After a decade of misery, investing in equities outside of the world’s advanced economies is finally emerging as a likely top performer in 2021.
For the past decade, the MSCI Emerging Markets Index underperformed the MSCI World Index, which tracks developed market stocks. However, the success of Joe Biden in the November 2020 US presidential election, and encouraging progress in the hunt for a COVID-19 vaccine, helped drive a resurgence in emerging markets.
Not only has the MSCI EM Index outpaced the developed market’s returns since the coronavirus pandemic took hold in March, but more money has been allocated to the area in the eight months to 23 November than in the two-year rally that began in early 2016 making it worth $8.3trn, according to Bloomberg.
Emerging Markets' value
Hedge funds located in emerging markets also grew 5.1% in the first three quarters of 2020, outpacing their developed counterparts significantly, based on data from Eurekahedge.
Despite three consecutive quarters of gains, emerging market stocks are still relatively cheap, prompting a number of money managers and analysts to suggest investing in foreign equities.
Teresa Barger, CEO of Cartica Management, thinks there are many economies in strong positions compared to the US. She launched the first index for emerging markets private equity, has been investing in the space for nearly 34 years — from the commodity supercycle rally in the 2000s to the rush for consumer goods after the 2008 global financial crisis. In more recent years, she has noticed that the emphasis has moved to disruptive business models, which she expects will be key to emerging markets building a digital economy of the future.
Maria Negrete-Gruson, manging director of Artisan Partners, agrees that emerging markets offer opportunities. She has found plenty of companies in emerging markets that have been neglected during the pandemic but that are still resilient and primed for sustainable growth. After 25 years of specialising in the area, she recognises that there is a rotation underway and expects the economic acceleration rebound to favour be a tailwind.
Caroline Cai, portfolio manager at Pzena Investment management, also believes that now is a good time to invest in the space because of compelling valuations. She finds that taking a value approach to emerging markets is a powerful way of generating returns that are higher than those in developed markets.
The three veteran investors tell Opto why they are placing their bets on emerging economies.
Hunting for value
“Emerging markets are dear to my heart for personal reasons. I grew up in China before I went to college in the US, and so when Pzena launched its dedicated emerging market value product in 2008, it was like coming home for me.
Emerging markets are fascinating to me beyond the personal connection though. We at Pzena do think that value investing, as an approach, is more effective in emerging markets than in developed markets, and there's good empirical evidence for that. It’s also an interesting area because there are lots of ways things can go wrong for a business. But by the same token, there are lots of ways things can go right — and valuation opportunities can be exceptional at times.
"Valuation opportunities can be exceptional at times." - Caroline Cai, Pzena Investment Management
When it comes to finding value overseas, we take a very much bottom up approach. We have a proprietary quantitative tool called StockAnalyzer. T flags for us businesses where the valuation reflects an expectation that future growth and profitability will be materially lower versus history. We then engage in deep dive research to determine whether that is a likely outcome or management has a credible plan for improvement. We then rank every stock from the cheapest to the most expensive based on price to a five-year earnings forecast and only buy stocks that are in the top 20% on valuation attractiveness. It is part of our investment philosophy — what we want to do is buy good businesses when they are on sale.
When we look to 2021, we do see an attractive starting point in valuation and if the macro conditions continue to improve then we do expect earnings to rebound quite meaningfully based on the aggressive cost restructuring that a lot of companies have undertaken. I think timing these things is difficult but looking at where we are in the earnings cycle and the starting point for valuation, we do think this is a very interesting time for value investors in emerging markets specifically.
If you look at our portfolio, we are finding opportunities everywhere in emerging markets today. Latin America, for instance, has not been a particularly interesting area for us for some time now, but we are adding to our exposure there because a lot of high-quality franchises have seen their earnings and valuations temporarily depressed due to COVID-19.
From a pure numbers perspective, we're underweight in China but that’s only because of valuation reasons, especially when you think that the mega growth companies like Alibaba  and Tencent  make up something like 16% of the MSCI Emerging Markets Index. One Chinese company that did make its way into the portfolio is Man Wah Holdings , which is the world’s largest maker of recliners. Since we added it to the portfolio, the stock has more than tripled, driven by a growing demand from more people investing in home comfort and the ramp up of their new Vietnam factory.
We do have [greater] exposure to the European part of emerging markets because we see more interesting valuations and that's certainly where some of the macro headwinds have been more significant compared to other parts of the world. We have meaningful exposure to the cyclical part of the market, including consumer discretionary, industrials, resources, energy, financials, but also technology.
Some of the stocks that we added to the portfolio in the last six months take advantage of the COVID-19 dislocation. One is Ambev [ABEV3], which is a Brazilian beer giant that has an unassailable business model that we believe is well positioned for a recovery. And in the small cap space, we like Pacific Basin Shipping .
“In the small cap space, we like Pacific Basin Shipping” – Caroline Cai, Pzena Investment Management
Our view is, if you have a long-term horizon, focus on an attractive starting point of valuation and if you can find great business that are going through temporary pain it should be a winning strategy over the long run.”
An emerging markets pioneer
“At Cartica, we take a private equity approach to listed markets. We focus on active ownership of emerging market companies, which is a unique approach among asset managers. That's a little bit of a surprise to me because it seems so obvious to us that you can unlock value by going to a company, which has say, below average capital allocation, and get them to fix the problem.
There are many things we like about emerging markets right now. One is that the dollar is coming to the end of a long cycle. I think we should be prepared for a secular decline in the dollar in the next couple of years and that has traditionally been very good for emerging markets.
In the wake of COVID-19 there's going to be a dearth of growth opportunities in the world. The US won’t get back to its 2019 trajectory until maybe 2022. On the other hand, North Asia is growing. In fact, China will almost be the only country that has positive growth.
“The US won’t get back to its 2019 trajectory until maybe 2022. On the other hand, North Asia is growing” – Teresa Barger, Cartica Management CEO
India has been very interesting because there is a very big disconnect between what we see happening on the macroeconomic front and the stock market. We are a bit against consensus in that we still like Brazil and that's because there's a big reform agenda that is still moving forward, although in fits and starts.
There are also areas like the supermarket industry, which has performed well throughout the coronavirus pandemic. I think we’ll find some growth potential in emerging markets in 2021 that will not be available in advanced economies, as the disparity between equity prices will make them more attractive.”
Emerging growth opportunities
“The fact that [investing] can have a very huge multiplier effect on growth and affect the lives of people in emerging markets was something that motivated me from the very beginning. It was about the true effect and so a lot of my team are well versed in those markets with many born and raised there, which has helped us [at Artisan Partners] find many idiosyncratic and non-correlated opportunities.
Our strategy at Artisan Partners looks at sustainability from every angle. Sustainability to us means endurance because we know there's going to be a lot of volatility and that these places we're investing in are fragile. I think companies that have sustainable models are really the ones who are going to survive.
"I think companies that have sustainable models are really the ones who are going to survive" - Maria Negrete-Gruson, Artisan Partners MD
You can find exceptional companies in this market. Argentina for example, which to many is seen as an uninvestable place with huge macro problems, is where we have two of our holdings in the portfolio.
Globant [GLOB] and MercadoLibre [MELI] are Argentinian companies that have understood the difficulties of their environment and created businesses [Globant is a technology services business and MercadoLibre operates an online marketplace] that have transcended beyond the region and throughout Latin America. Their business models are very resilient because they're borne out of difficulty, which makes them better equipped to deal with the realities of the environment.
In the Artisan Sustainable Emerging Markets Strategy, we’re underweight in China and overweight in places like Indonesia, Russia and Argentina. China is by far the largest absolute weighting in the index so we believe we can be underweight and still have exposure to the best current opportunity set. In terms of sectors, we have always maintained exposure to healthcare, as we believe it is a very dynamic sector in emerging markets. For example, in India we have holdings in a small cap company called Metropolis Healthcare [METROPOLIS], which we invested in before the coronavirus pandemic hit. This is an example of a company in a difficult circumstance that has adapted its model, which in turn strengthened its competitive position going forward.
We're interested in consumer discretionary goods, which is seeing rising demand amid a burgeoning middle class across these regions. For example, online travel across China is quite advanced and sophisticated with a company like Trip.com [TCOM]. Whereas there’s still a preference for brick-and-mortar [travel agents] in America, so we see these digital models translating well into other emerging market economies.
The travel sector is just one of the many areas that have been affected by the coronavirus pandemic, but there are businesses that have proven they have the resilience to survive, including [online travel booking service] Despegar [DESP], which we have in the portfolio alongside Trip.com.
While there are a lot of valuation opportunities out there at the moment, I would caution against investing in China, as I believe its equity market already reflects how the country and its economy have done a good job of dealing with the coronavirus pandemic. Where we are finding opportunity is in the other emerging markets, which haven’t been too heavily penalised despite demonstrating the type of resilience we look for in sustainable investments.
“While there are a lot of valuation opportunities out there at the moment, I would caution against investing in China” – Maria Negrete-Gruson, Artisan Partners MD
As investors, we're always looking for the next growth opportunity and so you have to look a little deeper. You have to go off the beaten path to where life finds the opportunity.”
This article was originally published in our Opto Magazine. You can purchase copies on our Opto Shop.