Letter to Shareholders
December 23, 2011
One Financial Place
440 South LaSalle Street, Suite 3900
Chicago, Illinois 60605-1028
Dear Shareholders and Friends,
As the holidays approach, I want to welcome the many new individuals, registered investment advisors and investment banks who have selected our professionals to manage a portion of their assets. We are especially appreciative of receiving these additional funds at a time when we feel there are so many undervalued companies in both developed and emerging markets. Personally, as a bargain hunter with a conservative bias, I take great comfort in believing that investors are mispricing a good number of well-managed companies with sound business models and strong balance sheets. What is especially attractive is that many companies have dividends near or above the current yields of U.S. Treasury bonds. We could not have wished for a nicer gift this holiday season.
Economies are Transitioning to Promote Sustainable Growth
Both developing and developed countries are in the midst of adopting more sustainable economic models. This transition suggests country growth rates will slow over the next decade as governments and businesses realign their focus.
Asia’s past economic growth model emphasized infrastructure investing and the export of consumer goods to the developed countries. When foreign sales eventually slowed, Asian consumers did not have the buying power to absorb these previously exported goods. Given consumption in Asian countries represents about 42% of their Gross Domestic Product (GDP), versus 65% in Europe and 72% in America, it will likely take the better part of a decade for new government policies in both developed and emerging regions to shift the size of their consumer sectors to where both have similar weights. This should largely eliminate the trade imbalances that created the excessive debt in developed markets.
Fortunately, many emerging market governments have solid balance sheets and large reserves to finance this effort. The developed countries need to invest heavily to replace aging infrastructure and to incentivize businesses to produce competitive exports, but, given most are heavily indebted, this could take them much longer to accomplish.
Factors that Drive a Country’s Growth
Economics 101 tells us that the major driver of a country’s growth rate is the amount that its government and private sector invests in productive capital equipment. This amount comes from encouraging citizens to reduce their domestic consumption as a trade off for strong, sustainable future growth. A country’s ability to invest more than normal to stimulate their economy in a recession depends on their balance sheet. Countries with low debt-to-GDP ratios can use this avenue to promote their growth in challenging times, but deeply indebted countries do not have this option.
The economic characteristics below come from the countries projected by the International Monetary Fund (IMF) in September 2011 to have the highest 2009-2016 growth rates:
Started with higher savings to GDP rates
Started with higher investment to GDP rates
Had lower debt-to-GDP ratios
Had budget surpluses or lower deficits
The IMF study also projected that the average credit quality of these countries would improve over the seven-year period, resulting in lower debt-to equity ratios and lower budget deficits than at the start of the period.
Some of the countries whose above average projected growth is supported by the ratios mentioned above include:
Europe: Norway, Sweden
Middle East: Israel
Latin America: Chile, Columbia, Mexico, Peru
Developed Asia: Hong Kong, Singapore
Emerging Asia: China, Indonesia, Korea, Philippines, Taiwan, Thailand
Regional Growth Projections
The IMF projects that the 24 MSCI developed countries will grow on average 3.4% from 2009-2016 versus 8.0% for the 21 emerging markets countries and 9.4% for the 8 in Asia. The ratios discussed above seem to explain the differences in these growth rates. The developed countries start the period with debt-to-GDP ratios averaging 74.1% and they end up higher at 80.6%. The equivalent ratios for the emerging markets are 42.5% and 38.7%, and for those in Asia, 41.9% and 35.4%. It appears that above average growth is the result of a country’s above average level of saving and investment in its productive capacity. While domestic consumption may stabilize a country’s economy, it does not promote growth.
Re-establishing Healthy Growth Can Require Strong Medicine
Borrowing heavily to support excessive levels of consumption has left the United States and many countries in Europe with stalled growth and no funds to stimulate expansion. Sadly, the IMF projections show that indebted countries that increase their debt in an attempt to stimulate their growth will fail, and instead will be left with even greater problems. For example, the United States 2009 debt-to-GDP was 85.2%. Its recent sharp increase in debt issuance to stimulate its economy should only produce a below average 3.9% growth over seven years while leaving the country with an even higher debt-to-GDP ratio (115.4%).
It appears the only way out of this “debt trap” is to sharply reduce consumption (by increasing sales taxes?) and for the government to invest the receipts in job-producing projects that improve the country’s productivity. Business incentives will also be necessary to encourage private sector capital expenditures. The initial indebted developed countries that have been forced by sovereign bond investors to make major fiscal cutbacks include Ireland, Greece, Portugal, the United Kingdom, Spain, Italy and now France. Creditors have not yet forced the United States to implement these painful actions, even though it has the same poor credit metrics as these European countries.
Given the above, our analysts have a strong preference for companies operating in countries with low current debt levels and sufficient cashflow to promote their long-term economic expansion.
Our Portfolio Strategy
We strongly believe investors will benefit from owning well-managed companies with sound business models, solid balance sheets and most with above average dividend yields. Our stock selection is influenced by the stability and growth outlook of the countries where the company does business. Portfolio holdings are carefully diversified across the world’s regions and industries.
While equities are the most volatile asset class, history shows they have produced superior, inflation-adjusted returns over the long term. Solid companies run by experienced managers and with prudent balance sheets have demonstrated the ability to weather a wide range of business disruptions and economic storms and to come back more valuable than before. By being able to cope with challenging times better than their weaker competitors, these companies should be able to use their advantages in scale, lower costs and greater access to capital to increase market share in their industries and acquire valuable companies or divisions at fire sale prices. Like us, company managers with long-term horizons recognize that difficult environments may offer exceptional buying opportunities.
Your Portfolio Manager and Others in our Firm are Fellow Fund Shareholders
To demonstrate my personal belief in our investment approach and in an effort to avoid any perceived conflicts of interests with shareholders, I keep100% of my personal stock market investments in the three Thomas White Funds.
I encourage you to stay abreast of the important events occurring in the forty-five countries covered by our analysts. Their insights and observations are available at www.thomaswhite.com. You may subscribe to this content on the site.
Enjoy the holiday season and have a prosperous 2012,
Thomas S. White, Jr.
Chairman and Portfolio Manager
Past performance is not a guarantee of future results.
Opinions expressed are subject to change, are not guaranteed and should not be considered recommendations to buy or sell any security.
Mutual fund investing involves risk. Principal loss is possible. Investments in foreign securities involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks are greater for emerging markets. Investments in smaller companies involve additional risks such as limited liquidity and greater volatility.
Diversification does not assure a profit nor protect against loss in a declining market.
The MSCI All Country World ex U.S. Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets, excluding the United States. One cannot invest directly in an index.