High-Quality Emerging Market Equities Continue to Look Good
U.S. Investors Should Take Advantage of Overseas Opportunities
October 23, 2017
Equity markets in the U.S. are at record highs, but emerging market (EM) equities are poised to outdo them. That’s the view espoused by Kim Catechis, head of global emerging markets at Martin Currie, an affiliate of Legg Mason.
“U.S. investors seeking equity values would be wise to look beyond their home market, given how high prices have soared,” Mr. Catechis declared. “Europe, Japan, and other developed markets are lagging, as many EM stocks continue to shine. There are many fine companies in emerging markets, stocks that can represent excellent value opportunities for savvy investors.”
“Yet much depends on the U.S. Federal Reserve. Sudden, aggressive rate increases could imperil the U.S. economic recovery, which would be bad news for the world’s financial markets.”
The too-common perception is that EMs are still largely dependent on the materials and energy sectors, which is incorrect. In January 2008, these sectors accounted for 33 percent of the MSCI Emerging Markets Index. By July 2017, their share dwindled to 14 percent.
“Commodities are less important than at any other time, making EM investments less cyclical,” Mr. Catechis reported. “Meanwhile, the technology sector’s share of this key EM index has expanded briskly to 27 percent. This makes it the most tech-heavy index in the MSCI stable.”
“Our conviction in companies like Naspers, Alibaba and Tencent is driven by solid underlying dynamics. By building robust digital ecosystems – competitive ‘moats’ – they are ensuring that they can continue to tap into expanding demand domestically, and increasingly abroad. As megatrends go, this is one that long-term investors can get very excited about.”
Earnings growth from 2016 into 2017 has led the way, quietly building EM stock momentum.
“Improvements in economic growth are feeding through to earnings expectations,” Mr. Catechis said. “The number of companies issuing positive outlook statements for the year ahead increased. Best of all, the improvement is broad-based: initially concentrated in the energy and materials sectors, it has extended into industrials, consumer discretionary and financials.”
“Can EM earnings momentum be sustained? We believe it can. GDP growth continues to be hearty, more EM countries reporting positive data. India is growing strongly. Fears of an extreme Chinese slowdown have receded. Russia and Brazil are emerging from recession. Positive long-term drivers, such as productivity improvements, industrialization, urbanization, demographics, growing middle classes and potentially looser financial conditions remain firmly in place.”
Global trade remains important to the economic growth prospects of emerging markets.
“EM companies now account for 45 percent of global trade,” Mr. Catechis said. “Over 10 years, trade among EMs has doubled, to nearly 17 percent of the total. The signatories of the Trans-Pacific Partnership voted to forge ahead, despite U.S. withdrawal. The Regional Comprehensive Economic Partnership should have more immediate, positive effect, since it will be simpler and easier to execute. China’s ‘Belt and Road’ scheme could be as transformative as the Marshall Plan, which helped rebuild post-war Western Europe. The stars are aligned for more EM-to-EM trade.”
Although some investors may be justifiably concerned with concentration risk, the Martin Currie team sees significant growth opportunity for selected emerging market technology companies.
“In China, as in many other EMs, the U.S. tech giants are very marginal players,” Mr. Catechis said. “China has the largest online population: over 730 million, yet still only 50 percent of total population. That will grow, not through PCs as in the U.S., but by the development of mobile internet services – about 90 percent of Chinese users access the web by smartphone. Chinese companies are expanding across Asia. Armed with Asia-centric games, social networking, and e-commerce platforms, they can give the hitherto dominant U.S. giants very tough competition.”
Martin Currie also believes that FinTech, the marriage between finance and technology, provides yet more evidence of the extent to which innovation drives investment opportunities in EM.
“EM countries – and companies – are ahead of their developed market peers in understanding and exploiting the growth potential of FinTech,” Mr. Catechis said. “A potent combination of favorable demographics, governments keen to accelerate inclusion, and tech-savvy populations leap-frogging traditional banking methods, foster EM FinTech adoption rates that outstrip developed markets in nearly every category, from money transfer to savings and investments.”
“China has positioned itself at the center of the FinTech revolution, creating an ecosystem unmatched in more established markets. As a result of early adoption, several Chinese companies are world leaders in the use of electronic distribution channels.”
All is not as rosy for Chinese markets as this may suggest, however. An example is the widely-reported, persistently poor air quality in China, an undeniable result of massive industrialization.
“China’s exposure to air pollution is extreme,” Mr. Catechis said. “Daily average levels of pollution in Xingtai, home to seven million people, is more than eight times that of Bakersfield – the worst-offending U.S. city. Investors struggle with the implications for their portfolios of the Paris Agreement on climate change, which has layers of impact: how climate change affects the countries invested in; whether it can lead to significant government policy changes (including taxation to encourage compliance); and how company finances in targeted sectors are impacted.”
“Extreme pollution levels are probably why, unlike the U.S., China remains committed to the Paris Agreement. President Xi Jinping is very unlikely to allow his country to weaken resolve.”
It remains true that many emerging markets have been poorly served by their governments.
“Economic growth periods have typically favored the upper echelons of society, failing to result in significant future investments for the broad majority: in education, health care or security,” he said. “Elites and the small numbers of the middle class contributed low taxes towards relatively small state provisions. The wealthy could afford to opt out of critical public services, while most had little choice than to live with the consequences of meager public-sector spending.”
“Things are changing,” Mr. Catechis noted. “Demographic pressures have forced governments to focus on their young, increasingly affluent populations. Information availability via the internet has also made these populations better informed and more demanding of their governments.”
“Rising incomes and social mobility are most starkly illustrated in Asia: the Brookings Institute estimates more than two billion people will join the middle class by 2030, a rise of 150 percent. This reflects the growing maturity of EMs, which will continue to underpin corporate growth.”
The best values are not easy to identify without experience in often tricky emerging markets.
“With 30 years in asset management, the last 21 focusing on emerging markets, I decided a long time ago that this is what I wanted to do,” Mr. Catechis said. “Our approach is agnostic, and often contrarian. We have 46 names in our fund. The goal is to find better companies in more favorable markets. It’s not about investing in countries for us, but participating in great companies.”
“We make rolling three-to-five-year investments with low turnover, usually less than 30 percent. We believe it equally important to avoid major minefields as it is to identify the high flyer no one else has. As a result, it is rare for us to dump a position unless big changes come.”
The Martin Currie team keys on environmental, sustainability and governance (ESG) standards.
“We believe ESG is far more than a fad, or an easy way to avoid tobacco companies or weapons manufacturers,” Mr. Catechis explained. “Companies with high ESG standards usually are stable, well-managed and keenly focused on delivering long-term value for their shareholders. By positioning for sustained success, they become the stocks every investor should want in their portfolios.”
Five Reasons Why EM Leads the Tech Revolution
About Martin Currie
Martin Currie is an active equity specialist, driven by investment expertise and focused on managing money for a wide range of global clients. Its approach to investing is simple: it focuses on companies. The integrated investment floor seeks out those companies it believes have the fundamentals to deliver material outperformance on a medium to long-term basis. Once identified, these ideas are molded into well-balanced portfolios. The firm’s approach to portfolio construction reduces and controls macro-factor sensitivity, aiming for client portfolios to derive maximum value from stock insights and for returns to be delivered in a predictable and sustainable fashion.
Martin Currie is an independent investment affiliate of Legg Mason, a global asset management firm with over US$19.5 billion in assets under management as of 30 June 2017. Legg Mason provides active asset management in many major investment centers throughout the world. The firm is headquartered in Baltimore, Maryland, and its common stock is listed on the New York Stock Exchange (symbol: LM).
About Legg Mason, Inc,
Legg Mason, Inc. is a global asset management firm, with $754 billion in assets under management as of September 30, 2017. The company provides active asset management in many major investment centers throughout the world. Legg Mason is headquartered in Baltimore, Maryland, and its common stock is listed on the New York Stock Exchange (symbol: LM).
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