8 experts. 90 minutes. Roundtable. five current issues. Discuss.
Exploring emerging markets
Emerging markets look exciting again after a hike last year, but global volatility remains a very real threat for investors in these regions. The election of Trump, a strong dollar, and Brexit have all fuelled sentiment-related movements, but savvy investors might feel confused about how important these events really are. We figured we could help by inviting a few of our favourite emerging market fund pickers to share their thoughts.
We hosted a roundtable during which Dylan Emery chaired our seven delegates, who shared experiences and investment preferences as they mulled these events. Some delegates were worried about the US president, others less so, but many saw opportunity in valuations altered by sentiment. We also looked at regional preferences, and the benefits of different investment styles with a focus on active versus passive, and value versus growth.
The delegates included Andrew Cormie (team leader and portfolio manager) and Sam Bentley (client portfolio manager) from Eastspring Investments, the US$146 billion (as at 31 December 2016) Asian investment management arm of Prudential plc. They told us how they identify value at a stock level and take positions in companies that many investors do not. As such they often invest in clusters of stocks in countries and sectors that are out of favour with the mainstream. To find out more about Eastspring’s Global Emerging Market Fund click here.
Let’s take a closer look at the conversations from the day.
Meet the panel
Group Editorial Director
& Co-founder, Last Word Media
Group Editorial Director & Co-founder, Last Word Media
Dylan Emery is group editorial director and co-founder of Last Word. He created and launched International Adviser, Portfolio Adviser and Expert Investor and now heads up all of Last Word’s research projects.
Portfolio Manager, Eastspring
Andrew Cormie is the team leader of the Global Emerging Markets (GEM) team at Eastspring Investments and lead portfolio manager of the GEM Dynamic Fund. With over 35 years of experience Andrew previously worked at JP Morgan where he was Head of the Global Equity team, based in London. Andrew is a CFA charter holder and holds a Bachelor Degree in Business Administration and a Diploma from the Securities Institute of Australia.
Associate Director, Coutts
As a Senior Investment Manager at Coutts, Jeremy is responsible for the management of the Personal Portfolio multi-asset fund range as well as numerous other discretionary managed portfolios. Prior to joining Coutts, Jeremy worked at Newton Investment Management on the global equity desk as a lead portfolio manager on Global Equity and EAFE mandates. Jeremy has a Bachelor of Business Studies in Finance from Massey University in New Zealand.
Head of Fund Research,
Head of Fund Research, Brewin Dolphin
Ben is Head of Fund Research at Brewin Dolphin covering the major asset classes but also more alternative investments such as absolute return funds and structured products. Ben has a degree in Mathematics from Loughborough University, is a Securities Institute Diploma holder and a CFA charterholder. Ben sits on the Brewin Dolphin Asset Allocation Committee and supports the award winning Managed Funds Service proposition.
Fund Research Analyst,
Fund Research Analyst, Quilter Cheviot
Ernst Knacke is a fund research analyst at Old Mutual Wealth. Specific responsibilities include research and selection of US, Japan, Asian and Emerging Markets Equity funds as well as Private Equity strategies. Ernst joined the Quilter Cheviot Collectives Research team in 2015 as part of the integration of Quilter Cheviot (QC) into Old Mutual Wealth, after spending eight years in the multi-asset team at Old Mutual Global Investors (OMGI). He has a BSc in Mathematics of Finance and a BSc (Hons) in Financial Engineering from the University of Pretoria. He’s also a CFA charter holder.
Client Portfolio Manager,
Client Portfolio Manager,Eastspring
Sam Bentley is the client portfolio manager for the Global Emerging Market equity strategies. He has 17 years of financial industry experience and has a background in Global Investment Strategy, Global Bond Portfolio Management and Institutional Marketing. Sam holds a Bachelor’s degree in Economics from Durham University and is a CFA charterholder.
Investment Manager, BMO GAM
Scott is a member of the multi-manager team, has over 15 years’ experience in researching funds. Prior to joining the group in July 2014 he was a senior investment manager at Aberdeen Asset Management, where he was responsible for a number of retail and institutional multi-manager portfolios. Prior to that he was a member of the Credit Suisse multi-manager team. He holds the Investment Management Certificate (IMC) and a BA (Hons) in Economics from Nottingham Trent University.
Head of Analytics,
Head of Analytics, Multi-manager, 7IM
Tony Lawrence joined 7IM as Investment Manager for their multi-asset portfolios in early 2015. Prior to this move he was Head of Analytics on the Columbia Threadneedle Multi-Manager team, accountable for all quantitative assessment on third-party products. He is responsible for all aspects of portfolio management, from asset allocation through to fund selection. He has over 15 years of experience in the finance industry, holding both CAIA and CFA designations.
01 The Trump influence
Will Trump singlehandedly destroy emerging markets?
Well, he probably can, but there are checks and balances in place. The more obvious risk is the border adjustable tax, so perhaps Paul Ryan’s a more dangerous man than Donald Trump. The greater the border adjustable tax decision, the greater the imposition it has on trade. The more revenue it raises, the greater the tax cuts Trump can offer.
Donald Trump does seem willing to negotiate if you look at some of his rhetoric. If he focusses on economic growth, as opposed to just job creation, then there is the possibility that new tariffs may be less extreme than people currently expect.
Although the protectionist policies are likely to be broadly negative, some sectors will be more affected than others. He might bring some textile work back to the US, but it would be very hard to bring back tech-based work from, for example, Taiwan. So even in the worst-case scenario there will be that kind of balance.
Some parts of the world shouldn’t be hugely affected. If you look at the direct earnings sensitivity for the MSCI China, less than 2% of the market cap derives more than 10% of its revenue from the US. That’s actually quite small, but stock market sentiment has such a big impact. This is the biggest risk in my view.
Trump is just the latest protectionist installment. There has been a trend towards this for a while. I read that the G20 trade restrictive policy measures now outstrip trade facilitating measures. Perhaps it’s part of a more cyclical approach to offshoring and globalisation generally.
EASTSPRING “We use bottom-up valuations”
02 Current Opportunities
Where do you see opportunities in emerging markets?
We are currently overweight in Asian equities (as well as Emerging Markets generally). We’ve been overweight now for the best part of 12 months, mainly due to the valuations and because we’re more bottom up than top down.
Last year investors went from zero exposure to underweight, or underweight to neutral. But we didn’t see the euphoria of 2006-2007, when it was a race to see how much you hold in Asian emerging markets. So, there’s still plenty of way to go. And Asia still looks cheap, compared with historic levels as well as compared with the US and Europe.
We have been reducing Brazil, we’ve been reducing Russia. We’ve been buying more China and more Korea on a stock-specific basis. We’re not getting there from a top down need to buy more Korea because the economy is improving, we’re buying stuff that is uncomfortable optically. But having done the work, we’ve decided that the margin of safety is big enough to take that risk.
We had found Mexico to be expensive, but with the election and the noise that followed, we’ve seen some stock valuations get back to the point where we can choose them.
Post-Trump, the pullback, especially in Asia, seemed to have been irrational. Although there is significant trade between China and the US how much does Alibaba sell into the US? I think that sentiment has allowed for some opportunities in emerging markets, specifically Asia.
The quality growth angle is interesting at this stage. Small, or medium-sized businesses with consumer exposure and an attractive growth outlook, perhaps in India, Indonesia or Brazil, have lagged significantly and afford opportunity. And if Trump does come out with some kind of tariff policy or border adjustment tax policy these companies will probably hold up. They provide attractive long-term exposure.
Trump’s protectionism is the latest in a series of measures of this sort and you can see China stepping into the breach and extending its global reach. The influence of China is going to grow and provide opportunity.
03 Investment Approach
What’s the best investment approach in emerging markets?
We support active management and have tended to be interested in defensive growth. But in a positive market this position won’t capture all the upside. A passive fund may provide more of that value kicker than an incumbent defensive growth strategy. The two approaches blend naturally, but it’s clear that active value management is the best way.
I think the key is to make sure that if you’re buying a passive it should give you full replication and be cheap. If you buy an active, make sure you genuinely buy an active fund. Don’t buy something in the middle.
I don’t think there’s any value in passive. I understand that people might want to use it short term to go from underweight to neutral, or because they have some short-term liquidity requirements. But if you’re going to invest in emerging markets you should have a long-term approach anyway. Active management helps mitigate the risk of political instability, fraud and other things in emerging markets.
We’re active, and we boldly put a stake in the ground around value. It’s been shown over time to be the superior way to make money in EM and works better over the long term than growth. There are times when it doesn’t work, for example, in three of the last four years it’s been a miserable place to be but we think it’s in the process of reasserting itself.
We also like to be as unconstrained as possible, with a clear value bias, but we go up and down the market cap range and across the geographic spectrum. We try to make sure that the active risk we’re taking in the portfolio is at a high enough level to justify the sorts of claims we’re making to our clients.
EASTSPRING “We focus on value”
04 The Strengthening Dollar
How will the strengthening dollar affect emerging markets?
If the dollar appreciates then finance becomes more challenging it will put commodity prices under pressure. So emerging markets could come under strain if something unexpected happens. And a border adjustable tax isn’t a zero probability, the market is pricing in a 50% to 40% chance.
The dollar must be one of the most overcrowded trades in the marketplace, in terms of the dollar strength it’s very hard to find anyone who’s got a negative view. If you look at all the possible currencies sterling, euro, yen, you can see why it’s so strong.
If the dollar strengthens, but doesn’t go exponential, we think that the attractive GEM valuations will counteract this, particularly where there are big margins of safety and the fundamentals are improving. It’s a different issue if it goes exponential.
That the strong inverse correlation of the dollar and commodities seems to have broken down is interesting. That had held for over a decade. So, we’re watching that quite closely.
I think we need to look at what’s driving the strong dollar. If we think it’s a genuine global synchronised pickup in growth, led by the US and creating a slowly strengthening dollar this can be tolerated. A racing increase in strength would be a different story, and the impact on commodity prices would be cause for concern.
If the dollar is going up because the US economy is doing well, then that’s a good environment for emerging markets. If it’s going up because of because investors are looking for safety, then that tends not to be so good.
05 Asset allocation
How did your emerging market asset allocation change last year and are you optimistic on emerging markets going forward?
Style indices - Cumulative Performance (quintile 1)
over the MSCI Emerging Markets index
Source: Macquarie Quantitative Research, 31 December 2016. Market-relative performance of respective style indices (quintile 1 minus benchmark), rebalanced on a monthly basis, from 30 June 1998. Past performance is not necessarily indicative of the future or likely performance of the Fund. The index described is unmanaged and not available for direct investment.
The oil price valuations in Brazil and Russia were beneficial for those markets, but there was also some self-help with the impeachment of Rousseff, for example. The Russian Central Bank has shown discipline and earnings are improving there too. There are signs that emerging market economies are managing themselves better.
Last year was more of a stabilisation than a recovery. Commodities bottomed out, and some of the important ones at the margins have started to trend back upwards. Another important point is that ROE, which had been falling for several years, is now improving.
We think the investment case is really strong for global emerging markets because valuations are cheap compared with the asset class itself and with developed markets. It’s one standard deviation cheaper when other things are looking fairly valued to overvalued. We also see coordinated growth in the world, and as sales and margins increase, earnings should also increase. Some stocks in GEM equities have been value destructive (the ROE is lower than the cost of capital) and in many cases this has flipped to value accretive, because the ROE’s increased, you’ve got cheap valuations going from value destruction to value accretion. We think that’s a pretty strong indicator.
Over the last five years, investors have been relatively defensive and positioning themselves within the more defensive sectors in those markets. They have tended to overpay for certainty, yield and cash flow. So we see a huge opportunity within emerging markets on the cheaper cyclical stocks but the gap is closing as the risk appetite comes back.