Value to be found in emerging market equities

While investors have traditionally been attracted by emerging markets because of faster growth, the emphasis is shifting today towards value investing.

“Thinking of emerging markets as a growth opportunity is increasingly flawed,” states John Ventre, head of multimanager at Old Mutual Global Investors (OMGI) in London.

“We want managers that are more value-biased, buying cheap stocks with margins of safety within that environment, as opposed to managers focused on growth or growth improvement.” 

Emerging markets today trade at 30 per cent discount to developed markets. Value-biased managers are those able to buy low price to earnings or low price to book stocks, ie stocks discounted because they are based in emerging countries but also discounted relative to their own benchmark.

As a consequence, in October last year the firm appointed two new specialist emerging markets investment management boutiques to manage the emerging market ex Asia exposure across its £5bn (€6.4bn) multi-asset portfolios.

The two firms, Jardim Botânico, a Brazilian boutique and Eastern European specialist Renasset, replaced Henderson, which previously managed both Latin American and Eastern European assets in a growth style.

On a tactical basis, OMGI overweights China, investing through futures, which are cheaper than ETFs. “In China, the value is in big index names, but most active managers are underweight these names,” says Mr Ventre.

The Chinese market trades on 8x earnings, which is very cheap, he says. The People’s Banks of China’s decision to start loosening policy, interest rate cut and fall in oil and commodity prices are other positive factors.  

Not only is China under-owned by the global investment community relative to its economic size, but volatility has been rising together with stock prices – a rare signal indicating the beginning of a bull market.

Within emerging markets, Mr Ventre’s preference goes to Asia. Countries in the Eastern part of the region are all net commodity importers, standing to benefit from weaker commodity prices, as opposed to Brazil or Russia. “Asia is the area I am most bullish about because I see both value and positive catalysts, whereas in Brazil or Russia, while you cannot deny the value, and we still like these markets as they are too cheap to ignore, it’s hard to see an immediate catalyst for improvement.”

On a tactical basis, Henderson Global Investors moved its multi-asset, multi-manager portfolios, with £6.5bn in total assets, to a 3 to 4.5 per cent overweight position in emerging markets in mid-late October 2014, during the global market sell-off. The move, implemented by adding assets to the iShares MSCI EM ETF, was driven by attractive valuations, explains James de Bunsen, the firm’s multi-asset fund manager.

On a strategic long-term view, he prefers active, value based managers and his two core funds are the First State Global Emerging Markets Leaders fund and the JP Morgan EM Income fund.

 “Volatility in emerging markets gives opportunity to disciplined managers to buy good companies at a good price,” says Mr de Bunsen. Indeed, quality firms, with good management, track record of producing strong cash flows, good corporate governance and growth in earnings are sought after at higher multiples. “Some managers fall into the trap of overpaying for quality, but the key determinant on long term returns is the price you pay.”  

The firm also invests in a greater China fund run by Hong-Kong based equity manager, Value Partners, believing in the importance of selecting managers on the ground, with local market knowledge and speaking the language, particularly valid for China.

“We use ETFs on a tactical basis, but emerging markets are less efficient than developed markets and a good fund manager can make very attractive returns over the long term,” adds Mr de Bunsen.

Growing dividends

Despite its reputation for growth, dividend investing in Asia has tended to outperform, says Nicolas Simar, head of the Equity Value Boutique at ING IM. “We expect dividends to become an increasingly important element of total return for investors in Asian equities, because companies are increasingly focusing on alignment with shareholders, and more are initiating or increasing dividends.”

Although Asia is not trading at bargain level, acknowledges Robert Horrocks, CIO at Matthews Asia, “valuations are low but a significant portion is accounted for by depressed valuations in state-run banks, predominantly in China, and heavily-cyclical or indebted businesses.”

When focussing on businesses having a high return on invested capital, valuations are closer to the level of the S&P500. However, analyst estimates project much faster underlying earnings growth for these Asian businesses. “Portfolios focused on dividend-paying equities can far exceed rates of growth in the S&P500, at price to earnings discount of more than 20 per cent,” says Mr Horrocks. Asia is the part of the world most focused on reforms and, according to the International Monetary Fund, will account for two-thirds of the world’s middle class in 2050.