'The KSE-100 index should be around 60,000 points by the end of 2018,' says co-founder of Tundra Fonder

BR Research recently sat down with Mattias Martinsson, who is the Chief Investment Officer and co-founder of Tundra Fonder - a Swedish Mutual Fund that invests in frontier markets, including Pakistan. Tundra manages about $130 million in its Pakistan fund. Mattias has previously worked at HQ Emerging Markets and Varing Capital. In 2011, he along with his partners started the Tundra Fund. Below is an edited transcript of the interview.

<B>BR Research: When did you start looking at the Pakistan equity market and what made you invest in it?</B>

<B>Mattias Martinson:</B> I came across the Pakistan equity market in 2005 while searching for new ideas to pitch to my institutional clients at my previous company. Back then, I also had a very wrong perception about Pakistan and the same prejudice which many investors have to this date. Mostly because of what is portrayed by the media.

However, for some reason I started looking at the valuations and liked them. There was decent turnover in some of the top stocks and as I dug in deeper, I found out that the volume in the Pakistan market was one-third of Singapore, which was unbelievable. The companies in Pakistan were following international accounting standards and the fact that I could get data on them for 10-20 years and rely on it was something I did not expect, especially from my experience with the Russian market, where we had no actual numbers and had to fill in the gaps ourselves.

It was not until the end of 2008 that I first travelled to Pakistan and met with around 30 companies. Some of these companies were family-owned and had been around for 40-50 years. Their businesses were growing at an average of ten percent and the political or security situation was not having much negative impact on their performance. As I headed back to Sweden and went over everything that I had found out, I realized that this could be an once-in-a-lifetime opportunity for me. I kind of fell in love with the Pakistan market and decided to make it my life-work.

<B>BRR: When did you start your fund and were there any hurdles initially?</B>

<B>MM:</B> Once I had decided to invest in Pakistan, I was looking for the easiest way to do so, which would be through an ETF (Exchange Traded Fund). While India had many ETFs dedicated to its equity market, Pakistan had none. The solution for this problem was to start my own fund dedicated towards Pakistan.

Eventually, after convincing my partners, we started the Pakistan fund with $1 million in October 2011. Our start was not that good as the stock market went down sharply because of a Nato helicopter attack on Salala check post, after which Pakistan also closed down the trade route to Afghanistan. The market bottomed out at the end of December 2011 and since then it has been on ascending.

<B>BRR: How do you convince investors to invest in the Pakistan fund?</B>

<B>MM:</B> Convincing investors is not easy because they come with this set perception of camels on the road, terrorism, and chaos. They expect us to tell them that Pakistan has somehow turned a corner and the companies here would start making profits. We tell them that it is not like that and show them the data from the last 30 years, wherein if they had invested 10 years ago, they would have made fantastic returns. If they had invested 20 years ago then they would have made even better returns. The Pakistani market has always been good. It is not a recent phenomenon.

We do not force our opinion down their throats. We provide them with data and being sophisticated investors they then come back to us with some of the insights. For example, most Swedish investors are surprised to find that volatility in Sweden and Pakistan is almost the same. We try to be smart about how we present the data and try to navigate our investors towards the right direction.
We then show comparisons between Pakistan market with that of other frontier markets and on most of the metrics Pakistan comes out on top. The breadth and depth of the market here is far greater than its peers.

<B>BRR: How is Pakistan's market compared to some of the regional and global peers like India and Nigeria in terms of valuation and risk?</B>

<B>MM:</B> There was an article in Barron's a few years ago where this Pakistani writer used the expression 'perception arbitrage' and I think it is the same case today. If we look at the overall picture, then I would not say that Pakistan is riskier than India or Bangladesh. India has its own problems with respect to its size and diversity; they have these internal tensions too between various states, and the sheer size of India makes it much harder to manage.

However, both India and Pakistan are good stories with a young population, but one is trading at almost 20 times earnings multiple and the other (Pakistan) at below 10 times earnings multiple. So, valuation-wise we would go for Pakistan because it is trading at a steep discount.
Moreover, the financial infrastructure in Pakistan is far better than countries like Sri Lanka, Bangladesh, Nigeria, and Vietnam. In Nigeria, we could only find a couple of banks to invest in. There are barely any listed manufacturing and consumer companies there and those which are listed have very little turnover and are trading at very expensive valuations.

For Pakistan, I always ask my investors to imagine the potential they see in Africa and then add financial infrastructure to it.

<B>BRR: How do you select which companies to invest in?</B>

<B>MM:</B> First of all, we try to identify the sectors which are going to outgrow the economy as a whole. We derive this scrutiny from our global experience and ascertain what Pakistan needs right now and pick our companies from there. We also like to invest in companies that can control their profitability, which means that over time we are usually underweight on commodities and energy sector because it is very hard to control the price of your product in these sectors, and therefore control over profitability becomes tough.

We also look at how strong the company's brand is and whether it is able to maintain its margins during inflationary and non-inflationary years.

Lastly, corporate governance is also a big part of our selection criteria. We do not usually invest in companies that have mistreated their shareholders in the past and have not been transparent with earnings reports.

<B>BRR: How were you able to generate significant returns and out performance from 2012 to 2014?</B>

<B>MM:</B> From 2012 to 2013, we made very good returns in the consumer sector and we believe that was probably one of the best themes to invest in during the last few years. As we entered the market, we found that the consumer sector was under-appreciated, so we bought a few percentage points in companies like National Foods, Shezan, and Murree Brewery, which gave us outstanding returns and were the main reasons for our out performance.

Local investors at that time were more focused on dividend and secure earnings, but we were always interested growth stories and almost all of our consumer picks have done remarkably well.

<B>BRR: During the course of the last five years, you have not invested in any car industry stock. Why is that?</B>

<B>MM:</B> Honestly, that was my mistake because my team had brought it up to me several times but I always thought that the competition would come much sooner. I did not expect the incumbents to maintain their position of strength for this long.

<B>BRR: What is your view on the fertiliser sector? Do you think stock prices have bottomed out?</B>

<B>MM:</B> We have always been underweight on the fertilizer sector because we don't see any structural growth in this sector. We also believe that Pakistan is not the place to produce fertilizer either. You can have a great agriculture sector but you can source fertilizer from other places and use the gas for other industries.

Secondly, the demand and supply volatility also makes it an unattractive sector for us. The current situation is a good example where you cannot predict when the inventory surplus would end. So right now we are not bullish on this sector.

<B>BRR: How do you see MSCI EM upgrade playing out?</B>

<B>MM:</B> The emerging market upgrade will be a big positive for the Pakistan market. Many investors are banking on the potential flows that will come into the market and are buying due to this. We think that flows are going to even out as some of the frontier funds will exit while emerging market funds will enter.

However, one thing is for certain; it would be very hard to keep the valuations of Pakistani stocks down to half of what the other countries' stocks are trading at. So, we can see a big upside after the upgrade.

<B>BRR: Recently we have witnessed outflows of around $100 million from the Pakistan market. Are some of the foreign investors worried about devaluation?</B>

<B>MM:</B> According to the math we have done, over 50 percent of the KSE-100 companies' benefit from the currency devaluation.

If you look at the energy and utility sector, everything is priced in dollars. Devaluation would bring in inflation, which would enable the central bank to increase rates, which would be a net positive for the banking sector. The textile and IT sector benefit from devaluation straight away.

If the devaluation is in a controlled manner and there are no wild swings, then it is something we are not worried about.

<B>BRR: What is your take on CPEC? Which companies and sectors do you think would benefit the most?</B>

<B>MM:</B> CPEC is a game-changer for the whole region. I cannot think of any other region where so many things are going on. As far as Pakistan is concerned, there are many projects under CPEC, especially in the power sector, which will propel GDP growth beyond 5 percent. Also, Pakistan is coming off from such a small base that any stimulus will have a huge positive effect on the economy.
As far as investment is concerned, we believe that the trickle-down effect from CPEC would be massive. The small-scale industries, banks, and transportation sector would benefit the most and that is where one should invest to get the full value out of CPEC.

<B>BRR: What are your favourite sectors and where do you see the KSE-100 index trading by the end of 2018?</B>

<B>MM:</B> We are currently overweight on the financial sector and it constitutes around 30 percent of our current portfolio. It is not an exciting sector, but it should give good returns in the near future. Apart from that, I think that healthcare and IT sectors are likely to outperform other sectors such as cements and energy.

As far as KSE-100 index is concerned, if we have smooth sailing and there is no black swan event then the index should be around 60,000 points by the end of 2018.