Diversification to reduce correlation within the portfolio, is one of the holy grails of investing. The issue with diversification is correlation tends to rise, often times dramatically, during times of stress. But over a longer time horizon, like watching paint dry, it tends to do its job. AQR recently put out a piece advocating for international equities, arguing the international diversification factor won’t save you in the short term, but likely will save you from painful longer term bear markets:
However international investing often can’t pass my own screen for investing because of my yield test. Simply put, I want and need durable longer term yield, and international index investing doesn’t get me that. Sure, the Brazil ETF (EWZ) has a double digit yield today, but that’s on the back of high concentration in resource companies doing major dividends on due to high commodity pricing. If I want big exposure to Vale, PBR, etc. – I can just do that directly.
Asset managers are another way to get broad exposure to factors by taking different risks. The increase in risk is single name exposure, a material risk versus indexation. What one gets in return is exposure to a cash machine that generates its earnings from a diversified set of products, underpinned by a track record of positive value for its clients.
I’ve likely mentioned Vinci Partners in the past. It’s an asset manager whose business comprises of 50% private capital and 50% publicly marked capital. Since its 2021 IPO, the stock price is off from $15 to $8 / share due to a major slowdown in AUM growth. Its balance sheet generates $20M of current earnings and the asset manager does about $30M, annually. Market value of the equity is about $425M, and it pays out about 35M in dividends at its current trough level of earnings on the back of a decimated Brazilian liquid assets market. In 1Q23 alone, 4% of the BRL public equities market redeemed and the market is trading at the lowest relative valuation to developed markets in decades, according to the company.
Earnings likely rise when interest rates in Brazil come off their near 14% level, which may bring flows back in some form to public markets and accelerate private markets flows. If rates don’t come off, the business is has roughly flat net flows in its public markets business, a feat in this market, and modestly positive flows in its private markets business. It likely continues to muddle through, growing slowly, and paying a healthy dividend. One never knows when cycles turn, but getting international exposure through this venue, with a shot at a bad market getting slightly less bad, is interesting.
As always, while the above commentary is about a single name, I personally don’t take concentrated exposure, and we own it as a small part of a diversified portfolio.