When will emerging markets pull out of the doldrums? And which should you back?John Stepek chairs our Roundtable.
John Stepek: Between the strong US dollar and the falling oil price, emerging markets have had a tough time will that continue?
Omar Negyal: Typically a strengthening US dollar isn't great for emerging markets. But you have to differentiate not all countries or companies will respond the same way. And while currency weakness has hurt some countries, at least the currency is being allowed to adjust. That makes valuations look more attractive.
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Sandra Crowl: The dollar and oil have hammered commodity producers. But Asia outperformed last year. The new government in India has triggered a major rally there, while China has had a great run and is steadily opening up its markets. Ever since the 'taper tantrum' (when markets swooned as the Federal Reserve started to trim quantitative easing) in May 2013, we've been focusing on markets that aren't reliant on US dollar funding and have surpluses or improving deficits, and so stable currencies. China and India have been our best picks since 2012.
Max King: I'd say that India is getting overhyped it's quite expensive and due a setback. China has also had a great run so I'm cautious in the short term. However, I'd expect to see a turnaround in Brazil and Russia this year, based on a switch to reformist policies. Brazil at least isn't getting any worse although we might need to see the currency hit my long-term target of three reals to the dollar (compared to 2.70 today) and a real blow-up in Petrobras (the state-owned oil company). By rights, President Dilma Rousseff, who was chairman of Petrobras from 2003 to 2010, when the corruption scandals date from, should be impeached.
John: People often talk about governance in emerging markets how key is it?
Max: Governance certainly matters. We want to see corporate governance improve, with companies striving to raise returns on equity and reward their investors. And we want to see political governance improve, so that living standards and incomes are boosted by encouraging growth and investment in the private sector.
More reform-minded countries, such as India, Indonesia and Mexico, are seeing better growth and returns than others. Commodity producers in particular have become complacent with high prices and need to understand those aren't coming back anytime soon.
Omar: We focus on dividends. Dividend growth in emerging markets has outpaced developed markets over the long run, so there's a decent pool of companies with high and rising dividends to choose from. Taiwan has a good dividend culture. Turkey and Saudi Arabia are also interesting from that perspective. South Africa is a classic case where things often look bad from a macro, big picture angle, but good at the individual company level, with mature managements.
Max: Yes, you want to go for private-sector businesses with good corporate governance, rather than state-run behemoths but those quality companies do tend to be expensive.
Fergus Argyle: Gazprom looks cheap, but it can't be controlled by shareholders, whereas something like retailer Magnit is a lot more expensive, but it's a solid, private company. We like quality but we try not to overpay we're looking for underpriced growth where we can find it. India, Korea, South Africa and Turkey all oil importers, and so beneficiaries of the weak oil price have produced interesting opportunities in recent months. As far as governance goes, we focus on how minority shareholders are treated. Broadly speaking, governance is probably best in South Africa and improving fastest in Turkey.
John: Deflation is a big worry for developed markets are you worried about it in emerging markets?
Max: Concerns about deflation are overdone. Consumers don't defer purchases because of falling prices. At least 99% of populations if you asked them would say they'd favour stable or lower prices over rising ones. And they're not wrong to do so.
Fergus: Lower wage inflation means companies are more competitive, while lower oil prices help consumer demand.
Max: The key is that you want to invest in strong brands that can maintain their pricing power.
John: Russia's the emerging market that's taken the biggest hit and it has the cheapest currency would you buy?
Max: Yes, but I am the sort of investor who is happy to buy early and wait, despite short-term downside. The key to Russia will be economic reform. The country has, rightly, embarked on a programme of import substitution behind trade barriers it's a response to Western sanctions, but justified anyway. The outlook for agriculture, steel and many other sectors is positive, helped by currency devaluation, tariffs and lower energy prices, so Russia's economic woes are exaggerated. We shouldn't be blinded by the agenda of Western politicians and the media most reporting is hideously biased against Russia.
Fergus: One particularly interesting stock is Yandex (Nasdaq: YNDX), the 'Russian Google'. It's developing various applications, which currently make no money, but will ultimately create value. Yandex could end up having a stranglehold on the Russian Uber; Russian classified advertisements for cars, the Russian e-Bay, etc. There are a few speed bumps in the road along the lines of monetisation and mobile search and switches to social networking and search patterns, but the dollar price on the Nasdaq has pretty much halved in the last three or four months. This is a firm with entirely rouble revenues, and a very small amount of dollar cost. So that looks attractive.
Max: It sounds a great story. Looking for the final dip before you buy is a mistake buy it, and if it goes down in the short term, who cares? You know you'll be happy in three years' time. Picking the bottom in any market is virtually impossible it's not even worth trying.
Fergus: You can buy over a period of months and build a position that way.
Max: The trouble is that what tends to happen is you buy a bit and it goes up, and then you're stranded with a tiny position. If you like it, just buy a decent chunk. Leave room to buy more, but just go with it, and don't worry be patient.
Fergus: But do be mindful of the fact that there's going to be a long and ugly recession in Russia no matter what, so you need to make sure that you feel that's adequately reflected in prices I don't think we're there yet.
Max: A few months ago there was too much "oh, the rouble's collapsed, so buy Russia" going around. You've got to be wary of knee-jerk contrarianism. But I think buying some Russian stocks within an emerging-market fund is a great idea.
John: What about capital controls?
Omar: Obviously, we've lived through capital controls in various forms in emerging markets. China still has capital controls today. We were concerned about Russia last year. But so far they have not been tilting that way.
Max: If Russia was going to bring in capital controls it would have done so by now. A perfect argument against it is Argentina. It has capital controls and it's a joke. You can pay in dollars for your taxi fare and in restaurants it utterly discredits your domestic currency, so that nobody wants to own it. Anyone tempted by capital controls should visit Argentina to see how well they work.
Fergus: Rosneft refinanced a big dollar deal in December, so that was positive. And there was an episode in September when Sberbank had queues outside the doors. But that seems to be dying down.
John: What about Greece, which is now technically an emerging market?
Max: Greece is very good at justifying extreme cynicism. Whatever government is in power has one objective to be paid in euros. Yes, there's no doubt that the Europeans want to prevent the Greeks leaving because it would have risks, so the chances of a fudged settlement are pretty high. But I don't think Greece would choose to exit, because it would mean Greek politicians would get paid less in real terms. In any case, what difference does one small, distant Balkan country make to the eurozone, let alone the global economy?
John: What about Africa?
Max: One of the most interesting areas is gold mining in South Africa. We've been rather negative on South African gold mines for many years, but they are starting to look attractive. You've got a firm gold price and a weak domestic currency. So the product is priced in strong US dollars, and the costs are all in rand. Another good thing about South Africa is the great company management. My classic example is fast-food chain Wimpy. It died out in the UK 30-odd years ago, but in South Africa it's thrived and beaten off competition from McDonald's. How the hell does it do that?!
More broadly, Africa has been a difficult area. It probably will get better. But I'd focus on a broader emerging-markets fund with a really good manager who is allowed to pick stocks in South Africa and Egypt and Nigeria.
Omar: Also, many South African companies invest in sub-Saharan Africa for growth. In terms of investing directly, it's still a very narrow market, even by emerging market standards.
Max: The real problem with South Africa is that exchange controls keep a large amount of money inside the country. Inflation is persistent, which erodes bonds. So a lot of money goes into equities because it's got nowhere else to go which results in them being overpriced. So South Africa tends to be expensive, and that's probably not going to change soon. Chile is similar: valuations are kept high due to buying by the domestic pension funds. There are some great firms and that won't change, but again it means the market tends to be a bit more expensive.
John: Let's move on to individual tips.
Our Roundtable tips
Fergus: Samsung (L. Int.: SMSN) basically you are buying one of the best semiconductor businesses in the world.I haven't liked Samsung for quite a long time because I thought its handset business (the big profit generator) wasn't very good.
But last year, for the first time since 2010 or 2011, the semiconductor business improved more than the handset business. So you're returning to the old Samsung, which was a high-quality business. And you're not paying much for it about nine and a half times earnings.
Markets might take fright over the handset business the management has to be sensible about how it winds it down or stabilises it. But what you're left with is a business with less market cap than cash. I think it also spends more on research and development than any other company in the world.
I also like Hungarian bank OTP (L. Int.: OTPD). It's underperformed for about seven years due partly to its eastern European focus. But it is now a highly capitalised, increasingly cash-generative business. You're paying 0.7 times book value for a firm with a return on equity of almost 20%. It's got the strongest market share in Hungary.
It's beating its mostly state-owned competition. All of its foreign subsidiaries, apart from those in Russia and Ukraine, contributed to net income last year. We own it because it's got the potential to be a great eastern European franchise.
Super Group (Jo'burg: SPG) in South Africa is a logistics and fleet management business, the third of three in South Africa. It's a thorn in the side of its competition. It doesn't do bulk carriage, it only does specialist stuff, like petrol stations, and has very high penetration. It's also got a great fleet-management business in Australia that has high profit margins and fairly stable market share. It's trading on about 11.5 times earnings, with 10% revenue growth and 15% earnings growth.
Sandra: In India I like global IT consultancy group Infosys (NYSE: INFY). It's had a tough time, but it's got a new CEO in from German group SAP, and fourth-quarter results were good. Its income from the US is good and its internet services unit is growing there and catching up with its rivals. It's also increasing its focus on software and artificial intelligence, particularly for business services and big data. It trades on a price-to-earnings (p/e) ratio of 18, which is cheaper than the wider Indian market. We expect earnings growth of 15% for the full year 2015.
ICICI (NYSE: IBN) runs a network of banks in India. It's benefiting from the growing middle class and increasing number of bank accounts per head, as well as demand for financial services. It has a strong tier-one capital ratio of 13%, and bad debt levels should improve as the business cycle picks up. It's not cheap, but one to buy on any correction.
AIA (HK: 1299) is a leading Asianlife-insurance company. Currently 12%of its business is in China, where thereis great potential for growth and more need for life insurance and protection policies, not to mention health care as other Asian markets mature. Corporate governance is good, and the balance sheet is strong stronger than many of its peers in Asia.
John: Max, any funds for us?
Max: We like the Fidelity China Fund (LSE: FCSS). It had a few wobbles at the start, and now former manager Anthony Bolton has retired, but actually, in the three years since its launch, it's been the best-performing fund in its sector returning three times the sector average in net asset value terms. I'm a bit wary of China, but there's no doubt this trust invests in the right firms, as its pre-initial public offering position in Chinese internet giant Alibaba shows. So that's a long term lock-away.
Another is Schroder Small Cap Discovery, a global small-cap fund with quite a strong Asia bias. I've known Matthew Dobbs, the manager, for 25 years or more. He's a great manager, and looks after a lot of money in Asia. Yet a few years back he started this little fund and put his own money into it. He didn't need the grief small caps are a pain in the neck, time consuming and hard work but he did it because he thought it was an exciting area and a tremendous opportunity to make some money for the fund and for his clients.
My decision to invest in this fund was one of the fastest I've ever made. I like Dobbs, I like emerging markets, and I like the small-cap thesis, which takes you away from the problems of state-controlled businesses and megalithic oil companies and the like.
My third pick is actually one of our funds the Investec Emerging Markets Local Currency Debt fund. We've talked about equity a lot, but we haven't mentioned debt. We've got a very good team in this area, and now the currencies are cheap and bond spreads have widened. I think there's good long-term value here, and you get paid to wait. There may well be a few road bumps ahead, but if you buy now and look through short-term turbulence, I think you'll have pretty good returns.
John: You don't think there's a wave of defaults waiting to swamp the bond market then?
Max: Oh, I'm sure there are a few there's Venezuela and Argentina but we're not invested in those.
Omar: My first pick is Taiwan's Delta Electronics (Bangkok: DELTA). If you own a laptop, there's a very good chance you own something made by Delta it has a very strong position in power supplies. But the management team also recognised quite a while ago that the PC industry was slowing. It needs to diversify into other areas, which it's done pretty successfully. These areas include industrial automation in China, which is a growth market as wage costs rise and companies try to improve efficiency. And even though it's an emerging-market company, it has a near-20-year history of paying cash dividends to shareholders. So we really like the governance, the business model, and the outlook.
My second pick is Brazilian beer company Ambev (NYSE: ABEV). We talked earlier about pricing power and how important brands are to pricing power in emerging markets. It's often quite hard to find. But Ambev has a brand; it's the dominant beer company in Brazil, with 70% market share or so. It generates a lot of free cash flow and, importantly, it wants to return this cash to shareholders. So we get a 4.5% yield today for a company that we think is going to be around for a very long time, with high-growth and profitability.
My final choice is a company called Life Healthcare (Jo'burg: LHC) in South Africa. This is a hospital operator and, again, management is very good at whatit does it has a good track record of reinvesting in high return areas, while maintaining profit margins. Health care in emerging markets is a great theme, but it can be hard to find companies that deliver profitably.
This is one of those companies. Obviously, it's dominated by South Africa, but it's got a tie-up in India now too, which could be interesting. It's also paying out a reasonable dividend just under 4% and we should have good dividend growth to look forward to.
John: Let's say you can only buy one emerging market which would you buy today, given a five- to ten-year time horizon?
Omar: I'll go for Taiwan. Taiwanese companies have shown that they cangrow earnings and dividends through a difficult period. It's hard to find that in many other areas.
Fergus: I'd probably go for India, even though the market has run very hard recently. There's a lot of reform and organisation still to take place. It's reasonably under-banked, under-penetrated in terms of the internet and mobile phones there's a lot of low-hanging fruit.
Max: It's tempting to just say Russia, but I think you've got to have some more conviction that it'll turn around. Argentina might be worth a small punt, with the election coming up there's an Advance fund that gives you access to this. But if we're talking one country, I'd probably say Fidelity China, and lock it away for ten years.
John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.
He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.
His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.
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