Arisaig: Investing Up The S-Curve

Arisaig Partners is an independent investment management firm founded in 1996. They focus on dominant consumer sector businesses in emerging markets. Their flagship, long-only Arisaig Asia Consumer Fund has ~US$3bn in assets under management and has compounded capital at a low-teens rate of return since inception. They also run an Africa Consumer Fund, a Latin America Consumer Fund and a Global Emerging Markets Consumer Fund.

Over the years, a number of Arisaig analysts have left to start their own investment firms. Many of these firms have a similar investment philosophy and consumer sector focus. Examples include Albizia Capital, Dempsey Hill Capital, Coupland Cardiff’s Asian Evolution fund and Bay Capital. It’s not quite the Tiger Cubs, but you get the idea. 

Given Arisaig’s impressive ~20 year track record, I thought it would be interesting to look at the firm’s underlying philosophy and its investment process in more detail. The source material comes from publicly available talks and interviews with the firm’s founders, which I will include at the bottom of this post for those who are interested.

Why Focus on the Consumer Sector?
It has often been difficult for investors in capital markets to access the underlying growth of emerging markets. Equity indices of early stage emerging market countries are typically weighted towards large but inefficiently run (low ROCE) companies in sectors that are not directly exposed to the domestic consumer. The earning profiles of these companies also tend to be more volatile as they are subject to broader macroeconomic forces that are often beyond their control.

By contrast, leading consumer businesses in emerging markets can often compound earnings at a faster rate than GDP growth. One reason is that companies that are dominant early on tend to stay dominant for a long time and become stronger along the way. We have seen this play out in developed markets with consumer companies such as Nestle, Coca-Cola, Unilever etc. These businesses often have valuable characteristics such as high margins, strong cash flow generation and low reinvestment requirements. As a result, they can widen their “moat” and reinforce scale economies by investing in their brand, product innovation, distribution capabilities and so on.

Arisaig describes the drivers of why leading consumer companies can be so powerful over time:

  • Formalisation – in the early stages of a country’s development, these companies benefit from both substitution and modernisation effects in the retail sector.
  • Sector consolidation – as leading businesses emerge over time, they tend to take share from their smaller rivals. The strong continue to get stronger.
  • Category expansion – this happens both within categories (e.g. moving from bar soap to shower gels, shampoo etc.) and by adding more categories (e.g. Nestle Nigeria able to sell more of its “billionaire” brands in the country over time).
  • Premiumisation – opportunity to move consumers up the product tier within categories. So, for example, consumers would go from “3 in 1” coffee to instant coffee to Nespresso over time. This also tends to push margins up as consumer switch to perceived higher value products.
  • Confluence of macroeconomic factors – urbanisation, access to credit and pent up demand are also drivers of the consumer story.

Arisaig’s thesis is centered around investing in dominant consumer companies that can compound up the S-curve over time. As developing countries move toward middle income status (GDP per capita of ~US$10k), disposable income rises faster than wages and there is a rapid growth in the consumption of basic consumer goods and services. Below is a quote from an interview with James Alexandroff, a founding partner of Arisaig: 

“For now, consumption of the products our [investee] companies sell remains very low. For example, in India the amount spent on personal hygiene and care products amounts to only about US$9 per person per annum compared to US$250 per annum in the USA and on packaged food only US$24 a year versus US$1,250 in the USA. Nestle in India has revenues of only US$1.5bn, this despite being the country’s largest player.”

Investment Process
Arisaig invests across five themes in the consumer space: eat, drink, wear, wash and shop. They look to invest in dominant businesses which are either the #1 or #2 player in their space. As a result, their investable universe is quite small. In Asia, for example, Arisaig has identified only about 90 dominant consumer companies across the five themes. Approximately 30 of those companies are in their current portfolio. 

Below are the specific criteria they look for in potential investments (taken from their newsletter):

  • Scalability – large target markets
  • Strong “moats” – brands, distribution, innovation
  • Low capital intensity – high ROCE (return on capital employed)
  • Predictability – compounding growth
  • Access – management who welcome their involvement

Nearly one third of the portfolio comprises listed subsidiaries of multinational consumer companies such as Nestle, Diageo, Heineken and Unilever. The remaining two thirds of the portfolio comprise domestic or regional consumer companies. According to Alexandroff, the fact that these businesses “tend to be of much higher quality explains why they tend to trade at higher valuations. But their growth is higher and more predictable. A proforma of our current Asia Fund would have generated 19 percent CAGR EPS growth from 1999 to 2013.”

In order to benefit from this long term compounding, Arisaig tends to have very low portfolio turnover (~5-10% per annum). They have owned a number of their companies for 10 to 15 years and typically do their valuation work on a 20 year time horizon.

Because Arisaig are bottom-up investors, they generally pay little attention to macroeconomic factors. They do, however, find many good opportunities in India, which stands out to them in terms of the quality of its companies – both listed subsidiaries of multinationals as well as domestic ones. By contrast, they have found relatively fewer investment opportunities in China as a result of a more intense competitive landscape and shorter brand histories.

Responsible Investment Policy
Arisaig believes consumer companies that are able to “effectively address Environment, Social and Governance issues will be the long-term winners in the emerging markets in which [they] invest.” They have been pioneers in developing and implementing a responsible investment strategy under the leadership of Rebecca Lewis. I highly recommend reading their excellent annual ESG review, which is available on the firm’s website.

Additional Resources
1) Introductory video on the firm’s website
2) Interview with James Alexandroff at the marcus evans European Pensions & Investments Summit
3) Presentation by Lindsay Cooper at Dixon Advisory’s SMSF & Investment Advisory Seminar