Picking emerging market winners

For Aberdeen Asset Management, emerging markets are not about markets but specific stocks.

Summary: Emerging markets, from a macro perspective, can be high-risk investment propositions. Economic, political, and even natural events, can have a huge impact on returns. In the interview below with Stuart James, head of distribution and senior investment specialist at Aberdeen Asset Management, it is readily apparent that successful investing in emerging markets is all about selecting specific stocks.
Key take-out: May was a bad month for emerging markets, with some $US20 billion of investment outflows. Over the past month there have been positive inflows back into emerging markets, with India the hot favourite, although volatility remains the name of the investment game.
Key beneficiaries: General investors. Category: Asset allocation.

After a rough few months emerging markets have been staging a comeback, with India leading the charge.

Just months ago, India was coming under severe pressure due to its current account deficit, with money gushing out of the local market. In a marked turnaround this month the Indian stockmarket hit a record high as shrewd investors took advantage of relatively cheap valuations.

But how long will the comeback last? Money started rushing out of these markets mid-year amid fears of an imminent tapering of the quantitative easing (money printing) stimulus program in the United States. Federal Reserve chairman Ben Bernanke’s decision to put a pin in “The Taper” in September was all investors needed to move back into these developing economies, but last week emerging markets saw the biggest weekly decline in four months, again on speculation that tapering could soon be on the way. Volatility is a central theme in these markets and investors need both a strong stomach and a measure of patience to see them through the difficult times. The MSCI Emerging Markets Index chart below demonstrates recent volatility.

Today, Eureka Report speaks to Stuart James, head of distribution and senior investment specialist of equities at Aberdeen Asset Management. The Aberdeen Emerging Opportunities Fund has over $1.2 billion in assets under management. Also see Doug Turek's thoughts on emerging markets in his article, Re-emerging markets?

What’s been happening in emerging markets over the past few months?

Since May things have been relatively difficult for emerging markets. The architect around that really has been the ongoing debate around QE and potential tapering. We’ve seen emerging markets come under a lot of pressure from May, really up until a few weeks ago, post the Fed’s announcement not to taper in September.

Has there been a marked pick-up in inflows into emerging markets recently?

It’s difficult to give exact inflows in the last few weeks because the analysis hasn’t been done but what we did see was the largest outflow in May, which was about $US20 billion. That was the peak of the outflows. Since then, all the way through to September, those outflows were slowing and I would suggest that in October, whilst we don’t have sufficient data, it would certainly appear that we had positive inflows into emerging markets.

So investors need to be aware of the extreme volatility in these emerging markets?

In an ideal world, what people should do is try and utilise this bout of negative sentiment to get into emerging markets and keep their eyes firmly fixed on the long term. For those who have slightly weaker stomachs, it may be an area they want to give a wide berth to for the time being.

What do you mean by that exactly?

I think if the risk appetite is not there and if you’re trying to be very clever and make short-term returns in emerging markets, i.e. you’re punting rather than investing, then I think it’s a very dangerous game.

Whereas I’m confident if you take a slightly longer-term view, whilst the ride may be a little bumpy or a little rocky, ultimately the fundamentals will drive the markets.

What markets is Aberdeen looking at right now?

We’re not really looking at markets … for us it really is about the companies themselves and, to be honest, where the companies are listed is pretty much irrelevant to us.

For us it’s really about trying to take advantage of some of this volatility. When markets are volatile you tend to get more overreactions.

What are some of specific stocks in these sectors that you’re looking at?

On the energy side, you’ve got companies like Petrobras [PetrĂ³leo Brasileiro], the Brazilian oil company. Not without its issues, but valuations post some of the concerns in Brazil became relatively attractive. It’s got huge reserves of oil off the coast of Brazil, which they’ll be looking to monetise through the cycle.

You’ve also got companies like PetroChina in China.

Stocks that look a bit full value include FEMSA, which is a Mexican company and Latin America’s largest Coca-Cola bottler. They also own a convenience store range called Oxxo, which again happens to be Latin America’s largest convenience store operator, so akin to 7 Eleven.

Again, from our perspective a very well-managed company, good long-term prospects, but a stock that has seen its valuations become a little full.

(Below is a breakdown of the Aberdeen Emerging Opportunities Fund top 10 holdings, as well as sector and country breakdowns).

We find valuations in the financial sector, particularly banks, less challenging. There’s more value there compared with the direct consumer sectors.

Banks in emerging markets are largely a proxy on the consumer anyway. We’ve got strong loan growth in emerging markets, demand for car loans, mortgages, credit cards, relatively high savings rates. The banks are taking in relatively good levels of savings and then relending those out at a healthy margin.

What are some of the banks Aberdeen’s been looking at?

Some of the banks are what I would call ‘local champions’ within their own markets. One would be Bank Pekao, a Polish bank. We’re seeing some strong growth in Poland and it operates mainly in Poland. Then we have banks like Bank Banorte, a Mexican bank and Bank Bradesco in Brazil.

These are all pretty good strong growth stories given debt levels in these economies are relatively low. Most consumers are net savers, so they’re very much at the start of the credit cycle.

If people are unable to access those stocks or are less comfortable [buying these stocks], there are names such as HSBC, which obviously started in Hong Kong and Shanghai, but obviously over the years grew into a global operation.

While it remains a global bank it is moving slowly back towards Asia. So it’s been selling off a lot of its assets, particularly in North America, and refocusing the business back towards Asia because it sees a lot more growth within those markets.

Another one is Standard Chartered, which some people would be more familiar with as a UK-listed bank, but 90% of its revenue comes from emerging markets.

We’ve been buying these banks because they’ve moved back to these markets or they’ve looked to their internal procedures. These have been bought post-GFC.

Over the long term is the outlook positive for emerging markets?

I strongly believe that the underlying fundamentals are there. Certainly growth rates have moderated in emerging markets, but from a much higher level than we saw in developed markets. I believe what we’re seeing in emerging markets is a cyclical slowdown and I see that as being healthy.

Whenever we’ve got strong growth it’s always good to take a breather to allow those balances to equalise themselves. So while it’s disappointing in the short term it’s healthier for more sustained long-term growth. We generally don’t believe the long-term story for emerging markets is broken.

If emerging markets get sold off that’s an opportunity to buy. Those who invested in May, when everyone was saying not to, will be feeling quite pleased with themselves.

Is Aberdeen seeing more interest in emerging markets from investors?

The long-term trend is many more people are investing into emerging markets than say five years ago. In terms of more recent flows, we saw a slowdown in flows around May/June but they are still net positive. Certainly flows in the past 2-3 weeks have picked up again. They’re where they were at the beginning of the year.

Why should a retail investor invest through Aberdeen or another managed fund rather than directly into the market?

Investing in emerging markets right now is quite difficult. When we start talking about markets such as Brazil and Russia, they’re very difficult markets to trade in in terms of opening up custody accounts, and being able to trade in local currencies.

The reality is we have fund managers on the ground, we’re putting a lot of hard work into understanding these businesses. We spend a lot of time thinking about where we want to move the portfolio to next.

Simply looking at a snapshot at the end of the month doesn’t necessarily tell you how we’re trending our positions; it doesn’t make you aware of what issues we’re currently discussing with management on behalf of our clients.

It’s that depth of knowledge and portfolio movement that you’re not going to capture. There’s still no substitute for getting on the ground, going over and talking to management directly, understanding local cultures, understanding local accounting rules, challenging on corporate governance issues. It’s still a very complex world out there and, for the unwary, you can lose a lot of money quite quickly.

What have returns been like in the Aberdeen Emerging Opportunities Fund?

We were under pressure over the past three months. We’ve had long-term overweights to markets like Brazil, India and Turkey, which all through May to the end of September were under pressure. But our long-term performance has been very strong. Over five years we’ve added in excess of 5% per annum after fees above the benchmark.

Like all managers, clients should expect some short-term underperformance. You can’t be all things to all markets all the time. Indeed, if you are you’re not being very disciplined, you’re chasing the market. There are times when it feels horrible, it hurts, but you’ve got to remain disciplined and where we’ve been underperforming we’ve been adding money.

How much of the average investor’s portfolio should be weighted to emerging markets?

It’s very dependent on risk appetite. Of their international exposure they should be looking at a minimum of 20% to emerging markets. I personally would be pushing that up to 30-40% on the basis that I do believe there are some very good companies in emerging markets which are local, regional and global champions and valuations are very attractive. The flipside is it brings in that additional volatility. In our own international portfolio we have about 30-35% exposed [to emerging markets]. We do as we say. Given the imbalance in valuations I’d be tempted to put even a bit more there.


This is an edited version of our interview with Stuart James.