Richard Cook, “Where there’s mystery, there’s margin”

I’m a sucker for an intriguing headline, and CityWire’s John Coumarianos came up with a doozy: “EM managers had (another) year to forget. But one fund defied the gloom” (1/9/2023). The triumphant reveal was:

only one out of the 816 funds in the Morningstar Diversified Emerging Markets category with a 2022 track record posted a positive number. That was the relatively unknown Cook & Bynum fund (COBYX), which returned 9.29%.

There are four problems with that announcement. They are

1. Morningstar does not list 816 diversified emerging market funds. Mr. Coumarianos gets that from a performance chart at Morningstar, but the number is inconsistent with the rest of Morningstar’s data. A screen on 1/31/2023 gives 763 results which is wildly misleading because …
2. The 763/816 number double counts dozens of funds because it is actually reporting each share class as if it were a separate fund. By this tally, American Funds Developing World Growth & Income counts as 19 separate funds. It’s actually one fund with 19 different marketing agreements, each enshrined in a separate share class. If we count each fund once, the Morningstar tally drops to 226 funds, but …
3. The tally ignores ETFs which are substantial players in the emerging markets and direct competitors with traditional funds. Lipper’s database, which the MFO Premium data screener draws from – and which, unlike Morningstar.com, allows head-to-head comparison of funds and ETFs, shows that you had 346 distinct options. Of those, four – not including COBYX – posted positive returns, including the slightly loony 105% gain registered by iShares MSCI Turkey ETF (TUR). All of which is dwarfed by one final concern …
4. Cook & Bynum Fund is not an emerging markets fund, regardless of what box Morningstar drops it in.

The Cook & Bynum Fund launched on July 1, 2009, and was modeled on a private fund that the team has run since August 2001. We wrote in our 2013 profile that the managers pursued a concentrated, absolute value portfolio. The translation is (1) they are willing to hold substantial positions in a very few stocks, and (2) they are willing to hold cash when they don’t find compelling opportunities in the stock market. We noted:

They’re willing to do what you won’t. Most of us profess a buy low / buy the unloved / break from the herd / embrace our inner contrarian ethos. And most of us are deluded. Cook and Bynum seem rather less so: they’re holding cash now while others buy stocks after the market has doubled and profits margins hit records, but in the depth of the 2008 meltdown, they were buyers. (They report having skipped Christmas presents in 2008 in order to have extra capital to invest.) As the market bottomed in March 2009, the fund was down to 2% cash.

They have been investing in the emerging markets since 2006, most famously in Latin American bottlers and distributors of Coca-Cola products. And they have been successful at it; by Mr. Cook’s estimation, over the history of the firm, their EM picks have substantially outperformed the emerging market index. Nonetheless, they define their investable universe much more broadly:

At Cook & Bynum, we are long-term investors in undervalued businesses that have sustainable competitive advantages and are run by well-aligned managers. We identify these businesses through immersive, on-the-ground research around the world, and we think carefully about which companies fall within our circle of competence. Since 2001, we have consistently applied this strategy in global public equity markets to companies of all sizes.

The fund has only owned 31 stocks since inception and rarely holds more than 10 at any time. Depending on how you count ownership of two separate share classes of Liberty Latin America, the portfolio currently holds eight stocks and has 65% of its assets invested in Latin America.

Cook & Bynum is an intriguing fund. It has substantial EM exposure. That still does not make it an emerging markets fund.

Assessing Cook & Bynum’s performance is tricky because they have always been so independent that they’re a poor match for most any peer group. The average EM equity fund has a higher correlation with the average global large value fund than Cook & Bynum has with either. And because Morningstar recently shifted the fund’s peer group, the long-term performance table is gibberish. Taken at face value, Morningstar now says that in 2013 the fund made 11.3% while its average peer lost 0.1%, making it the worst fund in its class.

Here’s the snapshot of the fund since inception from MFO Premium.

Comparison of Lifetime Performance (Since 200908)

So over the long term, the fund has lower returns (5.7% vs. 7.4%) than its peers but dramatically lower volatility (11.5% standard deviation vs. 16.1%), giving it a comparable risk-return profile. The fund has had three down years in the past decade (2015, 2018, 2020), a period that strongly favored all of the things that the manager strongly dislikes: high-priced, high momentum, high volatility story stocks whose stock performance is disconnected from the prospects of the underlying business.

So what are they doing in the emerging markets? We spoke with manager Richard Cook in late January 2023.

The first part of his answer is that they seek undervalued stocks. The emerging markets may be the world’s last reservoir of high-quality, undervalued businesses. While the US market is cheaper after the 2022 swoon, it’s by no means cheap. That means that opportunities might be few and fleeting.

Manager Richard Cook

The second part is that he wants to invest where he and his team can add value. Much of the US market is highly efficient, and the traditional pockets of inefficiency have contracted. “Private equity makes small caps much more efficient,” he argues, “which makes it hard to find excess return.” The emerging markets, contrarily, are marked by “less sophisticated investors using less sophisticated tools, which creates more possibility for us to uncover and exploit mispricing.” Many EM corporations have no investor relations team and might issue their investor documents in a language other than English, which keeps many investors away. Of the nine stocks in his portfolio, he’s the only fund investing in one and one of only two funds into a couple more.

The opportunity set is tempting enough that his investors encouraged him to launch a new private fund to pursue them exclusively, the Cook & Bynum Emerging Markets Ex China, LP, which is available only to high-net-worth investors. That said, in its first six months, the fund is up 22% net of expenses while the MSCI Emerging Markets Ex China Index declined by 2.6%. In explaining their decision to avoid China, Mr. Cook noted that “Many Chinese businesses are driven by the government, and we’re trying to avoid those businesses since we don’t have any idea of what the government is going to do. We want to avoid government entanglement and invest in high-quality businesses with durable advantages when we can buy their stocks with a sufficient margin of safety. It’s that simple.”

Bottom line

Cook & Bynum are in the emerging markets and will remain precisely as long as they believe they’re finding the best value in the world there. If the locus of value changes, say back to the US, that’s where the portfolio will go to. While Mr. Cook admits that valuation cycles can last decades, he counsels potential investors not to count on it or on C&B’s permanent presence in such markets.

The fund is disciplined, consistent, sensible, and distinctive. It has had a horrendous five-year run which net returns of 0.17% annually (per Morningstar). Prior to the period when the Fed subsidized irrational risk-taking and investors rewarded managers who targeted great businesses and good prices, COBYX had first-tier returns.

Much of the question is, have we moved past the period of “investing as a Fed feeding frenzy?” That is, is the decade ahead likely to be marked by more modest returns and a more consistent link between valuation, corporate strength, and market returns? If you think so, Cook & Bynum might well warrant more of your attention than it has lately received.