The current investment environment
Caroline Cai: It's very exciting for us as value investors. So, you know, value what it really means is you're sensitive to the price that you pay for something. The starting point of valuation spread in the marketplace we view as one of the best indicators of long-term expected returns. Despite the poor value turn that we've had since the middle of 2020, the middle of the pandemic, we are still looking at one-half to two standard deviation wider valuation spread today versus the long-term average. And that's a very exciting starting point.
The reason it's still that wide despite the last two years of value outperformance is how extreme things were in the middle of 2020 at valuation spread widened to four standard deviations above the long-term average at that point. We see absolute and relative valuation that we're paying to buy good, interesting businesses, and I wouldn't say this is the most extreme that we've seen. Middle of 2020 definitely is, but it's a very attractive starting point today.
Caroline Cai: On a global basis, we've been more exposed to Europe for some time now, and that continues to be the case. But emerging market has become much more interesting to us over the last two/three years for very obvious reasons. Things aren't going that well in emerging market for COVID-related shutdown reasons, for geopolitical reasons, and the valuation has corrected quite a bit.
I want to spend a few words on emerging market because I think that's particularly interesting. You know, if you look at our portfolio three years ago, we had fairly limited exposure to China. Today it's becoming one of the countries where we're most heavily exposed, and that's really a reflection of what's in trouble today naturally where the valuation potentially presents more opportunities. And we think this is the first time in the last decade or so that you're actually getting paid to take on some of that China-specific exposure. So we're very excited about that.
Brazil, we see a lot of opportunities there. We think we had the highest number of new names that entered the portfolio in the last quarter or so, which really speaks to how excited we are about the opportunity set in EM today.
Now if you look at it sectorally, the cyclical end of the market is still where we're finding a lot of opportunities, consumer discretionary, industrials, financial services, and technology; but increasingly, we’re starting to see some healthcare names becoming more attractively valued for us. Energy, this is an area where we were much more heavily exposed going back to the three years, but given what's happened to the valuation, we've been trimming back in our exposures there over the last year or so.
Navigating the past few years
Caroline Cai: If you look at kind of what makes for a great value investor over time, it is really understanding and properly assessing what's the risk of permanent impairment or structural change versus what's temporary and potentially cyclical. So, we think our focus on understanding what's the core value add of a business enhances whatever the new development may be that adds or subtracts from it has served us well over time. The outsourcing movement to China what does that mean for developed world companies? The emergence of e-commerce there are massive permanent value destructions for some industries.
We've navigated all these things well and the emergence of AI and the rapid development there is something that we are paying a lot of close attention to, to make sure that we're properly assessing the risk this presents for some of the businesses that probably will come into our cheapest quintile screen but also recognizing the potential for some of these businesses to take advantage of the emergence of this new development and get to a much, much stronger franchise and earnings power at the other end. That's something that's on our mind and we're very vigilant.