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This Interview was originally published by Investorama Magazine of LGT Capital Partners Ltd 2018 was a very difficult year for the markets in general and emerging markets in particular. The markets continued to set new lows, testing the patience of investors. In terms of fundamentals, however, the emerging markets remain an attractive investment destination. The expert and pioneer for investments in emerging markets, Mark Mobius, makes the case in the following interview that this asset class still offers lucrative opportunities despite the challenging market environment.Investorama: From a fundamental point of view, emerging markets (EM) seem to be less vulnerable compared to previous episodes of EM stress. Still, the asset class experienced significant drawdowns during 2018. How do you explain this sell-off? Mark Mobius: The sell-off was primarily due to the strong US stock market and the strong US dollar which attracted investment dollars to the US. The threat and then the reality of a trade war, accompanied by a strengthening dollar, have contributed to a bear market. Currencies have weakened in the vast majority of developing nations, while Turkey and Argentina have suffered financial crises. The MSCI Index has fallen around 16% last year.But there are also some positive signs. These markets remain the fastest growing economies in the world. The International Monetary Fund estimated that EM will grow 4.7% in 2019, more than double the predicted growth for developed countries. Furthermore, FX reserves have increased almost five times, from USD 1.7 tn to over USD 8 tn, between 2002 to 2017. EM government debt (as a % of GDP) is now lower than in 2002. This mitigates concerns about the rising cost of hard currency interest payments. Crucially, intra-EM trade has also increased significantly in the last few years, now representing 41% of total EM trade. This makes local champions far less dependent on developed markets.Most crucially, EM now offer a dramatically more attractive set of companies that no longer follow the developed markets – they lead.**Which factors are clouding the outlook for EM?**From an investor psychology point of view many would become bearish if the US-China trade war continues, oil prices go back up and US interest rates move above a 5% level. But the US-China trade war is beneficial to a number of EM since they will pick up the manufacturing and export business that China has to abandon. As regards to interest rates, much of that has already been discounted and – unless rates in the US go above 5% – much of the interest rate expectation is already in the prices and exchange levels. So those factors cloud the outlook but are, at least for 2019, not critical.**What could trigger the next EM bull run?**A halt in US interest rate rises and a subsequent weakening of the US dollar could trigger an EM bull run. Also positive growth numbers in those markets, although they already are good, would be another trigger. A rise in populist policies would be another trigger. For example, in India there are proposals by the government to cancel farm loans and at the same time recapitalize the banks. This would result in a surge of spendable cash in the hands of consumers resulting in a consumption boom. Although such free spending government policies could result in future financial instability and inflationary tendencies, in the short-term they would be bullish for markets.**Given the current pessimism of market participants, are their fears justified or is it time to take a contrarian approach and buy EM?**Many market participants have been holding off investing amid the recent volatility, particularly in view of falling EM currencies. We should acknowledge that this offers more attractive prices for overseas investors.Every market crisis always creates winners and losers. It is our job as investors to ensure that we can dig out the winners. The sharp drop in currencies and the fall in the market give investors a double opportunity for potential upside.**Where do you see attractive investment potential in EM (e.g. countries, sectors, corporates)?**Countries like Argentina and Turkey, that have suffered the most from the recent crisis, could offer the greatest opportunities. In terms of its economic size and export potential, Turkey could be particularly interesting. However, this is contingent on whether the volatile political situation calms down. At this stage, it is all about winning back the confidence of investors. With the Lira down, any exporter will be in a good position to trade with developed countries. At the same time, the currency crisis makes investments in Turkey relatively cheap.Generally, the global currency depreciation is a big opportunity for EM. It will allow them to grab a bigger share of the export market. Furthermore, countries like Brazil, Mexico and India, for example, could benefit from a continued trade war between the US and China. Brazil could sell more soybeans to China, Mexico could take a portion of Chinese auto parts exports, while India could grab some of the manufacturing capacity moving out of China.As investors, these changes to the status quo and the knock-on effects are where we see greatest opportunities.EM have been the winners of the (hyper-)globalization of the past decades. Is the fact that we have reached the peak of this development and globalization’s momentum is declining a chance or a threat for EM? EM are estimated to grow more than double the rate of developed countries this year. A lot of this growth is coming from intra- EM trade and internal demand.Populations and living standards in emerging and frontier markets have ballooned, creating enormous middle classes with growing consumption levels. Furthermore, there has been a notable shift from traditionally export-driven industries such as textiles, towards sectors such as technology. These new industries tap much more strongly into the home market. When I go to trade shows, it is increasingly the EM companies that have started to dominate in areas such as robotics and high value component manufacturing. Intra-EM and especially intra-Asian trade is a common characteristic for a number of sectors such as technology, fashion, shipping and media.In China, technology ‘unicorns’ are being born with increasing frequency, without ever leaving the domestic market. In Indonesia, entire sectors (such as banking) remain undeveloped, offering numerous multi-billion-dollar markets to tap into for Southeast Asian companies that can combine cultural and domain expertise.These sorts of domestic and regional growth opportunities, regardless of what happens in developed markets, offer resilience at a time when many are concerned about a fallout from the ongoing trade war and a decline in the globalization movement.Therefore, I believe that developing economies are well positioned to generate significant and sustainable returns. As a result, this year we might be seeing more money flowing back into EM stocks.Dr. Mark Mobius co-founded Mobius Capital Partners LLP in May 2018, an emerging and frontier markets asset manager offering innovative and sustainable investment solutions. Prior to that Dr. Mobius was with Franklin Templeton Investments for more than 30 years, most recently as executive chairman of Templeton Emerging Markets Group. Dr. Mobius is an internationally recognized pioneer of emerging markets investing and a member of the Economic Advisory Board of the International Finance Corporation (IFC). His career and influence has earned him numerous industry awards, including most recently the Life Time Achievement Award in Asset Management (2017, Global Investor Magazine) and 50 Most Influential People (2011, Bloomberg Markets Magazine).

**MCP: Can you tell us about your career up to date?**Marcin: My passion for capital markets and investing dates back to university. (My first stock investment at the time proved to be a rather painful experience!) This led me on to an internship at an asset management company and the realization that this was the career path I wanted to pursue.Prior to joining Mobius Capital Partners, I was part of the emerging markets equity team at Franklin Templeton where I co-managed the Eastern European Fund and was responsible for sourcing investment opportunities from the region. I was also a member of both the Templeton’s emerging market private equity strategy as well as the active ownership group – two initiatives that deepened my interest in active investing.**Why did you decide to join Mobius Capital Partners?**I strongly believe in the investment strategy of the firm and the team behind it. I am convinced that an investment strategy which combines deep fundamental research with active ownership can deliver positive risk-adjusted results.By actively engaging with portfolio companies, we aim at creating value by improving their ESG framework and positioning as well as their perception among other investors. At the same time we work with the companies to improve their business operations.During my years at Templeton I observed that the greatest opportunities in emerging markets could be found within the small and mid-cap space. These companies are still relatively undiscovered by international investors and often offer above average growth prospects.Mobius Capital Partners combines all these elements in one strategy and I am excited to be working with their experienced team on the execution of this unique approach.**Where do you see the greatest potential in Emerging and Frontier Markets?**In the current environment we see plenty of opportunities across different geographies. The last twelve months have been particularly difficult for emerging markets as concerns about the trade war and China’s slowdown have negatively impacted many EM currencies and market valuations. But depreciated currencies and low valuations have created opportunities for investors. For example, we see significant potential in the consumer and technology related sectors, which present the largest number of companies with sustainably growing business modelsFurthermore, the vast majority of companies in our investment universe are not familiar with the concept of ESG and the impact it may have on their valuation over the long term, so there is an interesting upside potential there.When it comes to particular countries, I do believe that the Brazilian equity markets offer countless opportunities as the economy is just about to recover after several difficult years. With the new government under President Bolsonaro’s leadership, we are positive about the prospects for the economy and see a number of opportunities in the consumer and industrials related space there.**Why do you believe in ESG investing?**I personally believe that ESG is nothing new to the industry – many investors have previously paid attention to the environmental, social and governance risk factors in their investments, at least to some degree. But I am glad to see that ESG has gained more prominence. By taking ESG factors into account, investors can significantly reduce the risk profile of their investments, which over the long term not only translates into positive risk-adjusted returns, but also positively impacts all stakeholders. I am convinced this is the future of investing.In emerging markets, the “G-overnance” part of ESG investing plays a particularly important role. Despite the significant progress made in recent years, most EM companies still lag behind their developed-markets peers in this respect. There remains great potential for improvements in terms of how EM companies are governed and how minority investors are treated.**Your home country, Poland, has recently been upgraded from an “emerging market” to a “Developed country” by the FTSE Russell, the first country in almost a decade to be upgraded, and the first in Central and Eastern European. What in your opinion were the (economic) milestones since the fall of the Soviet Union, allowing for this re-rating?**Poland’s modern history has indeed been very complex and the country has undergone profound changes economically, politically and socially over the past three decades. Poland’s entry into the European Union in 2004 was a key milestones in our recent history. It created a big opportunity for Polish corporates who were now able to access the common market and it provided significant funding. But possibly most importantly for the first time Poles were able to work and study abroad. This I believe contributed to Poland becoming the dynamic and very entrepreneurial country it is today.**In another life, what would be your dream job?**I could imagine myself as a travel writer, – penning travel guides at some exciting off-the-beaten track location. Even though I cannot travel now as often as I used to, I remain a passionate backpacker, excited about getting to know new cultures, people, places and – last but no least – cuisine! (the spicier, the better!).

I arrived in São Paulo from Dubai in Mid December and found Brazil’s largest city bustling as usual and with the characteristic traffic jams. We had a number of meetings scheduled and people within the business community seemed generally optimistic in view of the incoming president Bolsonaro and his economy or “super” minister, Paulo Guedes.Bolsonaro’s agenda for the economy has two parts. First, fiscal austerity to reduce the public debt and second, increased productivity. On the productivity side, Bolsonaro and his economy minister are planning to pursue a very ambitious agenda to remove bottlenecks to infrastructure spending, cut red tape, and lower trade barriers. This kind of program would be a real revolution for Brazil since the country has generally pursued a closed economy policy. For fiscal austerity, the incoming president is planning to cut public spending, in particular through reforming the country’s costly pension system, while on the other hand raising revenues by selling state-owned assets.There are as many as a hundred state-owned companies which could be liquidated or privatized. These include the Brazilian post offices (Correios), the loss-making biotechnology company Hemobrás, and the logistics planning company EPL. With some of those state-owned companies being among the largest in the country and such a move would add a great deal of liquidity to the stock market and provide opportunities for investors like ourselves. Along with helping the government raise revenues to cut debt, the privatization program would also help to reduce inefficiencies in the respective sectors.The most important privatizations will involve Petrobras, Eletrobras, Caixa, and Banco do Brasil since, together, they account for a large part of the net worth of all federal state-owned companies. The fact that the government is unlikely to relinquish majority control would limit the amount of revenue upside. However, the huge electric company Eletrobras could be liquidated by the government, with the government relinquishing control to a share offering. This could result in over R$10 billion flowing into the pockets of the treasury.It’s important to note that the outgoing president, Michel Temer, had already advanced the privatization plan. Temer’s group had started analyzing the sale of the national mint (Casa da Moeda do Brasil) and sold all but one of the Eletrobras distribution companies. They were planning to put up minority stakes and some federal airports for auction. In addition, the start was made under Temer to auction off railways that laid the groundwork for Bolsonaro to liquidate Valec, the state-owned company which builds, maintains, and operates Brazilian railways.I was pleased to hear that Salim Mattar will become the secretary for privatizations and sales of real estate assets. Mattar is a founder and chairman of the board of the Localiza Rent a Car SA , which he turned into one of Latin America’s largest car rental firms. I remember visiting one of their call centers a few years ago and at the time I was impressed by their efficiency and the innovative methods they used.However, the privatization program faces some constraints. The Brazilian Congress would be the first hurdle but not a major one, according to political commentators. A second constraint would be the Federal Audit Court (TCU), as they are responsible for analyzing such sales. There are also several judicial challenges that come up in such asset sales, but usually, although time-consuming, they are overturned. In my opinion, the faster these constraints are overcome, the better it will be for the country_Since my journey to Brazil Bolsonaro has taken office. And we remain confident that Brazil is on a new path of reform and change. The country will stay a focus of Mobius Capital Partners’ investment strategy, and we have recently made our first investments in Brazil._

Moon Jae-in was elected as South Korea’s president 18 months ago after the impeachment and imprisonment of his predecessor Park. His mandate was clear: drive out corruption and improve corporate governance, particularly at the nation’s Chaebols. It started well: he appointed Kim Sang-Jo as the Head of a Fair Trade Commission. The so-called “Chaebol Sniper” has been a long time governance crusader, and his role was to curb the excesses of the Chaebol. But the initial enthusiasm was followed by disillusionment. Kim Sang Moon’s domestic agenda has lost momentum as reconciliation with North Korea has seemingly become his priorty. And his voters are far from happy: workers repeatedly took to the streets in November to protest Moon’s lack of reform. With an domestic economy in jeopardy and governance reform on the ropes, the “Korea Discount” is back.

Source: Bloomberg

The Rise of the Chaebol Context is key. In the 1960s Park Chung Hee (killed by the head of the CIA in the Blue House, 1979) enrolled the help of leading businessmen to rebuild Korea. The “Miracle on the Han River” transformed Korea from a war ravaged country with per capita GDP below $100 to the economic powerhouse it is today, where per capita GDP stands at near $30,000. The achievement was astonishing – within barely two generations – and it was mainly down to a small group of entrepreneurs and their “chaebol”, the conglomerates they built in the process.[1]The Chaebol touched and continue to dominate all aspects of the economy. There are two dozen or so Chaebol remaining – of which Samsung, Hyundai and LG are the most famous. Their power is enormous – sprawling, interconnected webs of businesses in sectors as diverse as heavy industry and biotech. But with generational change, the Chaebol have fought to maintain their wealth and with that governance has suffered.Misaligned interestsBecause of an incentive structure skewed towards the preservation of control rather than the creation of value, Korean governance has been marginalised. The reasons are varied: 1) why disclose information which could jeopardise a competitive edge or anger customers; 2) why engage actively with financial markets when the focus is to build relationships with a few key clients; and 3) (in extreme cases) why increase your company’s valuation before a transitional period when the top rate of inheritance tax is almost 50%. Ironically, from the perspective of owner-managers and the wider shareholder value movement, there is no quicker way to weaken an owner’s control over a company than to attract external investors who increase its valuation. The result is webs of inter-related companies (despite improvements), excessive cash positions and limited focus on shareholder returns.Pressure to reformUntil recently, it was a given that what is good for the chaebol is good for South Korea. But this has changed after years of scandal and subterfuge. President Moon’s election in 2017 brought optimism around reforms to make Korean corporate governance more transparent, crystalising efforts made by previous administrations. Crucially the National Pension Service has adopted a formal stewardship code in July this year. The explicit aim is to push for better governance, transparency and accountably from its portfolio companies.[2]South Korea is at an economic cross-roads. The high growth days post-Asian crisis are long gone and Korea’s economy grew 2% year-on-year at the third quarter 2018, the slowest on-year growth since 2009. The export model that served them so well is faltering. China is doing to Korea what Korea did to Japan; and this is most evident in Korea’s biggest companies. Samsung Electronics’s market share in China has fallen from >20% in 2013 to less than 5% now; Hyundai Motor & Kia have lost 5% of market share to domestic auto manufacturers. The Korean economy is increasingly reliant on consumption – but consumption growth is tepid. The housing market is over-heating (despite the government’s efforts to dampen it), minimum wage regulation – designed to raise basic earnings – has just pushed jobs overseas, strained small and medium businesses, and reduced Korean competitiveness.

Source: Bloomberg

Opportunity for changeTax reform is rarely a subject to set pulses racing but in Korea it is essential: Korean individuals – particularly the third generation owners of Chaebols – are disincentivised to pay-out cash because they pay so much tax on their income.This goes some way to explain why the Korean market’s pay-out ratio is the lowest of major global markets at 20.8% (even Japan’s at 30% is higher); and why Korean company owners and managers are so pained to raise dividends. Ironically, tax code reform was taken off the agenda by a left-leaning president – partly because it is seen as a fillip to the oligarchs. President Park planned to address it.The corollary of higher pay-out ratios is focusing investment decisions on return on equity or return on invested capital: management deploying capital only when it makes economic sense, not because a client or the chairman says so. Employee stock option schemes – aligning interests between managers and owners – are rare. Adopting compensation structures which align the interests of owners, managers, employees and minority investors would be a marker to international investors that the old, misaligned ways are gone.Investment outlook The outlook is far from gloomy, however. After years of engaging with management teams, we are always impressed by the expertise and dedication they show. Korea is not the finished article, but change is afoot, and this brings the chance for re-ratings. Activist funds are springing up domestically, encouraged partly by the efforts of Elliot Advisors. In November Korean Airlines parent company was engaged by a local private equity house, the first high profile domestically driven activist case. This has sent shockwaves through boardrooms. A recent trip to Seoul confirmed how emboldened locals are feeling. Change is underway and corporations – feeling the pressure from investors – are taking notice.Our approach at Mobius is relatively straightforward: target companies offering earnings and cash flow growth trading at discount to their intrinsic valuations. Avoid businesses at risk from being disrupted by “China Inc.” and seek companies that have experienced generational change of ownership. There are several exciting opportunities in fast growth sectors (medical technology, ecommerce, gaming) but also less glamorous sectors (food products and turnarounds in heavy industry). South Korea is a source of world class intellectual property – from semiconductors to biotechnology and materials science. These companies are leaders in their fields and many trade at steep – and unjustified – discounts to international peers.We are excited about what the future holds. In the near term, it would help if Moon refocused on his agenda.[1] “jae” – wealth or property; and “beol” – faction or clan[2] NPS is itself not unfamiliar with corruption – the Chairman, Moon Hyung-Pyo was caught up in the scandal which ended President Park’s term.

If you find yourself inadvertently sat next to a stranger in India, there are three topics of conversation that will usually be met with a receptive ear. Whilst discussions of the latest Bollywood blockbuster and the fortunes of the Indian cricket team may quickly find consensus, it is Indian politics that can stimulate some of the most engrossingly diverse perspectives. Indeed the long march has now begun towards May 2019, when the world’s largest democratic exercise in history will crescendo in the form of India’s 17th General Election.But for those in need of a more immediate political fix, you need not look further than 11th December. Important state elections are underway in 5 states with a combined population greater than Brazil. Of those, the ruling BJP party oversee three states – Madhya Pradesh, Rajasthan and Chhattisgarh – and their success or failure may be viewed as a barometer of their wider popularity. Opinion polls paint a mixed picture. Whilst it’s clear from history that electorates vote differently in state and general elections, a dramatic loss in vote share for the BJP will re-shape the thrust of their public policy for the remaining six months. The bond and currency markets await nervously for how destructively populist this might be.For us at Mobius Capital Partners, the market volatility driven by sensationalist political newsflow is something to take advantage of. Certainly, the general election in 2014 was significantly more important that the election next year. This is because the India of 2014 was a different animal – bloated by twin deficits, hamstrung by low foreign exchange reserves and self-doubting after years of policy paralysis.Today, India’s productive capacity has been transformed by policy steps and measures that have now been institutionalised by the current government. A sturdier Bankruptcy Law, a well-functioning Goods and Services Tax, a flexible inflation targeting regime and success in financially including more than 300 million Indians through the country’s unique biometric identification system are just a few examples. GDP growth has accelerated from 4.9% in the second quarter of 2012 to 8.2% in the equivalent quarter this year.In the longer term, this will reduce India’s equity risk premium and cost of capital whilst pushing up valuations to higher justified multiples. At the same time, income inequality will narrow through more efficient welfare transfers whilst inflation will trend lower and with less volatility. Huge disruption will take place in the financials sector as the traditional barriers to entry of underwriting, distribution and collection capability are beginning to crumble through the powers of digital disruption. Meanwhile in the shorter term, external vulnerabilities have diminished whilst corporates have emerged from a painful period of balance sheet repair, now limbering up to kick start India’s next investment cycle.It would be trite to argue that everything has been rosy though. Indian equity markets struggled through the third quarter of 2018 due to the unhappy combination of higher US rates, a stronger US dollar, resurgent crude oil prices and a domestic liquidity scare that threatened to snowball into a solvency issue. Meanwhile the local press was whipped up into a frenzy as rumours of a rift between the government and the central bank emerged. Foreign investors pared back exposure and India’s historical valuation premium to global markets began to recede below its long-term average of 20%.Whilst the bears continue to dominate the narrative, an attractive entry point has emerged for the long-term investor. Credit growth has accelerated to a five-year high whilst inflation continues to remain benign below 4%. The policy response to the liquidity crunch has been speedy and coordinated whilst domestic equity flows (which increasingly matters more than foreign flow) have been resilient. Price to book multiples are now below their long-term averages of 2.5x and foreign ownership has shrunk sharply to healthier levels. Despite this, earnings growth estimates are amongst the fastest across the emerging world with more than 20% and 18% expected for 2018 / 2019 respectively.This is being driven by India’s position on its own capital cycle – where the combination of excess capacity, improving demand and continued balance sheet restraint lay the foundation for operating leverage and rising return on invested capital. Indeed it is India’s bottom up, micro story, that will now be the engine for strong equity market performance.As we approach the end of the year and we go through the annual process of making bold predictions for 2019, how about this for size? The BJP underperform in the election, scrabble together a minority government but Indian equity markets outperform for the year. Micro trumps macro.Wishful thinking perhaps, but it’ll sure keep the stranger by your side entertained.

Brief Answers to the Big Questions – by Stephen HawkingWhen reading Stephen Hawking’s final book, which was published posthumously, I was pleased to discover that not only does it give a comprehensive insight into some of the key questions he devoted his life to understanding, but it is also thoroughly entertaining and a truly spell binding read.Despite the rather high expectations raised by the title, what fascinated me more than the “answers”, were in fact the questions posed by Hawking. He attempts to cover some colossal themes from God’s existence, to global warming and the survival of humanity.Throughout, Hawking manages to convey his unsaturable passion for science whilst warning loud and clear that our planet is on the verge of collapse: polluted, overpopulated, and exhausted. Whilst he elaborates on how humanity has consistently destroyed its own natural habitat, interestingly he appears more concerned about the risk of a nuclear disaster by human error, terrorist action or machine failure. He concludes that “the best time to stop the autonomous weapons arms race is now”.On this subject, he provides brilliant clarity on artificial intelligence, touching on both its benefits and its dangers. Hawking warns of the potential damage should humanity fail to tread carefully. However, he believes that successfully creating true AI “would be the biggest event in human history”.I particularly like how he demystifies advanced robotics by focusing on the facts. Often references to AI are misused and emotionalised, especially in conjunction with topics such as machine learning or block chain.The book repeatedly returns to the underlying theme of recognising the longer term consequences of our actions today. Hawking reiterates that the use of our knowledge is crucial in limiting negative impact. He argues that “our future is a race between the growing power of our technology and the wisdom with which we use it”.There are some learnings for investors here: The question of the longer term implications of todays actions is very important when making investment decisions; some products and services may initially look attractive, but future risks need to be factored in. Excessive growth could meet strong regulatory headwinds or end up in existential trouble or have adverse effects on consumers. Take, for example, online gaming and the many unintended effects this has on society in general, and particularly children.Hawking also makes some brief, yet incredibly relevant comments on contemporary politics. While he refers to the election of Mr. Trump a few times in a humorous way, he comments on Brexit and Trump as “witnessing a global revolt against experts, which includes scientists”. He elaborates beautifully on the importance of teaching and learning, “behind every exceptional person there is an exceptional teacher”. This is a great reminder of the vital importance of our educational institutions. Interestingly, it is a subject that we encounter frequently at Mobius Capital Partners. As Asian universities slowly conquer the list of the top schools in the world, a domain previously occupied by the US and the UK, the implications are far reaching for local businesses and the wider societies they serve.Hawking’s death coincided with Einstein’s birthday and his famous predecessor features often in his last book. “Where did his ingenious ideas come from?” asks Hawking. He concludes “a blend of qualities, perhaps: intuition, originality, brilliance. Einstein had the ability to look beyond the surface to reveal the underlying structure”.I believe any good investor should aspire to these character traits. Originality is especially crucial when looking for unique investment opportunities, i.e. the importance of developing one’s own convictions and ideas independently from what others have suggested before.Significantly, Brief Answers to the Big Questions leaves the reader with a positive assessment of technology and how its undeniable power can be harnessed by humanity. Technology helped Hawking communicate, as well as lengthening his life by 30 years longer than doctors originally predicted. As a result, he is of the firm belief that there is much more to come, when facilitating human development.He ends the book with this very encouraging and optimistic note. Motivating readers to look up at the stars and not down at their feet, to be curious and to be persistent.Certainly this must have been his motto in life, and we all can learn so much from this great visionary.

We are living in a world where increasingly, assessing corporate governance factors is becoming a checklist exercise. From a plethora of rating agencies scoring on governance factors, to ESG funds who screen out the worst offenders. In this interview, I speak to Mark Mobius on the limitations of utilising such an approach and what the ingredients are for a great board.Usman: Mark, you have sat on numerous boards. What do you believe investors overlook when they assess the competence of a board?Mark: As active investors, the composition of boards is one of the first things we look at when considering investing in a company. A balanced board has a crucial role to play in maintaining corporate governance standards which we consider an important lever for social, environmental and operational improvements.However, this is not always straightforward. For example, if one looks at Enron, the board seemed to tick all the governance boxes. The board members turned up for meetings, they were aligned as they had personal money invested in the company and they had all the necessary committees. There were independent directors on the board and the board itself was not too big or small nor was it too old or young.Investors tend to focus on procedural issues when assessing if a board is competent and assume these factors produce a well-functioning and attentive board. What is so scary about corporate scandals over the years is that in spite of these companies ticking the conventional boxes of good governance, they failed. In reality, boards are complex social systems which cannot be reduced to statistics.Usman: What are your thoughts on the optimal skillset of a board?Mark: It is important for at least some board members to have strong expertise with the underlying business. Moreover, there must be a genuine interest in the company. A breadth of skills is helpful but a willingness to ask difficult questions is particularly important. These issues cannot easily be assessed by equity investors sitting behind a computer.My experience on boards has been very educational in the sense that I realised, that to do a great job, you have to spend a lot of time and effort studying the underlying business. Whilst serving on the board of an oil company, I quickly realised my knowledge of the oil market was limited and it was necessary for me to learn fast. I therefore asked the President to arrange a tour of the firm’s major facilities, so I could talk to people on the ground and observe what they were doing. This experience was invaluable and enabled me to understand the challenges and opportunities the company was dealing with in a more granular way.Usman: What is difficult for public equity investors to assess?Mark: Whilst many investors and rating agencies are quantitatively scoring companies on board independence, board size, compensation practices, separated Chairman and CEO positions etc, one cannot quantitatively assess ethics and board dynamics.We once invested in a large Mexican retailer partly because of its high corporate governance standards; they were transparent and the executives played by the rules. Then one day, a pair of investment bankers flew in from Wall Street and dazzled the company’s finance director with visions of the profits the retailer could make from the “super Peso”, as Mexico’s currency was being characterised in the press in 2008. The CFO was persuaded, and exposed the company to a huge, off-balance-sheet currency risk by taking a speculative position in currency derivatives with escalating payoff structures that allowed losses to accumulate rapidly.The company, which was very profitable, filed for bankruptcy a few months later with losses approaching $2 billion. There was a lesson here. The company’s governance system was good by Mexican standards, but the CFO didn’t feel it obliged him to be prudent.Usman: So what would the ideal board look like?Mark: In my opinion a well-functioning board consists of members who respect each other. Vice-versa, a management team and the CEO in particular, must trust the board and share complete information in a timely fashion. I have experienced boards where the CEO has hidden information from the board or has failed to deliver complete information in a timely manner. This must not be underestimated. Sending a board pack on a Monday for a Tuesday board meeting is poor practice. These issues are extremely difficult to assess behind a desk. In addition to requiring an understanding of the local culture, they require close interaction with board members and the management team. Even then, board members may not always be honest to investors.Usman: How concerned are you about groupthink in the boardroom?Mark: Whilst mutual respect for fellow board members is incredibly important, this must coincide with the capacity to challenge one another’s assumptions and beliefs. Group think is unfortunately very common in boardrooms. Chuck Prince, the former CEO of Citigroup, illustrated the dangerous power of group think, when he explained Citi’s ill-fated enthusiasm for subprime mortgages and consumer loans in July 2007 in the Financial Times: “..as long as the music is playing, you’ve got to get up and dance.” Four months later Prince resigned, after Citigroup announced a fourth quarter loss of almost $10 billion.Over the years, I’ve observed board members who feel under pressure to fit in, so they’ll be renominated. When executive search firms and nomination committees search for new board members, they often search for compliant people. No one likes a trouble maker. However, in my experience, it just takes one dissenter on a board who can make a valuable difference. Great boards are not afraid of dissent, nor do they discredit dissenters.Usman: What would be your advice to boards and investors?Mark: Boards of public companies must think about all stakeholders, which includes minority investors. There must be a sufficient number of independent directors as a minimum, but this alone is not adequate.Board members ought to be open to scrutiny and should be subject to external board evaluations. In emerging and frontier markets, this is still uncommon. At the same time, boards should make an effort to engage with their investor base: after all, the independent directors are there to represent shareholders. A lack of feedback is one of the biggest self-inflicted problems a board may possess.Investors should also bear in mind that assessing great boards is an art, not a science. Even when a board looks perfect when numerically scored, one must dig deeper into the issues mentioned above. Board dynamics cannot be quantitatively scored: they require human judgement and face-to-face interaction. At a time when flows to passive funds are increasing, it is even more important for active managers to partner with their portfolio companies and provide constructive feedback to boards.