Emerging Markets Mid-Caps are Diamonds in the Rough

Cartica: ESG and quiet activism buttress investment theses

Hamlin Lovell
Originally published in the November | December 2019 issue

Cartica Management, LLC (“Cartica”) is a concentrated, “active owner” in small and mid-cap publicly-traded companies in the emerging markets and has a constructive outlook for these stocks. “Whereas most developed economies may have limited remaining dry powder to stimulate slowing economies, emerging economies have substantial headroom in terms of both fiscal and monetary policy,” says Teresa Barger, Co-Founder and CEO of Cartica. “And small and mid-caps have to some extent been orphans in a bull market narrowly led by a handful of, mainly technology-oriented, mega-cap stocks that come under the umbrella of growth and momentum factor investing.” She continues that, “Value investing has also been something of a Cinderella. The most crowded trade is market cap weighted indices and the S&P 500 is the most crowded trade of all. As of October 2019, emerging market mid-caps have underperformed for nearly three years and are lagging the Emerging All-Cap Index by two standard deviations. We expect some mean reversion.” The firm defines mid-caps using the MSCI EM parameters, with a maximum market cap at the time of initial investment of $9bn. The median market cap for Cartica’s portfolio is around US$4bn. 

Whereas most developed economies may have limited remaining dry powder to stimulate slowing economies, emerging economies have substantial headroom in terms of both fiscal and monetary policy.

Teresa Barger, Co-Founder and CEO, Cartica

Country selection 

“We generally invest in countries with tailwinds: economic growth, positive domestic political and geopolitical dynamics, and reform agendas,” says Emily Alejos, Senior Managing Director and the CIO at Cartica. “These can help to reduce companies’ cost of capital. For instance, Brazil and India are both seeing lower interest rates, accelerating economic growth, and reform agendas implemented by strong leadership. “Given our country preferences, we have some bias to the growth style of investing, but we also have a few value stocks, in financials, consumer staples, and materials,” she adds.

Company selection and corporate governance

Cartica runs a concentrated, high conviction strategy typically owning around 20 to 25 stocks and the top-down analysis does not rule out finding “rough diamonds” in more challenging countries. Barger says, “We are open minded about particularly interesting bottom-up ideas so long as a country is relatively stable, and not significantly declining. South Korea faces economic headwinds, slowing growth and a weak currency, but we have found two entrepreneurial companies independent of the domestic macro situation, which have no links with the chaebol conglomerates that have been widely criticised for corporate governance. Russia is another outlier where the macro environment is clearly not improving, but we have found a very small investment. Similarly, the Philippines was ranked as having the worst corporate governance in Asia, by the Asia Corporate Governance Association annual report. Yet it is still possible to find well run individual companies,” says Barger, who developed the first two corporate governance funds in the emerging markets, for Korea and Brazil, when she was at the International Finance Corporation (IFC) a member of the World Bank Group, where Cartica’s other founders also worked.

The team spends plenty of time on the road doing grassroots research. “We spend two weeks at a time in Asia, where we get different levels of access not only to investee and other companies, but also to suppliers, distributors and retailers, to allow for channel checks. This supplies different levels of information, as well as informing macro work. Our career histories, not least at the IFC, have given us a wide network of contacts in many market sectors,” says Barger, who also has experience of private equity experience in emerging markets. She was Director of Private Equity and Investment Funds at the IFC, when she created the first index for emerging markets private equity and co-founded the Emerging Markets Private Equity Association (EMPEA).


The median market cap for Cartica’s portfolio is around US$4bn. 

Corporate governance is considered on a case by case basis at the company level and Cartica keeps abreast of improvements. Barger, who was Director of Corporate Governance and Securities Market Development at the IFC, hones in on China as having recently made some very constructive changes. “Historically, China was the most worrisome country on corporate governance as they generally did not enforce laws. We are encouraged by domestic reforms in China. In preparation for being both a capital exporter and importer, and MSCI increasing the inclusion factor for ‘A’ shares from 5% to 20% (in a three stage process ending in November 2019) China has made some changes, such as revising securities and criminal laws to allow individuals and companies to avail themselves of the go to criminal court for claims of fraud and fake disclosure. Class-action lawsuits can also be brought against companies. And since 2017, two of China’s stock exchanges have been bringing companies in to discuss financial disclosures, relationships with controlling shareholders, and any irregularities.”

Even so, before Cartica invests, the firm needs to get comfortable with individual companies, and avoids investing in some Chinese companies that are listed outside China. “We have never owned Variable Interest Entities (VIEs), which were really designed to circumvent a legal prohibition on companies investing outside China. We have thought Chinese companies could be vulnerable to tighter criteria on US listings for some years, due to the VIE structure and US sentiment,” says Barger. Nasdaq has recently tightened criteria for smaller Chinese IPOs. Companies structured as VIEs include the “BAT complex” of technology stocks (Baidu, Alibaba and Tencent), which have been disproportionately driving China’s stock-market performance. 

Common stock in privately owned, listed companies 

Cartica avoids controversial legal corporate structures and primarily invests in “plain vanilla” common stock, though some countries do have different share classes offering varying degrees of preference. “For instance, Brazil has a Novo Mercado (which I helped to create while at the IFC) that has a single share structure and other higher standards, and attracts higher valuations than other levels of the stock market that have multiple share structures and lower standards. Most of our Brazilian investments are already listed on the Novo Mercado, though in one case the investment thesis was partly based on migrating a company’s listing onto it,” says Barger. Cartica is not involved in arbitrage trades amongst multiple share classes or listings from the same firm.

Cartica is generally invested in founder, family or group controlled but publicly listed companies, and is nearly always a minority shareholder due to the available free float. Cartica has not historically invested in majority state owned enterprises (SOEs) or quasi sovereigns. “We would never say never, but they can have issues with governance and separating ownership from regulation. Their key goal can be keeping capex low rather than shareholder returns,” observes Berger. “SOEs are also a lower priority as it can be harder to engage with them to promote ESG improvements. Privatisations can be invested in but in practice we have often found their valuations to be rather rich and are more likely to get involved after a flotation. This can be a time when companies are especially receptive to engagement and are seeking to raise their game on corporate governance.”


Cartica’s team of emerging markets and corporate governance experts actively engages with management teams, boards, and shareholders to drive long-term, value enhancing improvements in corporate governance, environmental and social factors. In September 2019, Cartica hired Kate Ahern as Managing Director of ESG and Sustainability.

“We form two theses for each company: investment and engagement,” says Barger. “They must stand alone on the investment thesis, which will be based on typical metrics such as growing revenues, margins, and market share, organically or through acquisitions. The engagement thesis identifies scope to make the company more valuable, based on all three areas of ESG, and we add a fourth category: capital allocation. There are enormous opportunities to improve capital allocation, as many emerging markets corporates are less sophisticated and have had limited interaction with investors. Many companies do not understand the concept of cash drag. We invested in one company making a 35% return on equity that had 50% of its assets in cash earning 1%. Eliminating this cash drag through a two-year programme of capital reduction raised the ROE to 55%, even after setting aside money for capex and opex.”

Cartica is sensitive to local cultural norms here and recognises that some emerging markets companies might keep somewhat more cash than developed markets companies. “We appreciate that as most emerging markets companies are run by families or founders, they naturally want some comfort from cash balances on hand, in case they lose access to capital markets or low-cost funding,” says Barger. “They have not evolved into being strategic with their cash, so are more likely to do share buy backs or dividends than put cash to work in strategic M&A. But in one case we proposed that a company with volatile earnings streams acquire one with a steadier earnings profile to improve the valuation multiple of the combined entity, and they liked the idea.” 

When engaging with companies on ESG, we get very little pushback. Most companies embrace it.

Teresa Barger, Co-Founder and CEO, Cartica

Quiet activism

Since circa 85% of companies in emerging markets are at least 51% owned by families, founders, the state or some other principal shareholder, such as a holding company, Cartica is nearly always investing in minority stakes and is of the opinion that proxy battles would be futile. Therefore, the great majority of activism takes place discreetly. 

She continues that, “The degree of activism varies between companies and probably follows a bell-shaped curve, as some companies have more dramatic engagement theses than others. Engagements tee up in some cases and quieten down in others. We see different types of engagement over time and different impacts from it. We may remain invested after ESG changes are made, if we still like the investment thesis. For instance, one company has dropped foreign ownership limits and expanded its range of properties, and we still like it.” Ownership overlaps with other activists are rare and Cartica has not collaborated with any other activists but may share views with corporate governance teams at some investors.

Negative screening and positive ESG improvements

Exclusion is a small part of Cartica’s overall ESG approach. The emphasis is on identifying companies with high integrity and good ESG practices, sometimes with potential for improvement, particularly in terms of articulating and communicating ESG policies. “We most often find that even if practices are good, policies and disclosures can improve. Therefore, we are open-minded about investing in firms with mid-lane ESG scores that can get them uprated,” says Barger. Where ESG ratings are based on public disclosure, plugging gaps in this disclosure can lead to a higher ESG rating.

The desire to find “ESG improvers” also reduces the likelihood of investing in some industries that are not excluded. For instance, “thermal coal is not formally excluded but the bar would be very high for finding a company in that industry that could raise its ESG score,” says Barger.

“When engaging with companies on ESG, we get very little pushback. Most companies embrace it and are keen to fill out a questionnaire that helps them understand what investors are looking for. We encourage them to seek inclusion in the Dow Jones Sustainability Index, and its criteria also help companies to tackle tricky issues.”

No countries are excluded on ESG grounds (though some countries and/or corporates with exposure to them may be excluded due to individual investor preferences and/or sanctions). “Generally, countries have good environmental, health and social laws and it is enforcement of the laws that is the element lacking in emerging markets,” Barger declares. Therefore, Cartica favours a bottom-up, case by case approach. Just as some companies in emerging markets have higher credit ratings than the local sovereign, so too, some companies in emerging markets demonstrate higher ESG standards than the minimums defined by governments. 

Board diversity 

Cartica is majority-owned by women (though Barger does not recall the firm having ever received a “minority mandate” investment, a special type of allocation from some US pension funds). Barger and Alejos both featured in The Hedge Fund Journal’s 2019 ‘50 Leading Women in Hedge Funds’ report in association with EY and are keen to foster the advancement of women and other minorities in emerging markets. 

One focal point for engagement is encouraging board diversity, not least due to studies showing that companies with at least three women on the board have generated better shareholder returns. “Currently, 14 out of Cartica’s 22 investee companies have a woman on the board, and eight do not yet. Other dimensions of diversity include nationality and ethnicity. We suggested that a Brazilian rail company would benefit from having a North American on the board. Another important metric in Brazil is the percentage of African Brazilians on boards and in management positions. This is near zero in many Sao Paolo headquartered companies,” says Alejos.

A differentiated DC perspective 

Cartica aims to take a unique approach to activism and ESG in emerging markets. The firm’s location also contributes to a different mindset. Cartica find being based in Washington, DC distinguishes them from firms based in New York or London due to differentiated information flow arising from the huge concentration of multilateral institutions, think tanks, embassies and international professionals. “We have the World Bank, the IFC, the Inter-American Development Bank, the Peterson Institute, the Institute for International Finance, the John Hopkins School of International Studies, CFIUS, the Brookings Institution, and the Carnegie Institute, to name but a few,” says Barger. Cartica’s offices are three blocks from the White House, which leads Barger to wryly comment on Trump’s presidency that she “did not expect to see more political risk emanating from developed markets than emerging markets”. Though Trump’s tweets can cause market volatility, they have not impaired the compelling investment case for selected emerging markets mid-caps.