The portfolio only holds companies whose valuations can increase by around 10% in hard currency over five years.

One of the biggest risks of investing in emerging markets is governance, and Skerryvore prides itself on the high bar of integrity on its watchlist.

“It kept us from exposure to Russian and Chinese tech companies and kept us away from state-controlled companies where huge corruption is taking place in emerging markets,” Mr. Finegan said.

The fund stays away from Brazilian oil and gas company Petrobras because it is state-run. The company has been implicated in several corruption scandals, resulting in the imprisonment of dozens of Latin American political and business leaders. Former Brazilian President Luiz Inacio Lula da Silva was imprisoned in 2018 for corruption and money laundering.

“To think that Petrobras is a fundamentally different organization today than it was then is naïve. It is a state-controlled company where foreign minority shareholders are not considered by Petrobras decision makers,” Mr. Finegan said.

The fund does not like Chinese offshore listed entities because it believes their legal structure, known as variable interest entity (VIE), is risky.

“Foreign investors have no rights in the underlying business,” Mr. Finegan said.

Under a VIE, a Chinese company sets up an offshore entity for overseas listing purposes that allows foreign investors to purchase shares. This was designed to help circumvent Chinese rules limiting foreign investment in sensitive sectors such as media and telecommunications.

Most of China’s overseas-listed tech companies, including Alibaba Group and, use VIEs, giving them more flexibility to raise capital while bypassing the scrutiny and time-consuming vetting process. IPOs that companies incorporated in China must follow.

Late last year, China’s watchdog changed the VIE landscape that previously had little regulatory framework, and companies seeking to list overseas will now need to obtain approval. before any agreement is made.

Skerryvore takes its name from the tallest lighthouse on the west coast of Scotland, known to help warn ships of rocks.

“There are a lot of rocks around emerging markets: Russia was a big rock and China’s VIE was a big rock too,” said Mr Finegan, who holds a master’s degree in oceanography from the University of Southampton.

Chinese banking and real estate sectors “under tension”

Skerryvore does not invest in Chinese education, media or technology due to weak governance. The fund much prefers Chinese companies listed on the mainland because domestic shareholders offer some protection against government interference. The portfolio invests only in private companies.

The fund also avoids investments in the Chinese banking and real estate sectors.

“All of these are very stressed due to decades of overbuilding and over-indebtedness,” Mr. Finegan said.

As a long-term investor, Skerryvore favors defensive sectors such as the pharmaceutical industry, even though the fund prides itself on being selective. It also requires a long track record before buying shares, which essentially rules out participation in initial public offerings.

“We’re not interested in investing in companies that are developing drugs because it’s quite risky,” Mr Finegan said. “Drug trials can fail and investors can lose a lot of money.”

He is also cautious about the risks of international sanctions if companies developing drugs in China are seen to be operating with stolen intellectual property. This is particularly the case of the United States, which has intensified its efforts to protect copyright.

Instead, the fund focuses on companies that serve pharmaceutical drug developers, such as those operating in customer relationship management.

Chinese clinical trials and research company Hangzhou Tigermed is among 55 holdings in the portfolio, whose investment watch list includes 400 companies from emerging markets.

Skerryvore is reassured by the protection offered by Hangzhou Tigermed’s listing in mainland China, where government intervention in its operations would primarily hurt local investors. Mr. Finegan also likes the business model of the company, which provides services to drug development teams.

“Its franchise succeeds because its customers trust it not only to provide high-quality services, but also to handle their information correctly, instead of allowing other customers to see it.”

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