomes are growing.
Kevin discusses that once he figured out that the indexes that were available to invest in these markets were allocated relatively heavily to the legacy, inefficient, state owned enterprise portion of economies, he got to work on building indexes that were more targeted to capture emerging market growth.
Meb and Kevin then discuss the reality of emerging market allocations for most investors today, and talk about the current weights of emerging market indexes and the implications for investors.
Kevin gets into launching and running EMQQ, and how the index is constructed. He follows with a discussion on emerging market internet company valuations and the current pace of revenue growth.
Meb then poses what he thinks is some of the most common “pushback” he hears about why people can’t invest in China. Kevin addresses some of the arguments he hears for not investing in China, including made up numbers and communism and explains why he doesn’t think there is a lot of merit to those arguments.
As the conversation winds down, Kevin covers his thoughts on India, which he thinks is a particularly interesting opportunity from the standpoint of population size and growth.
All this and more in episode 187, including Kevin’s most memorable investment.
Links from the Episode:
- 0:50 – Introduction to our guest, Kevin Carter
- 1:14 – The start of Kevin’s career
- 2:14 – A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing (Malkiel)
- 4:40 – Starting his own company
- 7:08 – The Arithmetic of Active Management (Sharpe)
- 9:55 – The atmosphere in Silicon Valley during the dot com bubble
- 15:50 – The creation of active indexing
- 20:10 – Kevin’s next entrepreneurial venture
- 23:37 – Investment Strategies to Exploit Economic Growth in China (Malkiel, Mei, Yang)
- 25:32 – The emerging market landscape
- 32:04 – How to put money to work in emerging markets
- 42:00 – Putting together EMQQ
- 46:21 – Building the EMQQ Index
- 47:28 – Emerging markets as a value trap
- 51:28 – Most common arguments against trading in China
- 53:48 – Bridgewater’s Ray Dalio Discusses the Impact of China’s Growth on the World Economy
- 55:06 – Opportunities in the future outside of China
- 56:46 – Creating investment tourism opportunities
- 1:00:57 – Wager proposal
- 1:03:06 – Resources to learn more
- 1:03:54 – The Alibaba Story – Crocodile in the Yangtze
- 1:03:55 – Six Billion Shoppers: The Companies Winning the Global E-Commerce Boom (Erisman)
- 1:04:19 – How to connect with Kevin and EMQQ: LinkedIn and emqqetf.com
- 1:04:34 – Most memorable investment
Transcript of Episode 187:
Welcome Message: Welcome to “The Meb Faber Show” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: Hey, podcast listeners, we got a great show for you today. Our, guest founder of EMQQ, the Emerging Markets Internet E-Commerce Index. Prior to that, he is founder, CEO of AlphaShares, an investing firm offering all sorts of Emerging Markets funds. He partnered with Guggenheim before that. Founder, again, of Active Index Advisors and founder and CEO of eInvesting. Welcome to the show, Kevin Carter.
Kevin: Thanks. It’s good to be here.
Meb: Did I also see you started your career at Robbie Stephens?
Kevin: I started my career in January of 1992 at Robertson Stephens & Company. It was my only interview.
Meb: Good vintage starting in the investing world in the early ’90s. I mean, that’s pretty good timing.
Kevin: Things were booming at Robertson Stephens. And Robertson Stephens was sort of the premier West Coast investment bank. And technology and consumer growth types of businesses were coming through the investment banking part of the business. And I remember I showed up for my interview, and I had to wait two hours for the guy to show up to interview me. And I was unhappy because I wanted to go home and play basketball with my buddies. And he showed up and we talked about Pac-10 basketball for 20 minutes. And then he explained the investment business to me for three minutes. And then he said, “You can start on Monday.” And I said, “But I don’t know anything.” And he got out a piece of paper and he wrote on it “A Random Walk Down Wall Street” and said, “Go buy this book.” I thank him for that because that had an important impact on my career.
Meb: Yeah, and we will come full circle to that. And so you worked there I assume as just like a junior associate banker or something. And then kind of what came next?
Kevin: Actually, it was the investment management part of the company, which had just started and what it was, they had one mutual fund, the Robertson Stephens Emerging Growth Fund. It was owned by the investment bank, but it was a fledgeling young business that had, I think, 100 million dollars. And what had happened was in 1991, there was a big rally, Nasdaq and small-caps, in particular, and the fund was up over 60%. It was on the cover of “Money Magazine” and the phones were ringing off the hook. So they needed… I was like the third person, kind of, on the marketing side to basically just answer the telephone and…
Meb: Just take orders at this point.
Kevin: Just basically, taking orders.
Meb: Not, “Do you wanna buy it?” “How much do you wanna put in?”
Kevin: That’s right. And we’d get in, in the morning and all the East Coast people would have 150 messages with people saying, “Send me the prospectus. Send me the prospectus.” So but it was a great way to learn investing because the first fund was a growth fund. It was emerging growth. So it was small-cap tech. Cell phone companies were kind of a new thing at the time. And then, pretty quickly, we added a value fund. And I got to sit across the hall from the guy that ran the value fund. And I was sort of an investment gym rat at this point. And so I would sit in there and ask him about investing and value investing versus growth. And he gave me the, “I like to try to buy dollars for 50 cents. And this is kind of the Warren Buffett way.”
And I gravitated towards that super fast. And that’s about it. I as I tell people I pray towards Omaha first. I’ve been working in the ETF and indexing world for almost 20 years, but I still have one foot in the active world. So that was I’d see the growth investing, see value investing. And then we had Paul Stephens, his name was on the door, who launched the Contrarian Fund, which said, “The sky is falling. Buy timber and gold.” And it was the three different guys. We had three funds, and none of them agreed on how to do it. And so I really enjoyed starting there, and it’s now I think it’s maybe a $60 billion operation that is RS investments.
Meb: Mm-hmm and now maybe part of Victory or Victory? I don’t know. It’s hard to keep up.
Kevin: Yeah. Somebody bought them at some point.
Meb: So okay, so tell me the career path. There’s got to be a couple stops you had starting your own company, as well as the original idea to jump ship and go the entrepreneurship route.
Kevin: Well, I worked as an analyst, and again, I mean, I was just completely consumed by figuring this out. How does Warren Buffett do that? And that led to value investing. And so I read all the Berkshire Hathaway Annual Reports. I read “A Random Walk Down Wall Street” as I mentioned was kind of my primer. I bought that the weekend between my interview and my first day. So I worked as an analyst, basically doing research on both long and short ideas for a group called Feshbach Brothers, which had been the largest… They were a short-only hedge fund that had blown up in 1991. They sort of licked their wounds and sold the airplanes and the Ferraris and were rebooting, and I joined them. And that was also a great opportunity because these guys had been pretty high up as hedge fund managers. I think they had the number one hedge fund in the country for five years, short only. And you know, if you think about shorting it’s really the ultimate in value investing. So I did that.
And then I ended up… I had never thought I would be an entrepreneur… That didn’t… I don’t know. It just didn’t seem to be something I was interested in doing. It sounded hard setting up a company. And I got kind of fed up with the investment business in 1997 or ’96, I guess no, ’97, 1997, and I quit at the beginning of the year and took most of the year off. My wife and I were gonna get married that September. So I just hung around in San Francisco, and we got married. And then we went on a kind of a five or six-month trip around South America and Africa, which was great because I also got to see a lot of emerging markets.
Meb: Jim Rogers style.
Kevin: Yes. Well, not probably as we were backpacking, I think he went in a customized Mercedes or something but yes, the same general idea. And I had been thinking… You know, in 1996, I had read the “Berkshire Hathaway Annual Report.” And I remember, it sort of blew my mind because, at one point, it said, I think this is the quote from Warren Buffett, “Most investors, both institutional and individual, would be better off buying index funds.” And since I was taught that he was sort of the role model of why you want to go active, and not by index funds, that kind of blew my brain up. And so I remember that afternoon I read it my friends like “We’re going out.” I’m like, “I gotta stay home and figure this out because my head hurts right now.” And I found the Bill Sharpe Arithmetic of Investing piece, which is, as you may know, a brief piece that basically just explains why the average fund charging 1 1/2% will underperform a fund that buys the index and charges nothing or close to nothing.
And so it was quite sensible to me after I read it. And I had also seen a lot of things in the investment business that I thought were unseemly. I got paid a lot of money for my research. I remember Janus Capital had been my biggest client. And I talked to Janus about two stocks, right, two years. I had two a long and a short. They were in the same industry. The short went bankrupt. The long is now called General Motors Finance. And they acquired the company, formerly AmeriCredit. And I just had seen a lot of things and I got paid a lot of money from these guys in Denver for talking about two stocks. And I just had seen things at my first company with 12b-1 fees, and it’s a pretty profitable business. And I just felt like maybe there was a better way and I re-read “A Random Walk” a lot of times.
And anyhow, literally, my wife and I were in the back of an open airbox truck on our way to a coffee plantation in Tanzania. And I sketched out what I call perfect capital, which was okay if we’re gonna deconstruct this whole thing, what would be the best, most perfect, optimal way for people to invest? And the first thing was, they had to invest regularly. So you got to start saving 500 bucks a month, 200 bucks a month, like a 401k plan. And, but the problem back then was you had to buy 100 shares of anything, a round a lot, or you had to pay an extra big commission. And so if you wanted to diversify 500 bucks a month, you had to buy a mutual fund. That was the only vehicle that would accept $532.19. So I had sort of figured out, you know, that was a very important foundational thing to making things perfect. It made the stock market just a lot more liquid to get into to buy 20 stocks without having to go through the wrapper of a mutual fund.
And there was another part to the perfect capital, which I guess is the second business. But the first business was called eInvesting and it was designed, sort of pioneered fractional share brokerage. The product, we called it Build Your Own Fund. So you could set up a 20-stock portfolio and say, “Here’s 173 bucks and buy all 20 stocks directly.” And so that was an idea that I had. And I talked to a few people about it. This was 1999. And I was very reluctantly convinced that I should actually try to do this because the dot-com thing was going. I was very sceptical, about the.com thing.
Meb: And you’re still in the Bay Area at that point.
Kevin: I was but I was like.
Meb: It was so much fun at that period. Can we talk about that for a second? I mean, so I used to visit… I graduated college in 2000, so I used to go visit my friends that were graduating in the late ’90s, all of them moving to San Francisco, the world of washing money. It was the big bubble, really, of my career. But I remember just wide-eyed being out there looking at all the companies throwing the big parties where everything was free. And everyone, just that was a sign of the times.
Kevin: It was a sign of the times. And unfortunately for me, I wasn’t buying it because I was this idealistic value investor, Warren Buffett. Everybody wanted to talk about Cisco. And every time I looked at Cisco it was like, “This company is selling for 50 times revenue.” And I decided to start this company because certainly the environment to start a company was good in San Francisco to find venture capital and go for it. And so there’s two other sorts of parts to the story that relates to that environment, which was so I had this idea.
And I talked about it for a while. I was reluctantly convinced to start eInvesting. And we built it, and we ended up getting acquired by E-Trade in the year 2000. But as part of that, going back to “A Random Walk Down Wall Street” when I was thinking about this idea during the bubble, I saw a company change its name from KTL to KTL.com, and the stock went from a dollar to 30. And it was the same week that I was… Going back to it was a fun time. It was the same week that I shorted Amazon and lost a third of my net worth in a day and a half the fall of ’98.
Meb: The funny part about that story is you can walk that forward about every 3 years for the next 15.
Kevin: It’s become a running joke between… Yes, I think the most pure sign of a bubble is companies changing their names. And so what happened was, I think it was the fall of ’98, I saw this company changed its name. I was getting beaten up in my Amazon short that I thought that was an overpriced bookstore. When I saw the company changed its name, I said, “I’ve read about this.” And sure enough, I went up to my bookshelf and I found my copy of “A Random Walk Down Wall Street” and I found a chapter on valuations and bubbles. And there was a quote from Jack Dreyfus about the 1960s electronics bubble. Take a company called Shoelaces Incorporated, change the name to Silicon and Electronic Firth [SP] Burners. The stock sold for eight times earnings before, but by adding those buzzwords, including the word ‘Firth burners,’ which is a made-up word, the PE multiple now should be 68-4.
And I said, “Oh, my goodness, this just happened. And I have to call this guy.” And so, as you know, the guy that wrote that book is a Princeton economist named Burton Malkiel, who’s been a longtime advocate for index funds and ETFs. And I’ve used Inktomi, which was the leading search engine before Google existed for a couple of years. When I put in his name and Inktomi, up came his Princeton splash page and there was a phone number. And I dialled the phone and he answered. And I thought I’d get a secretary or something but he answered the phone. And I said, “Dr. Malkiel, you don’t know me, but I read your book. And you got to see. This is right out of your book. You could literally cross out Shoelaces Inc., and put in KTL and cross out Electronics and put in .com.”
And I thought he really liked me. But it turns out, he’s just the nicest guy in the world. And now, he likes me, I think, because we’ve worked together now for 20 years. But anyhow, I called him and we spoke and he told me to fax him a couple of the Bloomberg stories that I had printed out. And so I printed about and faxed him over and that was it. And a year later when I was, as I said, reluctantly convinced to start this company, even though the environment was really good, I still was a 20 something-year-old kid and I needed credibility.
And so one of the things you do to take on an air of credibility when you’re a young entrepreneur is, get an advisory board together. And so I’d gotten three or four of the top investment and accounting and legal guys in San Francisco to be advisors. And I picked up the phone and called Burton back at Princeton, and I said, “Do you remember me? We talked a year ago?” He said, “Yes.” Again, he gets a lot of calls, I think, from people. And I said, “Look, I wanna make this thing. I think it’s good for investors, and I know you’re kind of a champion for the investor.” And I explained it to him. He said, “I think that’s a really good idea. But you got to come out to Princeton. I wanna meet you face-to-face before I’ll agree to participate.” So I said, “Okay.” And that’s basically how my entrepreneurial career got started, was getting him to agree that maybe he would be part of that first company and one thing just led to another to another.
Meb: That’s awesome. Did the acquisition and absorption go well, and then you decided, hey.
Kevin: It was E-Trade and they already had 3 million customers.
Meb: Do they still have that branch right downtown that…
Kevin: They still do. That’s where I took my share certificate right next to the old H&Q Building. Yes. I think it’s round. It’s like around like the 60s era.
Meb: Yeah, it’s a weird building.
Kevin: So yeah, it went fine. And we got paid. And we were building it to sell through advisors to let advisors have the access to it. But E-Trade found out about it and call us. And we were about to actually raise our first real venture round and they said, “Well, don’t sign that. Don’t negotiate an agreement with TD Ameritrade venture group. Come down to Palo Alto and see us.” And so it went fine. I mean, I was sort of useless once we got acquired. I mean, they had a CEO and a big marketing team. And so I was sort of a lame duck but I finished developing the product. It wasn’t quite done when we sold the thing. And I was only on for maybe nine months after they bought us. So it was good. It was a great experience.
Meb: So you turned your attention to the horizon, the next kind of ideas. You went and started another company. Is this right?
Kevin: So the fractional share part was sort of the first piece of the perfect capital. The second piece was, “Okay, well, once you can do this, how do you actually invest your money?” Okay, you get rid of the share barrier. And if you believed in indexing it was, make your own index fund. We had put it together originally, the kind of lead … We called it Build Your Own Fund. E-Trade changed its name to stock baskets, but kind of the lead idea was the S&P 50 portfolio. And you can customize it and leave out tobacco stocks or whatever. And, again, we had targeted advisors with it. And one of the takeaways that advisor said was, “I don’t wanna be in charge of picking those 50 stocks or the 47, and if I buy 50 of the S&P, 500 companies how do I know it’s gonna act like the S&P?”
And so the second company, Active Index Advisors, sought to solve that. So rather than just be a broker-dealer, we would be an investment advisor and we would make you your own S&P 500 strategy. And that was the concept and the idea. I remember I had a one year kind of non-compete with E-Trade. So I was just home. My wife and I had a child and moved out to the suburbs. And I was going to Sears and buying drills and sketching things on my whiteboard. And Burton and I started talking on the phone about it, and Burton said, “Yeah, well, you could also… If you do this index-based separate account thing if you had low-cost basis stock because you have a separate account business usually, they sell everything you own if you get a new manager, whether there’s taxes or not.” And so the idea was you could both take in low-cost basis stock, but more importantly, you could do loss harvesting. You know, again, the idea was to buy 50 stocks that would track the S&P as closely as possible. So get the beta as closely as you could with 50 stocks and the more stocks you use if you buy all 500, obviously, you can have no “tracking risk.”
But for cosmetic reasons, and just because of the brokerage system and the reporting issues, 50 stocks seemed like the sweet spot and where we could get rid of most of the tracking risk. And then every quarter, you could sell the losers. So if the automobile industry was having a bad quarter, you could sell General Motors and buy Ford. And so if it was a taxable investor, you could not only get the index return, but you could beat the index after-tax just by doing systematic loss harvesting. And that was the theory behind it. It’s become a very large part of the…in particular with the ultra-high net worth advisors. There’s a couple of other companies that sort of built similar versions, but it was basically a math trick.
If you’re paying taxes, you can beat the index on an after-tax basis because those losses have value. And when we launched it, we had done pretty significant backtesting to see what we thought we could squeeze out in terms of after-tax performance. And we thought we could get one and a half per cent a year was the number we felt comfortable telling people. That strategy, the active S&P 500, is still being operated. It now has I guess a 17-year track record, 15 to 17. And its average outperformance of the S&P is I think 3% annually. So it’s beat the index by 3% a year for 15 years. If it was packaged as a hedge fund, people would say, “This is the greatest thing ever.” But it’s just sort of a…
Meb: It’s got to be better with your marketing. You should have just said, “This is a super proprietary algorithm we have.”
Kevin: Well, perhaps we could have been better with the marketing, but we did… We built it… I mean, the business ended quite well. We built the platform. I brought in some ICE shares portfolio managers to build it and some tech guys. And we ended up selling it to Natixis Asset Management, which is a big Boston-based company that owns 14 or 15 money managers, Harris and Loomis Sayles, for example. And so anyhow, it was a very beautiful, elegant product. It achieved everything that we thought it could do. It’s growing quite fast right now according to my former colleagues that are still part of the business. And most importantly, to me, the line…the performance of the product is twice that of the just buying the index if you’re a taxable investor.
Meb: All right, so at this point, you haven’t learned your lesson. You’re like, “I’m gonna be an entrepreneur again.” You don’t just continue that World Tour. You then go start another company.
Kevin: Well, so right after we had sold Active Index Advisors to Natixis, which was a December of 2004, January 2005 kind of timeframe, and Google had gone public. And before Google went public, they invited Bill Sharpe, Nobel Prize winner, famous for the Sharpe ratio… They did invite Bill Sharpe, and Burton, down to Mountain View to give an investor planning talk before the IPO. So all these Google engineers, you’re gonna get rich. We’re gonna bring in the two smartest guys we can find. They’re gonna tell you how not to screw it up. And I wasn’t part of that but I knew it happened. And soon after that, some of these Google engineers started calling me. We had been acquired by Natixis. I was once again in this kind of lame duck sort of position. The real CEO was in Boston. All the salespeople were in Boston. I was in San Francisco. The portfolio managers did their job, and I read the newspaper.
But what happened was… I didn’t just read the newspaper. That’s not true. But for a month or two, I did until these Google guys started to call and said, “We heard about this active indexing thing you do, and can you come down… How do I invest with you? Can you come down and explain it to me?” And I said, “Well, who’s your advisor,” to the first guy and he said, “Well, I don’t have an advisor.” And I said, “Well, we work through advisors. I mean, find a guy at Morgan Stanley.” He said, “I don’t wanna do that.” And I thought, “All right. Well, I’ll go out and meet with you.”
So I drove down to Mountain View and with my leather folder that’s still following me around and my yellow pad. And I sort of sketched out to them how it worked. And these guys were all engineers. I mean, these were smart people. They understand why indexing beats active in the mutual fund world. And I explained what we did and we could customize it. I remember his only choice for customization was he didn’t wanna own any Microsoft. So he wanted the S&P minus Microsoft as his potential security pool. And so I explained it to him. And he said to me, he said, “Well, how much money should I put into this?” And I said, “Well, I don’t know. How much money do you have?” And he said, “I have 100 million dollars.” And he was 25 and had been living on his parent’s couch, I think, two years before.
And I said, “Well, you know, I don’t know what a moderate pie chart is. I mean, you’re, you’re young, so you should be aggressive, but you’re already rich. So maybe you should be moderate, right? Maybe not conservative, maybe not aggressive, right in the middle.” And he said, “I have 100 million dollars.” And I said, “Well, you know, maybe 25 million.” And he said, “Well, what about the rest of this, the rest of the money?” And I said, “Well, I don’t do bonds or real estate.” And he said, “Well, take it and figure it out.” I told him, “You know, I think, we could use ETFs to give you a full asset allocation.” And so I ended up becoming his de facto investment advisor. And maybe five or eight other of these early Google engineers also found me. And so I ended up sort of becoming their advisor and putting together this ETF type of portfolio.
And about the same time or, you know, a few months after those guys came on as clients, Burton wrote a paper about investing in China in “The Journal of Investment Consulting.” And I knew he was going back and forth to China. And what had happened was two of his former students who were both also Princeton economists, they were Chinese nationals who had moved back to teach in China. One was a professor. The other one was a director of research for one of the largest Chinese mutual fund companies. And they had said, “Burton, you gotta come see what’s going on. We are coming back. We are capitalists. This place is booming. You gotta see it.” And so Burton was going back and forth. I knew about this, but I had never been to China before and I wasn’t involved in his whitepaper. But he ended up publishing a piece. It got a little bit of attention. And the Google people said, “Can Burton come down and give a talk about investing in China?” And we said, “Okay, well, the next time he’s in town, sure.”
So we drove down to Mountain View when he was in town next, and Burton gave his talking about investing in China. And as soon as he was over, this young man with a lot of money turned to me and said, “I want to invest in China.” And I said, “Okay.” And so I drove back to San Francisco, and now I do China. And basically, I thought I was driving to Mountain View, but I may as well have driven to Shanghai because from the moment that talk ended that’s all that I’ve done, which is I guess now about 15 years. Burton calls me a serial entrepreneur, but I don’t like that term. I always think of like the Post family or the Kelloggs or the other kind of cereal entrepreneurs. It sounds more fun to me. But I just kind of had one thing lead to another and found things that we could do better. And the China and emerging market puzzle has been perhaps the most fun, intellectual challenge for me that followed after that.
Meb: Well, there’s been quite a mountaintop, good times, bad times everything in between with China since that period. You had a massive amount of interest, post-2004 into the mid-2000s. The global financial crisis kind of wrecked everything, including a lot of the emerging markets, which we’ve talked a lot about on here, that the rest of the world ex-U.S. for a lot of the last 10 years hasn’t recovered as fast as the U.S. have. However, we have a lot of macro tectonic shifts happening. So why don’t you talk to us a little bit about the emerging market world? What’s going on? What’s your thoughts on it?
Kevin: Well, let me tell you, first, summarize the last 15 years in terms of investing, and then I’ll tell you where I think things are and, obviously, China’s a headline grabber these days. So I got back to the office that afternoon, and I said to the portfolio manager, I said, “All right. Well, we’ll probably just buy a China ETF, so give me a list of all the companies. Like if I’m gonna invest in China, what are the businesses that I’m going to own,” because with my Warren Buffett hat on, “Look, I want to…” I don’t just say, “Oh, that’s the index.” I love to see what’s in the index. And so as I tell people, the very first and most important rule in investing in emerging markets, especially in the ETF part of investing and in the indexing, part of investing.
I get back and I said, “Give me a list of all the companies.” And so the main rule I learned before I even was handed the list, Burton pulled me aside and said, “Look, when you get the list of all the companies that are in China, you’re gonna see that all of the top holdings are government-owned banks and oil companies. They are state-owned enterprises, usually referred to as SOEs.” And I said, “Yeah, I’ve heard about this. That doesn’t sound like a very good thing.” And he said, “Well,” and he gave me an example of a Chinese state-owned manufacturing plant that’s basically been bankrupt for decades, but it needs more money. So it goes to the Chinese state-owned bank, and says, “Hey, we need more money.” And whereas a normal bank, a traditional banker, if you will, would not give you another loan because you didn’t pay back the last two loans, the government-owned bank says, “Well, you have 15,000 employees and we cannot have them out in the streets protesting. So we’ll give you another loan.”
And I just remember like thinking, “Why would you invest in that at all?” You know, in my Warren Buffett simple hat on, earnings equals value. Growth of earnings equals growth of value. And if the people running the company show up Monday morning and growing earnings is not on their list of things to care about how do you ever make money?
And so that’s the first thing I tell people. And Petrobras the Brazilian oil company is now the poster child for this problem. I mean, I’m sure you have read at least the headlines that the problem with these government-owned companies, which it’s not just China. It’s this was part of a Russian economy, the Brazilian economy. Almost every emerging market has some state ownership of the energy sector, of the telecommunication sector, of the banking sector. And Petrobras is the oil giant from Brazil that was basically being pillaged by their government, not the government itself. The presidents and the Congress were stealing money for themselves. And it’s basically brought down the Brazilian economy. And the last three Brazilian presidents have been implicated. Two of them are in jail presently. Soccer stars, corporate leaders, and it was basically…
We did a pipeline of how much is it gonna cost? I’m making this simple, but it’s gonna cost $10 billion, but let’s make the receipt for $12 billion and we’ll split the other $2 billion. And so that’s by far the biggest problem with investing in China or investing in emerging markets. If you’re just gonna go by the index, you’re gonna put over a third of your investment is gonna go into those types of companies. So and I didn’t… Again, that was the first thing before they even handed me the list, they told me, “This is a problem.”
The second thing about emerging markets, and China, in particular, is that the thing that’s emerging are the people. It’s all about the consumer. These are emerging consumers in emerging markets. And emerging in [inaudible 00:29:51], 85% of the world’s people, and they’re almost 90% of the people under the age of 30. So we’re really talking about the world. Certainly, the future. And those people, their GDPs, are still growing twice as fast as the developed world. And their incomes are growing. And as they move on up, they want more and better stuff, food, more and better clothing, appliances, vacations. They want an automobile, and they want their kid to go to Harvard. And that’s the story.
And both of those things I learned on the first day, but all I’ve seen though and tried to fix, if you will, is that those things seem really clear. But if you bought the index, you put a lot of money into the legacy, inefficient, conflicted, and corrupt state-owned part of the economy. And you didn’t put much in this incredible growth story, billions of people that want stuff. So that, I think, is really what people should be focused on. And that’s what I’ve been focused on. Once I figured that out and realized the indexes were broken. We tried to make better indexes and more targeted indexes to capture the growth of emerging markets and emerging market consumption growth.
Meb: So it’s interesting because I feel like the world GDP stat always surprises people. When you say most people, when they think of the GDP of the world, they don’t think of the pie chart the way that it is. Probably one of my most controversial tweets of 2019, and there’s been plenty was one where I kind of laid out the case for emerging markets. So you’re preaching the same message where I said, “Here’s all the reasons people should be interested in markets,” and then I had summarized it with, “And by the way, oh.” So maybe the heading was, “This is why I put my entire 401k in emerging markets.” Now, part of the reason was we have to use Vanguard funds because that’s where our 401k is, so we can’t use anything else but man, people got angry. I think that’s probably a good sign. But wow, their responses were really pretty funny. And I think a lot of people, when they think of emerging markets, have a different impression than kind of the numbers dictate.
So anyway, let’s start walking through the investment in case you talked about a lot of the macro fundamentals. Let’s talk a little bit about how things are evolving. Let’s talk about how to actually put money to work in emerging markets if you want to. Did you do the Jim Rogers? He’s driving around the world opening brokerage accounts in all these countries and buy a few shares and reading about them.
Kevin: Well, I think it’s a little bit easier now than when Jim was riding around to access these markets and outsource some of the heavy lifting and trading parts of it. I think people should avoid the broad index funds. I mean, again, it’s just kind of wasted money. There’s a concept called the Emerging Markets 3.0 that I sort of copied from an endowment blogger.
The first 10 years of my China and emerging markets focus I spent most of my time at Ivy League endowments and family offices in and around New York in the northeast and the Getty Trust and people like that. And I’d seen this concept of Emerging Markets 3.0, which speaks to the refinement of how people like Harvard and those types of investors have refined their approach to emerging markets. Emerging Market 1.0 is the idea that you get your toe in the water. I’ve got a 3% allocation to emerging markets. I got a 5% allocation.
Meb: And I think the average for investors is about 5%. When the market cap weight globally is about 12. It depends on how you weight the float and everything else. But it’s about half of what it should be.
Kevin: Yeah, well, I think the market cap numbers I’ve seen indicate that emerging markets are even bigger. But perhaps if you’re looking at an index, it doesn’t include the China mainland market, which has been left out of most of those indexes historically. But your 5% number jives with what we see. We survey advisors, and that’s about the number that we see. But we start with a 3%. Again, it’s a much bigger part of the global market cap and as you said, it’s also more than half of global GDP. So when people ask Burton, “How much should I put in the emerging markets,” the only answer I’ve ever seen him say is “More.”
Meb: Well, you got to remember, this is from the default. And this is a message I’ve been preaching for five years now. And I actually saw today that Fidelity announced they were moving their ex-U.S. exposure up from 30% to 40%. But I tweeted out. I said, “That’s great that they’re doing this, but that’s still below the market cap weight.” Like the default market cap weight is 50%. And Vanguard recently moved up to 42 in the past year, and I said, again, “All well and good, but they’re still making an active bet.” And a friend of Vanguard said they actually wanted to move it to 50%. They thought it’d be too unpopular. So they’re maybe moving in baby steps. We’ll see but…
Kevin: I think you’re right. By almost any measure. I mean, going back to Burton’s answer, people are underweight. They’re underweight based on population. They’re underweight based on GDP. They’re underweight based on market cap. But, again, I think just going out and buying the index is not the way to do it. So the Emerging Market 1.0 is, “Okay, I’ve got a 3%, 4% position and I’m just gonna buy the Vanguard emerging markets fund or the ICE shares emerging market fund. And I’m gonna buy the Brazilian oil companies and the Chinese banks,” and so forth.
Emerging Markets 2.0 is sort of, okay, the institutional investor gets a little more comfortable. They say, “Hey, we’re underweight. We’ve thought about this more. We should go from 5% to 8%, or 3% to 9%,” whatever it is. They increase their allocation as they get more comfortable. But then they start to look under the hood, as perhaps I’ve described, and they say, “This is not the way to do this.” And they get to Emerging Markets 3.0 where they refine and try to get more precise in their targeting. That might be separating Asia from South America. If they’re doing active manager having it on the ground Asian manager and on the ground South American manager or it might be something more thematic. It could include China A-shares, which were not in the index at all back when I was thinking of this concept. They’ve been added to the index a little bit now. But anyhow, that’s what Emerging Markets 3.0 is that it’s and you put in a bigger allocation. And my version of Emerging Market 3.0, going back to your question, investing in emerging markets, I launched with Guggenheim partners, several China ETFs. They trade on the New York Stock Exchange that now have the Invesco brand on them.
Meb: I pitched my first ETF idea to the precursor Guggenheim of Claymore. And we were actually gonna be a sub-advisor on one of those funds back in 2008. We had a launch date on December 2008. This is a little-known story. I don’t even know if we mentioned it on the podcast. Forbes, the media brand was gonna move into ETFs, which would have been… They would probably have, I don’t know, $500 billion under management now if they had. But the world was ending and they decided not to, for obvious reasons in December 2008, which was a shame for us. But it’s good in a way because we ended up doing on our own instead of just being the kind of third party on it. But then Claymore became Guggenheim, which is now Invesco. A fun little history, listeners.
Kevin: Yes. Well, so I had partnered with the Guggenheim people to launch some China EFTs. And over the years people would call me though. They would ask me, “What’s the best emerging markets ETF to buy?” And I never told them to buy one of my funds. I always told them to buy ECON, E-C-O-N, the Emerging Market Consumer ETF, because if you believed the story, this emerging market consumer story, McKinsey, calls it, “The greatest growth story in the history of capitalism.” That’s their quote. And every major investment bank and consulting firm has 100 or 200-page report showing you, “There’s a lot of humans out there that don’t have all the stuff that we have, but they want the stuff we have, and they’re getting that stuff.” And so the simple answer to me was, “Just tell people to buy ECON.” That’s the story. Stay away from the state-owned enterprises. Don’t buy the broad index. Just get your sail up in this wind, this giant tailwind, that McKinsey feels so strongly about.
And the EMQQ story starts with that. And what had happened was about six years ago, I had decided I just wanna just do my Warren Buffett meets emerging market thing. And I was gonna stop working with all my index partners and focus on that. And I set up just for my own money, and some family and friends, an investment partnership. And I bought five stocks. And I was gonna go around town one day with my hat to my friends and family to see if they wanted to invest alongside me. And I made a few slides. And one of the slides had the five stocks. And the first three I put in one column. They were stocks that were part of ECON, the Emerging Market Consumer ETF. The first one is in Nabisco of China, if you will, Want Want, that branded snack food company. The second two were Chinese sportswear companies, Li Ning and Peak, which both traded in Hong Kong. These are sort of the Converse and Reebok of China if you will. And so traditional consumption categories.
One of the other big sub-messages I have for people is databases, particularly when you get into emerging markets can be deceiving. And there’s probably opportunity for people to start rethinking how to categorize things. But I guess there have been some index changes recently. But anyhow, these were traditional emerging market consumer companies. Literally, Want Want makes crackers and milk, literal consumption, those types of businesses.
But then I owned two other stocks that were not in that same column because they weren’t in the same sector. They were both technology stocks. One traded on the New York Stock Exchange. It still trades on the New York Stock Exchange with the ticker symbol WUBA, W-U-B-A. This is the “Craigslist” of China. It’s actually called 58.com. WU is five, BA is eight. So that’s the ticker symbol on the New York Stock Exchange, the Craigslist of China.
The second company on the list is called MercadoLibre, ticker symbol M as in Michael, ELI. MercadoLibre is the leader in e-commerce and epayments everywhere from Mexico to the tip of South America. But these are technology companies. And after I put those five companies down, I stepped, leaned back. And I looked at it and I said to myself, “These food and beer companies are great. They’re growing at 15% or 20%. I think they have moats,” to use a Warren Buffett term. “They’ve got high margins, high returns on equity, good growth. The management team is not the Communist Party. They’re actually entrepreneurs that own the same share classes I do.” So I felt good about those companies.
But then I looked at the two internet companies and in the case of WUBA, it was growing at over 100% and in the case of MercadoLibre, it was growing at like 70% or 80%. And I looked at them I say, “The ones to the left the traditional consumption are good. But these technology companies are also consumer companies. I mean, the people going on MercadoLibre are buying this stuff they used to buy at the Walmart de Mexico.”
So I just had this epiphany about that. And I left. And I drove around town to see my friends and family and I got a few checks. And I was driving home. And I was at a stoplight and I got a phone call from a friend. And she asked me what was the best emerging markets ETFs to put in her daughter’s college fund 15 years out. And I started to say, “ECON,” but I stopped myself. And I said, “Consumption’s changing. The way this is going, the future consumption companies they’re not even in the consumer category. They’re in the technology category.” So that’s what sort of really led to when I went home that day and started putting together EMQQ.
Meb: Let’s hear it. So what was the process? How did you eventually decide on kind of the way that you guys go about it and eventually it became a product, man, almost five years ago? Congrats. You’re gonna hit a five-year real-world track here.
Kevin: We hopefully should make it a couple more months. So what I realized was that because at the same time that this went down was when I had started to notice that there was a brown truck or white truck in my driveway once a week dropping a box off. And my family was going to the Target store a little bit less. And what I started to realize was, I was trying to understand why these companies were growing so fast. And if you think about it, the smartphone has changed how we consume. My family goes to Target once a month now, and we get 15 or 20 deliveries. I can tell what colour the truck is just from the sound of it. I don’t even have to see it. And some of the white ones I can differentiate based on the sound of their doors. So I’ve seen how we…our consumption has changed. But if you take that power… Remember, we had computers before. I’ve had a computer for 30 years and at first, it took up my whole desk. Then it got skinnier and it folded up and now it’s in my pocket. And we’ve had the internet for a long time. We’ve had telephone dial-up, modem access, and then we…
Meb: You know what I learned this past week? You’re a Bay area guy. The first transaction on the internet was in the 1970s, whenever it eventually got started, the University System, between MIT and Stanford. Do you know what the transaction was for?
Kevin: I don’t. I think I’ve heard the story but I can’t remember.
Meb: Cannabis or what you would call marijuana before that. But the students…
Kevin: I did not know. I would remember that if I heard that.
Meb: I’m sure it was going from Stanford to MIT, not vice versa.
Kevin: So pot invented the internet.
Meb: Yeah, basically.
Kevin: I love it.
Meb: Al Gore and pot.
Kevin: Now, it all makes sense.
Meb: Yeah, it’s all coming together.
Kevin: So the smartphone has changed how we consume but then you take that same power and you map it over to this giant wave of consumers in the developing world, they never had a computer. So there’s this leapfrogging going on. Basically, there’s what we call the Great Confluence. You have this giant consumer wave, a huge megatrend. You’ve got the smartphone, basically a supercomputer, in everybody’s pocket for this population that never had a computer before and never will. Most of the world will never have a “computer” the way we think of it. They will never have a desktop.
Meb: Which is a little sad, because I grew up with the Commodore 64, and I saw… My brother doesn’t listen to this podcast, so he won’t be a spoiler alert. I saw that they’re reissuing like one of these like modern versions with all the games on it. So that’s, Wayne, that’s your Christmas present, but I see that it’s gonna be out in time for Christmas with all the famous games.
Kevin: I love it. I had a Commodore 64, I believe, myself. I definitely had a Commodore something. It might have been a 32. Anyhow…
Meb: All right. So no computers.
Kevin: So no computers. So they’re getting them fast. But importantly, this is happening on Android. I mean, there are rich people that can afford an iPhone in every country. But if you’re in India or western China or Nigeria, you’re not spending $1,000 on a smartphone because you probably don’t make that much money. So it’s $50 smartphones. It’s $25 smartphones. I think the average selling prices are now about $100 in the developing world. That’s the average. So there’s lots of $50 phones and $200 phones and whatnot. And this is a big deal. I mean, again, most of the world is just getting their first computer and as they’re becoming consumers.
And they’ve got the internet now too because they never had cable. They never had telephone lines in a lot of these places. So they’re getting their first internet access on their first computer. There is no Target store to go to. And so you’re combining those three megatrends. And it’s creating, I believe, with some strong conviction that the emerging market internet companies, the sector the EMQQ represents, is, I think, the fastest growing sector of publicly traded companies ever in terms of revenue growth. And, in fact, by the way, it’s averaged 40% revenue growth for about a decade. That’s for a whole sector.
Meb: That’s not bad. Tell me about the index, how you put it together. How does it work? How did you build it?
Kevin: So it’s pretty simple. It’s just rules-based. We buy every publicly-traded emerging markets internet company, as long as it has a minimum market cap and liquidity. And there’s 65 of those companies as of our last rebalance. The number’s growing. There’s a lot of IPOs in the space. It’s a rules-based index. The only thing that we do that’s a modification is we put a cap of 8% on the largest position. So Alibaba and Tencent, which are the Chinese leaders, are both sufficiently larger than if they went in at a pure market cap weight would be super heavily concentrated in those stocks. So it’s basically, this entire sector, we’re trying to find every public company that’s an internet company in emerging or frontier markets. And right now, there’s 65. Before the last rebalance, I think we had 58. So lots of IPOs. We just had a couple of months ago, Jumia, which is Nigerian. This is the “Amazon of Africa” J-U-M-I-A on the New York Stock Exchange. So I think there’s likely to be a lot more of these companies coming down the pipe.
Meb: Well, one of the things we haven’t really talked about much either is the fact that emerging markets, early mid-2000s, as you were talking about the endowments, like everyone, in many ways, was enamoured because they had great performance. And over this last cycle, as valuations of U.S. stocks in our opinion have gotten really high. And then you go down to foreign developed it is more reasonable, but for an emerging, often, one of the cheapest buckets.
Kevin: Well, I believe that emerging markets are the ultimate value trap if you’re talking about the broad index.
Meb: Interesting. Expand.
Kevin: So I don’t like it when I see those statistics and lots of people use them because it’s true. The MSCI index is usually what’s quoted. The FTSE Index isn’t much different, but there’s a couple nuanced differences. But they’re both cheap. Emerging markets are selling at 11 times earnings or 12 times earnings or whatever, you know, and a very big discount to the S&P, the biggest discount ever to U.S. equities. Remember, my first lesson. These are government-owned banks and oil companies. Imagine the Department of Motor Vehicles emerges with Chevron. These are not things that should have big PEs. The Agri-…
Meb: Have you had to update your license yet, by the way? There’s like a new county state… We’re both state of California.
Meb: So if you haven’t, you make an appointment and I had to do six different stops in the DMV to just get a new license.
Kevin: I have heard of that.
Meb: I have a current license and all I was doing is updating it. Six different stops and like nine different forms of identification, including your Social Security card, which I had spent like an hour looking for. I was like, “Why do we even have it?” Anyway, so my point being a really well-oiled running machine, the DMV.
Kevin: Yes. Yes, very efficient. So anyhow, when I see those numbers, I’m like, “Look, if you knew what the Agricultural Bank of China,” which is, if you knew what that company was, this is the weakest of the Chinese policy banks. And I don’t know that you should have a PE of anything because there’s some value to these businesses, but they’re not operated to grow the value of U.S. shareholders or really any of the equity shareholders. That’s not their primary function. So anyhow, yes, the emerging markets do have a low multiple right now, but I think a lot of that’s probably a good idea.
Now, our sector does not sell at 11 times earnings. But it is, I believe, right now, quite reasonable. I mean, emerging markets have had, basically, a lost decade and then a little bit of sunshine in ’07. And then maybe since the trade war and tariffs got into the headlines, they’ve declined it back. But our group of companies, which again, are the internet companies, is selling at about 22 times earnings, probably 22 after the most recent sell-off, maybe 23, on the forward earnings. And the revenue growth is still over 30%.
Meb: Right, which is the whole point. I mean, going back to you were talking about Buffett earlier, it’s two sides of the same coin. I mean, PE ratio is one thing, but growth is the other part.
Kevin: Without the G the PE means nothing because you’re buying the future earnings. So you want to… You gotta know what the slope of the curve looks like. I mean, this is basic math. As Charlie Munger says, “All investing is value investing.”
Meb: He also says in his recent Berkshire meeting or it might have been the local LA meeting… Have you been to one of the “Daily Journal” meetings? We’re gonna have to drag you know if not.
Kevin: No, but we are going to Pasadena sometime soon. I mean, I know that’s where Charlie is.
Meb: There’s only so many more chances, by the way. I mean, he’s like mid-90s at this point. But he also says, I think it was a young student asked him for advice, and he’s like, “Look, you should fish where… You’re a fisherman.” The analogy was, “Go where the fish are.” He’s like… If I was young today, studying large caps in the U.S., that’s probably not gonna be where the efficiencies. Me becoming a world-class expert on, I don’t know, Indonesia or some of these other countries may be interesting.
So I wanna now flip the script and play devil’s advocate hater. And the reason I know what the arguments are is because they’re all directed at me on Twitter. So people say, “Kevin, you can’t invest in China. They make up their numbers. Their government is totally,” or any of these countries you mentioned, Brazil. “It’s a socialist country. And the topic de jour. There’s trade wars, all these 1,000 things.” What are some of the arguments you hear the most as to why someone shouldn’t invest and if they’re misguided or not?
Kevin: Well, I think I’ve probably heard everything that can be heard about why this is a bad idea to invest in China. And the ones you pointed out are, you know the other main ones. We don’t trust them. They’re making up the numbers. They’re Communist. And there may be some truth… Well, there’s certainly truth to the fact that they have a Communist government. But they are certainly capitalists and they might be the most capitalist nation in the world today. And, you know, within their borders, lies what could be characterized as the largest free trade zone in the world. Soir the communism equals bad. That part of it I hear a lot.
Making up the numbers, I don’t… People think they’re making up the GDP numbers. I think that’s a bit preposterous. I mean, everybody’s GDP numbers are not precise, but they had a famine that killed 30 million people when they made up numbers during one of their five-year plans. So these are smart people that run this country. Most of them…many of them have education from our best schools. As Burton, likes to say, “Our best export is Ivy League educations.” The guy that runs the equivalent of the Fed was a professor in the University of Illinois before going back.
So I don’t think they’re making up the numbers. I don’t see what is in their interest to make up the GDP numbers. But as I said earlier, corporate governance is the biggest issue. And yes, there are people making up numbers. That happens in U.S. companies, too, by the way. I think that it’s important for people to be careful with governance. So I hear those types of questions the most. I think… I just saw a great video today of Ray Dalio, right now. I think it might have been recorded today, talking about why invest in China. It’s very good and he’s very bullish.
Meb: Let’s send this… We’ll add it to the show notes for the listeners.
Kevin: Okay. For those who are sceptical about China, I think he has a very measured and intelligent and thoughtful reason why you should be investing in China. And you should be, and as he says, “Now.” One of the things I thought when I got started in China, and I finally felt like okay, I understood their government and their economy was that Americans would feel less threatened by China. I’ve been travelling to China, quite extensively, over this whole period since I got involved. And pretty early on, I saw that most of the things I thought were completely misconceptions that I was sort of brainwashed into because of the headlines. And if you read the media, almost every adjective and adverb about China is negative. Every headline has some negative connotation in it and questioning the numbers and that kind of stuff. I thought that that would improve but that has not improved. I think the current trade war and tariff thing is an issue and a risk with China, but I don’t think making up the numbers is.
Meb: As you look out the next 3, 5, 10 years, if you look outside of China, you’ve got a pretty interesting allocation to South Korea, South Africa, Argentina, Russia, Brazil, Singapore, India. What are some of the countries… Now, this is more just like gossip because the index is the index. But what are some of the countries you see… Are there any in particular that you think are particularly interesting of the rest of the emerging list?
Kevin: Yes, India. If you look across the landscape of emerging markets, you’ve got basically over 500 million people in China that still don’t have a computer. They don’t have a smartphone yet, so if they don’t have the…
Meb: Five hundred million people is more than all the residents in the U.S., by the way.
Kevin: That’s true. So you’ve got 500 million people in China without a computer or the internet. And you’ve got a billion people in India that have never had a computer before or the access to the internet. So that’s where the growth is. There’s another 500 million people in the other emerging markets that don’t have a smartphone yet. But India is clearly gonna have the fastest growth in the space. I think every hour, 100,000 people in India get their first-ever computer, and it’s got internet access, and they’re gonna go home tonight and connect with their friends. And that’s got a long ways to go. Leapfrogging is definitely gonna happen in India. It’s happening in China too. So I think that’s the big story now is India and its consumers becoming consumers with a supercomputer in their pocket and cheap internet access.
Meb: I got a great side business for us. You start it because you’re the entrepreneur, the serial. Start a global investment theme travel company. You can go see all the boots on the ground, take people to a bunch of the countries. They wanna go do some due diligence in Indonesia. They wanna go to, who knows, Argentina. Mix it in with a little bit of sightseeing and fun. There you go.
Kevin: We would love to partner with you in that business.
Meb: I know. I’ll invest in it. I don’t wanna be involved in operations.
Kevin: It’s actually part of our business plan. So we’re gonna bring some advisors to China. I think we’re targeting Q1 of next year to do basically an investment field trip. And as Lee knows, my sort of hidden plan in life is to be the Anthony Bourdain of investing and travel the world because I don’t know anything about making food, but I’m really good at eating it. And so my goal is to travel around the world capturing content, as we discussed before the call, eating good food and bringing investors to see what’s going on out around the world because there’s a lot of people who have never been to China. And I think anybody that’s in the investment business professionally, Ray Dalio, makes this point as well, you have to go see it.
Meb: There was a good example. We recorded a podcast recently with a hedge fund manager who manages about a billion. And he said he had never been to China. And he went over there with the intention of being very sceptical. He was like going over almost to like just go look for validation of his thesis. And he said he came back totally the opposite where he said, “Look, we’re gonna commit a 10-year effort to this where we wanna make a bunch of connections, understand the market.” But came back like extremely positive on the country and the investment opportunity he said.
Kevin: So anytime I meet a young person, I tell them, “You have to go to China now. You don’t have a ring on your finger. You don’t own a home. Go.” I really do feel strongly that anybody in the investment business should go see what actually is this China thing. And it’s amazing, I’ve completely fallen in love with the place and the culture. I mean, they have a very, you know, a 5,000-year-old culture. We talk… Family values was sort of a buzzword around the United States a decade or so ago. The Chinese have the strongest family values of any society I have encountered.
Yeah, I think people should go and see it and just the high-speed trains and the density of the people and also what’s going on on their smartphones, right? I mean, they are leapfrogging in a major way. And, in fact, this last trip was the first time that I was denied a purchase because I only had cash. I tried to buy a bottle of water in the Nanjing train station. They said I couldn’t use cash. We don’t do that anymore.
Meb: I’ve heard this story many times. I’m cashless now, by the way. I’ve got no cash in the U.S. But there’s two great examples that I love to tell people. One is what we’re doing right now, which is podcasting. And podcasting in China, on a revenue basis, is like five X that is in the U.S. because it’s a lot more donation and subscription-based when the U.S. is more ad-supported. But this was years ago, so I don’t even know the stat now. But I remember having dinner with someone like three years ago and they were talking about China. And I said, “You know, the Macau, which is relatively new, already does multiples and multiples of revenue as Vegas.”
Kevin: Yes, I think it’s now at least 10 times.
Meb: That’s incredible. Like in your head if you’d asked people they probably say, it’s probably like a quarter of the revenue. No, it’s not a quarter. It’s not equal. It’s 10X the revenue.
Kevin: I have followed that sector very closely and have had some investments in the Wynn. The Wynn Macau property sells in Hong Kong trades on the Hong Kong Stock Exchange. It’s primarily owned by the U.S., listed Wynn, and same with Sands. So Sands is also listed there, Macau Casinos, as a separate thing in Hong Kong. So I love Macau. And they have great food there too.
Meb: Well, good. So we’ll start taking reservations for the Kevin Carter EMQQ Asian emerging market tour Q1 2020. We can start taking a trip around.
Kevin: I love it.
Meb: Look, we gotta start winding down. This has been a lot of fun. I hear you have an idea for a little wager. You wanna tell us about it?
Kevin: Well, as I said to you earlier, we believe that this is the fastest-growing sector ever. And I do a presentation on this emerging market investment topic for a lot of CFA societies. So I’ve probably done 30 or 40 CFA societies around the country in the last 5 years. And I started with a $10,000 bet. I looked at the growth rate for the sector and I’m like, “That’s incredible.” Like, it’s very rarely do I find a single company that’s growing at 30%. And if you grow at 30%, for five or six or eight years, the miracle of compounding is such that you get really big no matter what, if you’re a flower shop or a pizza shop or an internet company. And I didn’t think there could have ever been a sector that’s grown this fast. And so I had a $10,000 reward. I would tell people, “Look, if you find me a sector that’s ever grown this fast I’ll give you $10,000.”
I’m not 100% sure of anything, by the way, but I asked enough of these CFA groups and nobody challenged it. And I asked Burton. And Burton’s been around for a long time and followed the stock market and investing and he didn’t have any ideas. And I thought, “You know, maybe the tire companies back in the ’20s, or, you know, what else could have grown like this?” And after getting zero challenges, I think the fastest sector that someone brought to my attention was the robotic sector growing at 18% or 19%. And I just decided that almost certainly it was not anything that had ever happened before. So our challenge is if you can find us a sector of publicly-traded companies, and there’s a few asterisks and footnotes to what this means, but how many there are and no cherry-picking and stuff like that, any sector ever that’s grown this fast we’ll give you a $100,000 reward.
Meb: But over, like, what’s the time period is it?
Kevin: Well, this is in the footnotes, but I think it’s 5 years and it’s actually…this is a 10-year number, but I think we’ve seen a sector that’s grown at 40% for 5 years.
Meb: Wow, all right listeners, you heard him.
Kevin: Public. Public companies.
Meb: You heard him. Hey, Kevin, this is great. So if someone is interested in this space, they wanna learn more are there any particular resources that come to mind? It can be conferences. It can be books. It could be trade magazines. It could be whatever. Any resources that you think are particularly useful?
Kevin: Well, I think that there is one book that in particular is I would recommend. It’s called “Six Billion Shoppers.” And it profiles this incredible wave of consumers and how they’re becoming consumers as so-called digital natives. And the guy that wrote it, Porter Erisman, is a fascinating guy. He’s an American that ended up working at Alibaba, like in the early days. Like the week that they were moving from Jack Ma’s apartment into their first office, he joined. And he wrote…his first book was called “Crocodile in the Yangtze” which was the kind of the Alibaba story and more recently, he wrote a book called “Six Billion Shoppers.” It just happens to profile this confluence of events, the consumer and the smartphone around the world, and then he profiles China, and India, and Africa.
Meb: I haven’t read that one. Anything else comes to mind?
Kevin: Well, we’ll send you a copy.
Meb: Yeah, sure.
Kevin: If people wanna understand the story, I think that’s the best resource.
Meb: Where do people find more about what you guys are doing, what you’re up to, all your doings and goings-on?
Kevin: You can follow us on LinkedIn. And you can find out more about the index at emqqindex.com.
Meb: We got a last question that we ask everyone. As you look back on your career as all you’ve been up to ever since the days of eInvesting and Robbie Stephens and AlphaShares and everything in between, what’s been your most memorable investment? It could be good. It could be bad. It could be terrible, but just the what’s the one that’s seared into your brain?
Mine, by the way, was very painfully enacted. The trade was put on through E-Trade in San Francisco. Listeners have heard this a million times. We don’t need to rehash my painful option trade blow-up. But I remember where I placed the trade. It would have been in North Beach, in San Francisco, early 2000s. So, but loved that it was, by the way, through the E-Trade brokerage.
Kevin: So I would say the three most memorable investments right now in my head would be shorting amazon.com and picking up the phone.
Meb: How did that end?
Kevin: It ended with me losing a third of my net worth in a day.
Meb: The funny thing about Amazon is that it’s had so many periods of up and down. I mean, it’s had multiple maybe 350 plus… It had a 1% decline. It was like 95%.
Kevin: It had some choppy early times, and, I mean, obviously, I got it wrong. If you had told me 20-whatever years ago when I picked up the phone to dial Burton Malkiel because I just lost all this money shorting an overvalued bookstore, if you told me that the guy I was calling and he and I were gonna start a Chinese emerging market and a China-focused internet ETF I wouldn’t have believed you. So I remember that Amazon short, mainly because of the pain.
And I think my favourite long investment was USG Corp, which is U.S. Gypsum. They make sheetrock. That’s their brand. And it wasn’t a kind of name I would normally invest in. I have a friend who’s an attorney that I do a lot of investing with or at least was doing some stuff with him back then. He brought it to my attention and it was in bankruptcy. And Warren Buffett had bought, I think, 650,000 shares if I’m remembering the number properly, which was the most he could buy without triggering some kind of a corporate pill or something. And he had paid something in the low teens for it. And then they went bankrupt, and he didn’t sell any of it. It was selling it like two bucks or three bucks a share.
And Warren Buffett had paid like I said… Like if it got back to what he paid for it, it was like a six-bagger. And basically the company was in bankruptcy. They were getting sued and they were getting hundreds of thousands of lawsuits filed against them for asbestos from the mesothelioma. And they basically were drowning in lawsuits. It was a hugely profitable business that had gone back decades and was…and they had a great moat. I mean, the sheetrock, to add to their brand. They’re the Kleenex of your house wrapper.
Anyhow, I remember, we went through it in great detail. And essentially, the market cap I think was just a few hundred million dollars. And the Canadian part of the business and the Mexican business. Also, the ceiling tiles you have here, that’s another product that they sort of dominate. And the Canadian and Mexican businesses were not encumbered by the lawsuit and were easily worth a billion dollars. And so this was during the year I was going to Sears a lot after I left E-trade and I had a few bucks around. And I made a pretty big bet on the stock. And the idea was that the company’s… The way that my attorney explained it was like, “This is the golden goose. The lawyers don’t wanna kill the golden goose. They just want a big check.” And so they will write that big check just to get all these lawsuits that were literally drowning them in lawyers and the stock ended up going to $130. But I sold it at $20 to pay for my swimming pool.
Meb: Yeah, exactly. The multi-baggers are the hardest ones to hold on to.
Kevin: Now, it’s a swimming pool. I know.
Meb: You know, because oh, man, I’ve doubled. I’ve tripled. I’ve five X’d my money. And it’s rational in most ways, by the way.
Kevin: And actually now, I’m thinking about another one in that category. It was Macau. So I think the first… One of the first companies I invested in personally was MPL. I think they’ve changed their ticker but it’s Melco Crown, which was when they gave the licenses to Macau there were six different companies that got a concession to make a casino. You talked about Sand and Wynn or Sands and Wynn. This one was Melco Crown and it was set up by the richest guy in Australia, the Packer family. And then the son of the guy that had the monopoly in Macau, the whole family, which they’re all scattered around the casino business now. But those two partnered and they went public on the New York Stock Exchange or on the Nasdaq just to raise money. They had got the license. They had locked up the land. And they were gonna build a sort of Vegas-style casino called the City of Dreams with a Hard Rock and a Grand Hyatt and casinos and Rolls-Royce dealerships and whatever, and the world has started to crash. And they didn’t have a building yet. They had a piece of land. They had all the cash though.
I think Goldman did the deal at like 20 bucks a share. And 11 months later, and I’m guesstimating the timing, but 11 or 12 months later, it was selling at $2 a share. And I remember thinking to myself, I’m sure you’ve heard a million versions of this and probably wrote 1,000 versions of it, but you get your best deals when the sky is falling. And, I think, buying the risky assets because those are the usual things that get hurt the most, you know, “Risky assets” and so I just remember thinking to myself, “I’m buying an unfinished Chinese casino company. I feel good buying that,” when the day the Dow’s down 777 points.” It just felt like a good play.
Meb: There’s an old article we wrote. This has got to be a decade old now at this point but it was a riff on going back to Franklin Templeton and we called it Doing a Templeton where he had bought I think in the Great Depression every stock trading in the New York Stock Exchange trading below $2. It’s like these are all wiped out and I’m sure a bunch of them will go out of business. But it turned out to be an amazing trade and when 2009 happened and I’ll have to look it up on the blog and we’ll have the show notes, we wrote a similar article and then tracked it for a couple of years. And they did great. As you would expect, a bunch went bankrupt, But a bunch had multi-bagger status, but at least in the U.S., we haven’t had that much of a struggle, although we have in some other countries for sure.
Kevin: Yes. And I know Warren Buffett’s line about buying during the panic times. It comes from the last financial crisis, which is “When it’s raining money, don’t bring a thimble. Bring a bucket.”
Meb: Easy to say, hard to do.
Kevin: That’s right.
Meb: You know, when you talk to… We were giving talks over the last five years in a lot of these countries. Then I would say, “You know, I’m excited to talk about your stock market’s cheap,” and everyone was like, basically like, “No crap, Meb. We know but nobody has any money. No one has a job. We don’t have any money to put in because our stock market’s already down 60%, 80%, whatever per cent.” But you can see why and it’s painful and hard to do. That’s part of the challenge, right?
Kevin: That’s it. It is perhaps the hardest single thing to do in the investment business is to take advantage of fear because you are likely gonna be caught up in the fear yourself.
Meb: Well said, Kevin. Thanks so much for joining us today.
Kevin: Thanks for having me.
Meb: Listeners, check out Kevin’s website. We’ll have links to the show note links EMQQ index and all things emerging market, internet, and e-commerce. You can subscribe to the show on iTunes. Leave us a review. We’d love feedback on this episode, how you’re gonna win Kevin’s 100 grand firstname.lastname@example.org. Thanks for listening, friends, and good investing.