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Exclusive Q&A: Sean Feng, Investment Director, Kresge Foundation

by trusted insight posted 5years ago 7819 views
Sean Feng is an investment director of the Kresge Foundation, a private national foundation that works to expand opportunities in America’s cities through grantmaking and social investing. As a member of Kresge’s senior investment team, Feng and his colleagues manage the foundation’s $3.6 billion portfolio (as of December 2015). 

Feng is originally from China with an early background in science. He moved to the United States after college to pursue a Ph.D. degree in pharmacology, but soon found himself fascinated with finance and investing. He discontinued his Ph.D. study in pharmacology and instead pursued an MBA.
Feng began his career in finance conducting fundamental stock research for Citigroup Smith Barney and later worked as an equity analyst covering U.S. small- and mid-cap stocks at a money management firm. Feng received an MBA from the University of Chicago and a M.S. from the University of Texas at Austin. He is also a holder of the Chartered Financial Analyst designation.

Mr. Feng was recently named as one of Trusted Insight’s Top 30 Rising Stars At Foundations. He graciously spoke with Trusted Insight on March 29, 2016. The following interview has been edited and condensed for clarity.

Trusted Insight: How would you describe your investment philosophy? 

Sean Feng: Focusing on the long-term, thinking from first principles and staying humble.  

My background in science taught me to ask basic questions and to develop my own perspectives rather than blindly following others.
Long-term orientation is essential for institutional investors. While this principle is easy to profess, it is hard to implement. This is because of investors’ herd mentality, investment managers’ career risk fear and institutional constraints at many organizations. Structurally, the market’s short-term focus creates “time-horizon arbitrage” opportunities for long-term investors. Long-term orientation can be a sustainable competitive edge for an investment team, but only when the team has the right culture, incentive structure and long-term capital to truly implement it.  

Second, it is important to ground one’s thinking in first principles and build personal frameworks for investment. My background in science taught me to ask basic questions and to develop my own perspectives rather than blindly following others. In investing, when looking at different industry sectors, asset classes or different countries, I also try to focus on basic questions and to build my own frameworks to guide investment. For example, when evaluating technology investment, I will first step back and try to understand the fundamental nature of investing in technology companies: their business models and cyclicality, tried and tested best practices for investing in the technology sector. Breaking problems down to their first principles often leads to very different solutions.

Third, stay humble. Investing is such an intellectually fascinating yet humbling experience.  There is so much to learn: history, geopolitics, culture and behavioral finance. Knowing what we don’t know, knowing we all have biases and staying curious and open-minded are important.  Maintaining humility also helps me to be a lifelong learner and to build long-term partnerships. 

TI: You studied pharmaceuticals, first in China and then pursued a master's degree in the United States. What spurred the change of your career path into foundation investing?

SF: I love science. After college, I came to the U.S. to pursue a Ph.D. degree in Pharmacology.  Once in the U.S., I soon began to be fascinated by the economy and the market, which were quite different from what I experienced in China. Wanting to understand them, I started listening to The Marketplace (NPR) and reading the Wall Street Journal and still wanted to learn more. In the end, I decided to change my career. I did not continue my Ph.D. Instead, I got a master’s degree and worked in the biopharmaceutical industry for a few years before attending business school. 

There are a lot of similarities between fundamental scientific research and investing. Independent thinking is critical for both fields. In science, I read extensively, formed an independent hypothesis and then designed experiments to test my hypothesis. The same process can be applied to the investment world.
During the first five years out of business school, I focused on fundamental stock research and investing, working on both sell-side and buy-side. These experiences were very valuable. I tried different investment approaches. Eager to find the approach that fits me, I read many books and forced myself to think deeply about my own investment philosophy. In the end, I found that long-term focused, fundamental-based value investing philosophy resonates best with me.  

I joined The Kresge Foundation five years ago. What fascinated me about this job was the opportunity to apply the same fundamental-based value investment philosophy across many different asset classes and geographic locations. We have an excellent team and talented partners across the world; I learned so much from them over the past five years. At the end of the day, realizing that the returns our team is generating will benefit underserved people is a truly rewarding feeling!  

TI: The Kresge Foundation has total assets under management of $3.6 billion. What kind of assets are you investing in? What is the best performing asset class?

SF: We invest in different asset classes globally: public equity, private equity, natural resources, hedge funds, venture, buyout, real estate, etc. The best performing asset class for us has been public equity, generating over 5% annualized alpha during the past 10 years.  

TI: Tell me a little about your team. How do you make decisions and select managers?

SF: We have 14 people in our investment team, including front- and back-end offices. Our team is very stable; there has been no departure of senior team members for 10 years. Our investment process can be summarized in two simple principles:

First, we are a generalist team constructing a portfolio of specialist managers. Each senior team member, including our CIO, has responsibility for managers in different asset classes across at least two continents. Most importantly, we make decisions as a team. We have different backgrounds, debate a lot internally and maintain a strong culture of intellectual honesty. We pick specialist managers because we know how hard it is to generate alpha, and we believe that managers with strong domain expertise and deep fundamental research capability have better chances of outperforming the market.

Second, we separate alpha decisions from beta decisions when constructing a portfolio. We travel around the world, search across asset classes to find specialists or local managers who have true insights and proven capabilities to generate alpha. A portfolio of such specialist managers built from bottom-up research will have unintended over/underweight relative to our benchmarks. We then actively manage our beta allocation to address any mismatch. Picking alpha managers and managing beta allocation are the inseparable parts of our whole investment process.

TI: What is your outlook for emerging markets in the future?

SF: The long-term alpha opportunity sets in emerging markets (EM) is very compelling. The world we are in today is fundamentally different from 15 years ago. Today, driven by industrialization and urbanization, EM comprises at least half of the global output, global growth, global fixed investment and global commodity consumption. The locus of global economic activity and dynamism has been shifting to EM. In another 10 years, it is reasonable to expect that almost half of the world’s largest companies could be headquartered in EM. If so, the composition of global financial assets would change significantly, and global investors would have a much higher allocation to EM. Such a big shift could create many potential alpha opportunities. Constructing the right team and portfolio to take advantage of such a long-term shift represents, in my opinion, one of the best investment opportunities.  

However, a typical U.S. institutional investor might have only 5-10% of its portfolio invested in EM. The big shift to EM is easy to understand, but hard to implement, for various reasons:  historical high EM market volatility (perceived as higher portfolio risk and career risk), challenge of finding managers who can consistently generate alpha, benchmark risk, home country-bias and resource constraints. The diversity within EM and the rapid changes within each EM country, in my opinion, require a different investment approach – a more selective (regarding which country to invest) and more focused (on niche opportunities) approach. 

We approach EM investing by focusing on underlying fundamental changes rather than only GDP growth itself. We look for alpha opportunities instead of beta exposure, targeting long-term structural opportunities and structural inefficiencies. Such alpha-driven and change-driven investment strategy gives us the flexibility to invest across asset classes and to maintain high gross exposure to a country even when its economy is slowing. 

Implementing such a strategy requires deep knowledge and long-term commitment to target markets. In execution, we follow a few key principles: be as local as possible and truly understand the culture, history and political system of a country; build our frameworks for each country based on top down research and bottom up fundamental diligence; be asset class agnostic; ensure manager evolution mirrors changes in macro fundamentals. When traveling to emerging markets, we not only meet with potential partners in different asset classes, but also spend a significant amount of time visiting local companies in different sectors. Meeting with local entrepreneurs and management teams often gave us additional insights that we would not have been able to get from investment managers. It also helped us to discover structural niche opportunities early on.

TI: China has been the center of discussion in a lot of investment news. Given your background and financial experience in China’s market, how do you think the future will hold there?

SF: We are a long-term investor in China and currently have significant overweight in the country. We are excited about the opportunity sets coming from some long-term structural changes and structural inefficiencies in China. China has been changing its economic growth model. We have been proactively shifting our China portfolio to mirror such changes. Recognizing the long-term secular growth opportunities in healthcare and selective consumer sectors in China, we began partnering two years ago with sector/subsector specialist funds to take advantage of specific niche opportunities.

I was trying to find a simple and different framework for country allocation. The concept is quite simple: to view a country as a company.
Our knowledge of the country, our focus on key structural changes, combined with our ability to internally manage our beta exposure allows us to be a true long-term investor in China. As the Chinese economy continues evolving and its capital market matures, we see even broader opportunity sets going forward. Above all, staying local and nimble, anchoring on our long-term tenants, and maintaining a cautious optimism will be key as we continue to evaluate opportunities in the country.  

TI: Can you elaborate more on the future of healthcare and consumer sectors?

SF: The healthcare and consumer sectors are both long-term global secular themes that most investors are already aware of. However, drivers of these themes are very different for different countries and/or subsectors. We prefer to find opportunities from fundamental bottom-up, focusing on niche sector opportunities where long-term capital could have a sustainable competitive edge. We also like to focus on identifying the right partners to execute on the thesis.  

In healthcare, we see most opportunities residing in the U.S., China and India. Opportunities in the U.S. healthcare sector are driven by an aging population, unsustainable healthcare spending and true innovation, while opportunities in emerging markets are mostly catch-up spending stories driven by a supply-and-demand mismatch.  

In 2012, per capita healthcare spending in India and China was about $60 and $320, compared to $4600 and $8900 for OECD and the U.S. India and China’s total healthcare spending are about 4% and 5% of their total GDP, compared to 18% in the U.S. At the local level, the EM healthcare opportunities are driven by rising income level, urbanization, aging population, healthcare reforms and access to insurance, for example. Considering the size and growth potential for India and China, these opportunities are huge and long-term in nature. For example, in China, total healthcare spending is expected to increase from $350B in 2011 to $1T (7% of GDP) in 2020, resulting in double-digit growth opportunities for most healthcare subsectors. Such change has been creating different types of investment opportunities such as consolidation, local replacement or true global competitiveness. India, on the other hand, has the least developed healthcare infrastructure, lowest spending on health care among BRIC countries and an even higher growth potential.     

Global consumption drives much of the world’s economic expansion. We see many interesting consumer opportunities in the emerging markets. Over the long-term, we believe that investing in dominant consumer businesses in emerging markets is a better way to get exposure to emerging markets. In China, consumption upgrades and technology are creating new business models and different investment opportunities. India is a different story - almost 90 percent of India’s workforce has been engaged in the informal economy, and farmers still make up the majority of the population. The opportunity in targeting middle- or lower-income consumers in India is especially fascinating.

TI: How do you decide which country to invest in?  

SF: I got this idea on a long airplane ride. I was trying to find a simple and different framework for country allocation. The concept is quite simple: to view a country as a company.  

When evaluating a company’s stock, we typically examine the company’s economic model, or “competitive moat,” the quality of its management team and its current stock valuation, in that order. We can use the same framework to understand the long-term investability of a country: a country’s long-term comparative advantage in the global market is the most important factor, followed by the quality of its leadership and current stock market valuation. 

Using such a framework, it won’t be hard to understand the long-term “moat” of the U.S.: strong innovation, outstanding higher education, strong soft infrastructure -- legal system and sophisticated capital market, rich natural resources and excellent geographic location. The U.S. can be viewed as the “quality” stock in a portfolio and should deserve a high core position.  

The same framework can be used to understand Europe, India, China, Brazil and other countries. Anchoring our thoughts on understanding the long-term comparative advantages of different countries can provide additional insights and perspectives in thinking about overall asset allocation and portfolio construction.    

Of course, there are many other ways of looking at asset allocation -- by asset class, sector and risk factor. We can also add other factors to the simple framework mentioned above, such as long-term debt cycle and development of capital markets.  

TI: What career advice would you give to the more junior investors out there?

SF: First, discover and internalize some core tenets of long-term investing through reading books, talking with smart investors and investing in markets. Think hard to find the investment philosophy that fits your personality. 
There is no fixed formula, and there is no one right way of investing. Be a true lifelong learner!

Second, think independently. Try to develop your own frameworks to understand the world of investing, different asset classes and countries. Frameworks can evolve, but it is better to build frameworks to guide investments.  

Third, stay open-minded, and stay curious. Investing is such a fascinating career. The world is changing everyday and institutional investment constantly evolves. There is no fixed formula, and there is no one right way of investing. Be a true lifelong learner! 

TI: You mentioned reading multiple times. If there is one book you would recommend to any investor, what is it? 

SF: The Berkshire Hathaway annual letters. If you have time, go back and try to read all of them. 

Learn more about Top 30 Rising Stars At Foundations on Trusted Insight.