By Bill Mann
May 19, 2012
Corruption equals monopoly of power, plus official discretion, minus accountability.
-- Benigno Aquino III, President of the Philippines
Dear Fellow Fool Funds Shareholder:
Last month, Tim Hanson and I hopped on an early morning flight from Washington, D.C., to Albany, New York. In Albany we picked up our rental mini-van, which Tim described as akin to driving a sofa. We weren’t in upstate New York to see a company; we were on our way to Saratoga to spend time with the winners of our Annual Report contest.
For reasons logistical, practical, and geographical, it can be extremely difficult for us to meet individual members of our funds, but I have to tell you, I got a great deal out of meeting Joe and Nerie Cannizzaro (pictured below, on the right) from Ballston Spa, New York. They are a lovely couple, and consummate Fools, not to mention enthusiastic hosts and guides. We’re not supposed to make predictions about the future, but I can guarantee that we’re going to increase our efforts to meet more members in the upcoming years.
In fact, we’re kicking off those efforts next month with our annual Motley Fool Funds Open House and Party, which will be held on Friday, June 15, at Motley Fool HQ in Alexandria, Virginia, from 3-7 p.m. This year’s theme is “Where in the world is your money?,” a celebration of our quest to invest in great companies around the world, as well as here in the U.S. So that we can plan appropriately, please RSVP as soon as possible to RSVP@foolfunds.com to let us know to expect you.
We have quite a treat in store for you at this year’s event. In addition to refreshments from several of the companies our funds hold, we’re also featuring talks with me and the team, Motley Fool CEO Tom Gardner, and the one I’m personally most excited about, John Kearon, Founder and CEO of London-based BrainJuicer, an Epic Voyage fund holding.
You do not need to be a shareholder to attend -- in fact, there is a special question and answer session just for those of you who are considering investing with us, but haven’t yet taken the plunge.
In the mid-1990s I was working on a project that took me to India for long stretches of time. I have always had two minds about India. It’s a country that I dearly love and enjoy, with a dynamism and a spirituality lacking in the West. It’s a place where the possibilities for growth and improvement seem limitless.
It’s also a country with a bureaucratic system that has perfected the art of preventing anything from getting done. I’d call it byzantine, but I’m not sure that even Byzantium ever came up with anything so stultifying as Indian bureaucracy. During a particularly frustrating stretch of non-progress, I had drinks at the Intercontinental Hotel in Delhi with some French businessmen whom I’d gotten to know during my several-week stay at the hotel. One of them suggested, quite matter-of-factly, that perhaps I was not bribing the correct officials.
“We’re not paying bribes at all, actually,” I replied.
“Then you will certainly enjoy a long stay in India!” he quailed, in the same heavy French accent that you know you used as you read those words. “You pay a small bribe, and things get done. You don’t, they won’t. It is simple.”
This was pretty easy for him to say, for while bribery is illegal most everywhere (I’d say “everywhere,” but I’m sure there’s some bizarre place like Brunei, Nauru, or Cleveland where it isn’t), the United States takes a particularly dim view of its citizens paying off foreign officials. As a citizen of France, he needn’t have worried about the U.S. law known as the Foreign Corrupt Practices Act. But for an American citizen like myself, this was not a beast with which to trifle.
The thing is, he was absolutely right. In India, petty and not-so-petty bribes make things happen. And so while I resisted (to my detriment) any direct requests for payoff (euphemistically called “flower money,” or “making Gandhi smile twice”) I can’t be certain that all of the fees, tariffs, and assorted payments were legitimate, or that the funds made it into official accounts. I do know that on more than one occasion our unwillingness to pay was directly responsible for a “citizens group” coming to protest our project, causing additional delays. (We’re not talking about the construction of a massive factory here, by the way. By “project,” I mean a 3-foot diameter satellite dish mounted on an existing office building, with a cable running through existing conduit to a piece of telecommunications equipment.) In the end, not paying bribes probably cost us much more than it would have if we had simply passed the envelope.
Whatever the cost to us, ultimately it’s not companies or investors who bear the brunt of official corruption; it’s the locals. Corruption is the ultimate capital repellant. We remained in India then because our project made economic sense to do. But corruption increases the potential for cost, risk, and hassle, so its ultimate impact is far more widespread than the actual bribery. For example, horror stories about shakedowns of foreigners at Kinshasa airport by immigration officials make it much less likely that we’d ever look at a company in the Democratic Republic of Congo for investment.
Is all corruption bad?
You may not realize it, but as an investor in our funds, you may have benefitted from a corruption scandal that is in the process of roiling the largest retailer in the world: Wal-Mart. Last month, a massive, impeccably researched New York Times article exposed millions of dollars in bribes that Wal-Mart’s Mexican subsidiary, Wal-Mart de Mexico, had paid to officials to expedite every component of the store development process, and how it then proceeded to engage in a cover-up about the details, not just at the subsidiary level, but with knowledge of senior management in Bentonville. Wal-Mex (as the Mexican subsidiary is also known) has in the past been a significant holding in some of our funds.
In short, Wal-Mex has grown to be one of the largest companies in Mexico, employing more than 250,000 people, and now accounts for nearly 20% of total Wal-Mart stores, enjoying a dazzling double-digit growth rate for more than a decade. As the Times story indicates, one way that the company accelerated its growth was by greasing the bureaucratic cogs in municipalities all over Mexico by funneling bribes through a network of fixers known as gestores. Wal-Mex had aggressive growth targets, and its managers were under substantial pressure to hit them by any means necessary. And that meant ensuring that any permitting processes would happen as quickly as possible. So those bribes paid for expedited (and positive) responses, which helped Wal-Mex open stores quicker, which allowed the company to ramp up its revenues faster, which increased the value of the company, which benefitted shareholders, which, until March, included some of our funds. (We made a valuation call earlier this year and sold the shares.)
So, is corruption bad? Yes, absolutely. Even though in this case we profited, it’s likely that we both as investors and as global citizens it’s cost us much more.
“If no one is corrupt, no one will be poor”
In 1960, the Philippines had the second largest economy in Asia, after Japan. In 1965, its exports were worth more than those of Taiwan and Korea combined. Today, the Philippine middle class is less than 15% of the total population. Unemployment sits at 25%, and that doesn’t even account for the millions of citizens who leave to work in other countries. Even within Southeast Asia, the Philippines is nearly invisible, largely irrelevant. One of the main reasons is that successive regimes have run the country with an eye toward making themselves fabulously wealthy, looting the country of its best assets, and convincing foreign capital to look elsewhere.
Certainly, the Philippine market isn’t of particular relevance to the United States. But in a time when our companies are seeking additional markets to export American goods, the fact that a logical market for our products is a long-term economic basket case is still costly.
The current president, Benigno Aquino III, has made rooting out corruption a central cause of his administration, backed by a renewed effort to clamp down on corporate tax evasion. If he is successful, this is the best chance that the Philippines has had in decades to increase the income levels of a broad segment of its citizens. We’ll see -- after all, the number of “corruption fighters” who change their tunes once they get a taste of the trappings of power is legion. On the other hand, Aquino has been in office since 2010, so he’s already had plenty of opportunity to skim. As Morpheus said, “There’s a difference between knowing the path and walking the path.”
(Yes, that was a Matrix reference in an article about corruption. Thank you very much.)
In the end, investment cases in the Philippines (and we have looked at a few) are at least partially dependent upon the country’s will to slay the dragon of rampant corruption.
These stories are not related to one another, at least not directly, but they do each speak to the noxious mix that is money and power, and I hope that the retelling of them will illustrate how we at Fool Funds think about and discount corruption in choosing investments. Famed investor Sam Zell recently noted that at its core, investing in emerging markets is the trade off of higher rates of growth for the safety of the rule of law. This is an overgeneralization, but it doesn’t mean that it is wrong, especially on a market-by-market basis. You will note that several large countries have little or no presence in our portfolios that have international mandates (Independence Fund and Epic Voyage Fund). A major reason for this is our fear of corruption in those markets. Our heightened concerns about the treatment of foreign capital in Argentina, for example, convinced us that we should greatly reduce our exposure to companies generating large amounts of revenue there.
But in the end, everything in investing is about managing risk (and by risk, I mean potential for permanent loss, not volatility). One such risk is corruption, but others include things like overleverage (Europe), demographics (Japan… and Europe), and even “fairness” (the United States… and Europe). And that’s before you even begin to focus on the companies themselves.
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