Search the Internet          Tips  Sites: Finance, Investment

Emerging markets a numbers game for former engineer

Arjun Divecha likes to live by mantras. In the wildly volatile world of emerging markets investing, his best one is "emotion is the enemy."

Since being hired to create the emerging markets strategy at money management firm Grantham, Mayo, Van Otterloo & Co nine years ago, Divecha's approach hasn't wavered: remove the human element from stock picking as much as possible.

The 46-year-old former aeronautic engineer has used quantitative models, plus common sense to select stocks through crises from Asia's 1997 currency devaluations to Argentina's record debt default last year.

In the process, his funds consistently have outperformed. The GMO Emerging Countries III fund and others are among the top performers in their category this year.

"There's a calmness about Arjun," said Paul Gorman, an investment manager at Rochester, Minnesota-based Mayo Foundation, who has invested with Divecha since 1996. "The key is that he uses his models effectively, but doesn't rely on them exclusively."

With the dollar sliding, US stock markets down and interest rates low, emerging markets are back in vogue. Investors searching for solid returns have looked for success stories in less developed countries, where stocks are often valued at a fraction of those in the United States.

Emerging markets funds have stood out in an otherwise depressed market, rising 4 per cent so far this year compared to a 12 per cent loss by US equity funds, according to research firm Lipper Inc.

As a result, GMO's emerging markets portfolio has doubled this year to $2 billion. About two-thirds of that is from new money from big name clients like Harvard Endowment Fund, Verizon Communications, the state of Washington, and the MacArthur Foundation.

Divecha oversees several emerging markets portfolios, including the GMO Emerging Countries III fund, which returned 13 per cent year to date, making it the third best performer in its category, according to research firm Morningstar Inc. The fund returned 15 per cent in the past 12 months, ranking second.

PASSION FOR ECONOMICS

Considering his background, Divecha's reliance on technology isn't surprising.

He received a degree in aeronautic engineering from the Indian Institute of Technology in his hometown of Mumbai, then earned a master's degree in business administration from Cornell University.

He then helped found Barra Inc, a Berkeley, California-based company that designs risk management programs. After helping take Barra public, he began looking for a challenge that would blend his passion for world politics and economics.

"I love exotic places and one of my favorite things to do is read The Economist (magazine)," said Divecha. "I was looking for something where those things could be my job."

When GMO chairman Jeremy Grantham sought to hire Divecha to start an emerging markets department for his Boston-based firm, he accepted, with a condition that his team be based in the warmer, more academic setting of Berkeley.

Today he has eight fund managers and analysts, mainly with backgrounds in physics and computer science.

GLOBAL BARGAIN-HUNTER

Divecha is a value investor, looking for companies that are valued cheaply relative to peers and to the market in general.

The foundation of his model though, is to target countries rather than companies. The strength of markets, especially in emerging markets, is carried by the country's economic health as a whole, he argues.

His team has created programs that tabulate a negative two to plus two rating based on macroeconomic data, whether economic data and company financials are improving, and finally political atmosphere, which requires the most human interpretation.

"It sounds simple, and actually isn't that complicated if you know how to do it," he said. 'But that's the caveat, most people don't."

For example, in late 1998 South Korea came out as a 1.5 rating. Divecha began putting money into the country, which ended up being a hot performer.

Brazil, by contrast, has been in negative territory during the last six months, so Divecha found himself underweight in recent months as fears leftist presidential candidate Luiz Inacio Lula da Silva would win the upcoming elections caused investors to stream out of the country.

Yukos, a Russian oil company, caught Divecha's eye early last year, after the devaluation of the ruble cut the company's costs and rising oil prices boosted dollar-based revenues. The company also was becoming more transparent to attract Western investors.

In January 2000, he began buying Yukos stock for about $1.50 to $2.00 per share -- or about one times forward earnings. In the last few months he's sold shares at closer to $9 a piece, or a valuation six times forward earnings.

In exchange, he's started to buy Russian competitors like Surgutneftegaz, which have copied Yukos' model but are much cheaper.

TOO EARLY

There have been lessons learned along the way, says Divecha.

The most important is to resist the temptation to go into a country too early after it recovers from crisis, even if the model rates give it a positive rating. Divecha learned that after Asia's financial crisis.

After gobbling up stocks at pennies on the dollar, his Asia fund fell 14 per cent in 1998, its first year of operation, and plunged by 40 per cent in 2000.

Of course, when Divecha has stocks he likes, he doesn't sweat the short term losses. The Asia fund already is up 37 per cent this year.

"Arjun has faith in process and at the same time is always looking for a better way," said Peter Muller, a former colleague at Barra and now a hedge fund manager. "It's his view of the universe that's contagious."

ALSO READ:
More Money Headlines