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**Marcin, you have just come back from a trip to Brazil meeting with companies and investors. How did you find the mood six months after Bolsonaro was inaugurated as president?**The mood in the business community has changed since my last visit to Brazil in December, which was shortly after Bolsonaro’s inauguration. There is less optimism now. Both investors and the electorate are waiting for actual progress on the reforms that the newly-elected president has promised, particularly on pension reform. We agree that reforming the pension system is crucial for the economic development of the country. Currently, Brazil’s spending on social security is among the highest in the world. It continuously adds to the high government debt which the IMF estimates will reach almost 90 per cent of GDP this year.**Recently analysts cut their 2019 growth forecasts for Brazil. Does that impact your investment approach to the country?**Not really. The Brazilian economy has gone through a difficult time over the last 4-5 years and there is a lot of room for improvement once reforms begin to progress. Currently, the economy remains depressed and the 1Q19 GDP numbers of -0.2% q/q and +0.5% y/y[1] failed to show an acceleration of growth. However, there are some positive signs: car sales for May 2019 were strong (21.6% YoY)[2], whilst supermarket sales (Abras)[3] grew 8.1% YoY in April (in real terms).We believe that consumer and investor confidence will improve once the pension reform, in particular, is approved and the reform program springs into action.What do you see as the biggest risks and opportunities for Brazil at the moment?The social security reform bill has now moved to the Lower House Special Committee where amendments may be made. The key issue is to what degree projected savings from the reform might be watered-down. The initial proposal foresaw over BRL1.2 trn (c. 18% of nominal GDP) in savings over 10 years. If this falls significantly, which a first congressional committee report seemed to indicate, this might have a negative impact on the Brazilian equity market.Furthermore, apart from the significant increase in debt over the last 15 years, which now limits the government’s ability to increase spending through borrowing to stimulate the economy, there remain a number of structural issues left behind by the previous governments: the significant share of long-term unemployment (5 million workers have been looking for a job for more than a year; 3 million for more than 2 years) has led to a loss in skills and productive capability. The capital-labour ratio in the economy has declined due to insufficient, mis-allocated, and poor-quality investment for a number of years. And with investment lagging, much of the nation’s infrastructure and many public services are in decay.All of this will take time to correct itself. However, we believe Bolsonaro’s reform program, which is centred around free market policies, is the right way forward.Despite the downbeat mood, opportunities remain.Almost 22 years after Brazil undertook one of the largest privatization efforts in history, the new Bolsonaro administration is aiming to repeat, and perhaps exceed, the previous round. There are as many as a hundred state-owned companies which could be liquidated or privatized as part of Bolsonaro’s privatization plan. With some of those state-owned companies being among the largest in the country, such a move would add significant liquidity to the stock market and provide opportunities for investors like ourselves.If the Bolsonaro administration follows through on the privatization possibilities already put in the pipeline by the previous Temer administration, the government could sell nearly USD90bn (c. 5% of Brazil’s nominal GDP) over the next two years (including state stakes in Petrobras, Eletrobras, BNDES, Banco do Brasil and Caixa Economica Federal).Uncertainties remain about the size and timing of the privatisation programme, however the direction is positive – the less state involvement in the economy, the better for the longer-term outlook of the country. While long-term fiscal sustainability depends more on the social security reform than on privatization, the proceeds will nevertheless help fund the government’s transition and maintain fiscal discipline. Moreover, a well-structured privatization push would rekindle investments and improve the efficiency of the economy.Last but not least, another important item on Bolsonaro’s agenda is increasing the trade openness of the Brazilian economy. Brazil is an unusually closed economy when it comes to international trade (export plus imports as % of GDP is only 23.1% which is way below other emerging economies like India or China with 39% and 37.3% respectively))[4].If successful, this reform could lead to improved productivity and increased growth in the longer term.**What are the things you like about the Brazilian market and where do you see opportunities now?**The most differentiating feature of the Brazilian equity market compared to other emerging economies is the quality of management. You rarely find so much focus on return on invested capital (ROIC) and shareholder value creation elsewhere. In Brazil these considerations drive almost every business decision within an organization.Another characteristic of the Brazilian market is a strong desire to improve efficiencies. This is a common theme within Brazilian companies – whether it is an apparel retailer, auto parts manufacturer or a challenger bank- and is usually driven by the adoption of new technologies.During our visits we have been meeting with a number of interesting companies in the consumer, technology, education and industrials sectors. Generally, we remain cautiously optimistic on the Brazilian equity market as valuations are still at a relatively attractive level with strong earnings recovery to come once the economy returns to growth._________________________________[1]Brazilian Institute of Geography and Statistics[2]The Associacao Nacional dos Fabricantes de Veiculos Automotores (ANFAVEA)[3]ABRAS – Brazil Association of Supermarkets[4]EIU, 2017

How frequently have you heard of the following terms over the last 12 months: ESG, ESG integrated, impact, thematic, responsible investing, sustainable investing, ethical investing? If you tend to group all of these terms together, you are probably not alone. As I write this post, I’m sitting in the airport in Zurich, where I’ve been meeting prospective clients. At the start of one meeting here with a family office, the principal sceptically stated, “oh, not another sustainability fund!” Wariness from clients today is unsurprising given the vast number of terms which are thrown around in the public domain, combined with an abundance of products which are somehow linked to ESG.However, the active ownership approach we take at Mobius Capital Partners is differentiated from mainstream sustainability investing. Our investment philosophy focuses on actively improving governance standards and delivering a clear ESG pathway for our portfolio companies in emerging and frontier markets. As we have previously written about governance issues [see post “Governance is Key” by Mark Mobius], in this post, I will focus on how we approach ESG integration, and in particular, how environmental and social factors impact pricing, growth, cost savings, and risk.Whilst there has been considerable progress in Europe and the U.S. with regards to ESG standards, many companies in emerging and frontier markets lag behind their peers in developed markets. This is particularly true in small and mid-cap companies in emerging markets which are often run by entrepreneurs and families. These companies are more likely to suffer from poor investor relations, sub-optimal corporate governance, and provide limited protection to minority shareholders. What does this therefore mean for active investors like ourselves? The approach one takes in these markets requires rigorous research and a tailored engagement plan. Our bottom-up fundamental research considers all relevant information which can improve a company’s operations. We do not constrain ourselves to conventional definitions of ‘ESG’ but also assess political, macroeconomic, legal, and accounting factors. As global emerging and frontier market investors, we are cognisant of the variation of regulatory frameworks throughout our investment universe. Accordingly, we do not employ a blanket policy across our investments, but rather, focus our efforts on our customised active ownership strategy, which assesses companies on a pragmatic case-by-case basis.There are essentially two elements to this approach:

1. Governance

Our area of engagement is very broad, but is focused on increasing long-term shareholder value. Potential governance improvements may be made in, but are not limited to: capital allocation, management remuneration structures, board independence, balance sheet restructuring, investor relations, capital structures, acquisitions, and divestures.When we identify such problems through deep research, we address these in private meetings by partnering with management teams, boards, and controlling shareholders. We strongly believe that a regular constructive dialogue is the bedrock of the active ownership approach we pursue.

1. Environmental and Social

Our analysis goes beyond assessing pure environmental and social factors. We recognise that each company and sector presents unique environmental and social challenges. We focus on how these can be improved and how this can have a positive impact on long-term financial performance. This encourages us to concentrate on material factors such as selling practices, energy efficiency or employee relations. These can, in turn, impact operational areas such as pricing power, market share, operating costs, employee retention, and productivity.We believe environmental and social factors can impact emerging market companies in the following ways:1) Pricing: companies with strong quality assurance, a robust and transparent supply chain, high quality labelling, and packaging will often benefit from a stronger brand over their peers. This allows companies to charge premium prices, and accordingly, benefit from both topline growth as well as the ability to offer higher margin products or services. Taking the infant milk formula sector in China as an example, it is evident that poor supply chain and quality standards, combined with suboptimal health and safety standards hurt domestic Chinese players in the sector. During the melanine scandal in China in 2008, more than 300,000 babies became sick or were hospitalised. As a result, millions of Chinese consumers lost trust in domestic brands and turned to premium foreign brands. The top 20 foreign infant milk formula companies in China increased their market share from 35% in 2007 to over 53% in 2017. At the same time, domestic brands witnessed their market share decline from 41% in 2007 to 30% in 2017. It is also worth noting that prices for infant milk formula have almost doubled over the past 15 years.2) Growth and cost savings: companies with a market leading sustainability profile will benefit from a powerful brand which allows them to grow faster over their peers. Such companies benefit from growing their market share whilst potentially expanding into new categories and segments. For example a bank in Bangladesh which is known for microfinance lending to women has seen faster loan growth compared to its peers. Companies which run their business operations in a sustainable way should also benefit from higher margins and profitability. Whether this relates to reducing their input costs by lowering their utility bills to increasing productivity by lowering employee turnover. One example of this is an Indian beverage company which has seen a 600bps improvement in its gross margin due to lowering its water usage and offering customers the opportunity to recycle bottles. In resource constrained markets, such measures are critical to optimise efficiency whilst yielding tangible results for shareholders. 3) Risk: a body of recent research shows that companies with high ESG credentials benefit from a lower risk premium. This is captured via a lower cost of capital, lower business risk, as well as better access to financing. One example of this is in the banking sector, where we now see several emerging market banks assessing the ESG credentials of companies before they underwrite corporate loans. Companies with higher ESG standards are accordingly benefiting from a lower cost of funding.Evidently, integrating environmental and social factors into an emerging and frontier markets portfolio entails more than relying on quantitative scoring and third-party research. It requires a deep understanding of the business, a thorough analysis of what drives value and a strong awareness of a company’s resource productivity.During our many years of investing in emerging and frontier markets, we have observed a strong link between ESG engagement and improvements in the financial performance of our portfolio companies, particularly in the small and mid-cap sector. We strongly believe that capturing the improvement in ESG standards in emerging and frontier markets offers a greater opportunity to generate long-term returns whilst simultaneously mitigating risk.

Indian elections are particularly cacophonous affairs. As the largest democratic exercise in human history comes to an end after six weeks of highly charged voting, many will be relieved that normal life can resume. However, those hoping for an uneventful result may be in for a rude shock. Exit polls released after the final vote was cast on Sunday pointed to a strong Narendra Modi led BJP majority which looked increasingly unlikely just a couple of months ago. Having shocked global markets five years ago by triumphing with the strongest Indian government seen in a generation, Modi may have even bettered his performance in 2014. The polls pointed to the BJP securing over 300 seats of the 543 assembly which would represent improvement from his 2014 scalp of 282 seats. Markets celebrated with the Sensex rallying close to 4% on Monday.It is worth noting that exit polls have struggled with accuracy in the past. Whilst this should come as no surprise to readers in the UK and the US, India’s 2004 exit polls pointed to the BJP winning between 230 and 275 seats. Instead they ended up with only 187 and were kicked out of government. However since then, polling methodologies, sampling and data granularity have improved significantly which diminishes the likelihood of such a severe miscalculation.However, assuming the exit polls have some predictive power, why should this matter for investors and which elements of the reform agenda would then be prioritised?In a period of global policy turmoil, it’s clear that investors seek consistency and predictability. If an emerging market administration is willing to commit to this whilst embarking on a progressive reform agenda, the market will pay up. Whilst debates continue about whether Modi’s first five years had the hallmarks of a Bernie Sanders style administration rather than that of Ronald Reagan, solace can be found through the comfort of BJP’s fiscal conservatism and peerless focus on execution. This will remain in place. Key reforms such as a sturdier Bankruptcy Law, a well-functioning Goods and Services Tax, a flexible inflation targeting regime and success in financially including more than 300m Indians through the biometric identification system have been institutionalised. These will help expand Indian’s productive capacity and propel the country to faster and more sustainable growth. India’s longer term cost of capital will continue to fall.Looking ahead, a BJP led government will likely take less risks in the short term. The rural economy and small businesses have been disrupted by the short term pains of the Goods and Services Tax implementation, whilst demonetisation was largely viewed as a failed and disruptive experiment. The BJP will reward these two sectors for their continued support through a more supportive policy framework. Encouraging private sector participation in agriculture through introducing a regulatory framework for contract manufacturing would be a positive step. The development of modern, large scale warehousing and storage would reduce wastage, boost farm incomes and dampen inflationary pressures.The longer term reforms of addressing bottlenecks in the factor markets of land and labour will be perhaps be the defining feature of Modi’s next five years. Land acquisition continues to be a debilitating constraint to the creation of mid and large scale infrastructure and setting up businesses. Difficulty in acquiring land continues to be the top regulatory hurdle that stalls projects. Addressing this through a transparent auction process, a creative alternative form of compensation and the acceleration of the digitalisation of land records will go some way to relieve manufacturing stress. Tight and constraining labour laws continue to hinder the scale up of organised large scale manufacturing. State government approval is required for firms employing more than 100 workers to lay off staff. It is instructive that the proportion of businesses that employ more than 100 people in India is dwarfed by the respective share in South East Asia and China. India’s much vaunted ‘demographic dividend’ could quickly deteriorate into a ticking time bomb unless job creation is addressed.Clearly a challenging agenda is set out for whoever emerges as India’s next premier. If the exit polls are correct, whilst continuity will remain in place with Modi at the helm, much change will be required to drive India onto a higher plane of growth.

What we read and whyMy reading is rather eclectic. In fact, algorithms of online booksellers would find it quite difficult to provide me with new recommendations based on my previous purchases.For example, in the last few months I have read “ The Facebook Effect” by David Kirkpatrick, “Trump, the Blue Collar President” by Anthony Scaramucci, “Bad Blood” by John Carreyrou, “Anyway you Can” by Annette Bosworth and “Sycamore Row” by John Grisham. So I’ve gone from internet successes to political commentators, to financial scandals, to healthy living to legal mysteries – in a few weeks.“The Facebook Effect” is a very interesting insight into the rapid growth of Facebook from a small undergraduate online community to the global phenomenon it is today, driven by a visionary Zuckerberg whose overriding ambition has been to connect everyone in the world. The book provides a well-rounded assessment of Facebook’s “rise to power” and includes a critical analysis of how social media has changed our lives, for better or for worse.“Trump, the Blue Collar President” is a highly entertaining and insightful read about Donald Trump by the former and very short lived White House Communications Director Anthony Scarramucci. Scarramucci was fired days after his appointment because of an indiscreet conversation with a reporter in which he lashed out at a number of senior White House officials. While Scarramucci remains a Trump supporter he does not hold back in the book on criticisms either.“Bad Blood” by the Wall Street Journal Reporter John Carreyrou is the incredible true story of an ambitious young woman who promised to revolutionize the medical industry with a small device that would enable a wide variety of blood tests with only one drop of blood. She was able to raise hundreds of millions of venture capital funding and persuaded very prominent names to join her board including former Secretary of State Shultz. Only the device didn’t work. The company went bankrupt when Carreyrou revealed that the firm was cheating by secretly using larger, sophisticated equipment in order to obtain the required results.In “Anyway You Can” the author “Dr. Boz” describes how the keto diet helped her cancer-stricken mother to survive. The diet focuses on high fat and low carb consumption in order to increase the ketones and reduce the insulin in the blood, which has highly beneficial effects on general health as well as weight issues. I’ve tried it and it works.Finally, John Grisham’s bestselling legal thriller “Sycamore Row” takes place in the American South. A white man commits suicide and leaves most of his wealth to his black maid, much to the chagrin of his immediate family. There is a surprise ending which ties up the various threads of the story beautifully. A riveting read.