The changing tide of emerging-markets investing

Tech stocks gain prominence, says Capital Group's Shaw Wagener.

Sonita Horvitch 21 February, 2018 | 6:00PM
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Shaw Wagener, senior portfolio manager at Los Angeles-based Capital Group, says that an important trend in developing countries is the rise in prominence of major technology and e-commerce companies and the shift away from the traditional natural-resource dominance in their equity markets. "There has been a shift toward information technology in countries like China, Russia and Brazil."

In China, for instance, the more recent growth of companies like  Alibaba Group Holding Ltd. (BABA) and  Tencent Holdings Ltd. (TCEHY) has resulted in the information-technology sector now representing close to 30% of the country's benchmark stock index, Wagener says. These higher-growth companies have changed the valuation profile of that index. He says it had a recent price/earnings ratio of 16 times versus a low point of 13 times in 2013.

With a 30-year specialization in emerging markets at Capital Group, Wagener, who is based in Los Angeles, has a background in both fixed-income and equity investment in developing countries. He began his involvement in emerging markets as a trader in 1986. In that year, the asset manager launched one of the world's first emerging-markets equity funds.

Founded during the Great Depression in the 1930s, Capital Group now has approximately US$1.7 trillion in assets under management, of which some US$97.5 billion is invested in emerging and frontier markets.

Of the current economic state of developing countries, Wagener notes that many have made significant macro adjustments since the global financial crisis in 2008. "They have introduced better fiscal policies and overall reforms and this is paying off."

China, which accounts for more than 30% of the developing-country equity benchmark, the MSCI Emerging Markets Index, "stands out." In 2012-2013, the Communist Party introduced a new administration that has set about making some major reforms, Wagener says. "This administration has focused on issues such as corruption, pollution, infrastructure build-outs and on reforming state-owned enterprises." China has experienced rising employment, firmer salaries and declining inflation rates, he notes. "Against this backdrop, consumer confidence has risen."

A plus for China's financial markets, Wagener says, is that the authorities have improved foreign access to so-called A Shares. These shares are listed on China's two stock exchanges and previously were mainly available only to domestic investors. The MSCI China Index registered a total return of 54.3% in 2017 in U.S.-dollar terms. "Our portfolios have a lot less in China than its representation in the MSCI Emerging Markets Index." This index produced a total return of 37.3% in U.S.-dollar terms in 2017.

Shaw Wagener
Shaw Wagener

Of the recent volatility and weakness in global equity markets, which also affected emerging markets, Wagener points out that this followed the lengthy period of low volatility since 2015-2016."The new regime of rising interest rates in developed markets, with the U.S. bond yields, for example on the rise, has caused investors to re-evaluate their expected returns from equities." This resulted, he says, in these stock-price adjustments, which were a response to these larger macro trends. "But this has come after a period of strong advances in stock prices."

It must also be remembered, Wagener says, that the macroeconomic environment remains favourable to stocks, given the synchronized global economic growth. "Economic growth rates in the developing world have varied by country but overall are stronger than those in developed nations."

Key to the outlook for emerging-market stocks, says Wagener, is corporate earnings growth. "The overall price/earnings multiple moves only in a narrow band, unlike the P/E multiples in developed markets." Profits for emerging-markets companies continue to improve, and, in aggregate, are forecast to register another year of double-digit growth in 2018, he says. This growth is likely to continue in 2019, he adds.

Capital Group's emerging-markets team's mandates include Capital Group Emerging Markets Total Opportunities (Canada). (On the basis of its historical holdings, this mutual fund has been placed in the Global Neutral Balanced category.) At the end of 2017, it held 44.2% in equities, 43.5% in bonds and 12.3% in cash. "The objective of this fund," says Wagener, "is to produce equity-like returns with lower volatility than is typically associated with emerging-market stocks."

Capital Group's emerging-markets team consists of a global network of analysts and four senior emerging-markets portfolio managers, including Wagener. Each of these managers is responsible for investing in both equities and fixed-income securities. Their aim is to invest in companies that they have met with.

In selecting stocks for the equity component of Emerging Markets Total Opportunities, the portfolio managers look at the current stock price relative to the prospects for the individual company over the next three to five years. "It is an intensive research-driven process," Wagener says.

A holding in the portfolio,  MercadoLibre Inc. (MELI), could be considered expensive, says Wagener, adding that the company has excellent prospects over the next three to five years. This major e-commerce and online auctions provider is an Argentinian company incorporated in the United States. "MercadoLibre is Latin America's largest online marketplace, with a particular stronghold in Brazil." The company has been experiencing "strong revenue growth," as it extended free shipping to more markets and made further improvements to its payment systems.

An "innovative" telecommunication-services company in the portfolio is Bharti Airtel Ltd., which is based in India. This company has operations in 20 countries across Asia and Africa. "It is a well-managed pioneer in wireless communication; the company rolled out a national network in India at a faster pace than its rivals." In India, the telecom-services industry is consolidating and the price war is de-escalating, Wagener says. "This benefits Bharti Airtel."

The largest sector weight in the equity component of the Emerging Markets Total Opportunities portfolio is financial services. "This is based on individual opportunities rather than on an over-arching theme," says Wagener.

The portfolio's holding in India-based ICICI Bank Ltd. is a case in point, he says. ICICI, which has an American Depository Receipt and trades under the ticker IBN, provides banking and financial services both in India and internationally. The stock, he notes, was trading at a compelling valuation relative to the bank's three- to five-year prospects. This reflects the bank's depressed earnings due to a weak phase in India's credit cycle. "The credit outlook is improving and ICICI is a fast dividend grower."

ICICI Bank Ltd. MercadoLibre Inc.
Feb. 19 close $10.15 $369.87
52-week high/low $11.26-$7.35 $395.66-$190.07
Market cap $31.8 billion $16.4 billion
Total % return 1Y* 34.3 87.1
Total % return 3Y* -0.4 41.9
Total % return 5Y* 6.5 34.9
*As of Feb. 19, 2018. All figures in U.S. dollars
Source: Morningstar

Another financial-services holding in the portfolio is Hong-Kong-based AIA Group Ltd. It's one of the largest independent publicly listed pan-Asian life-insurance companies.

As an indirect play on emerging markets, the portfolio has a holding in the global brewer Carlsberg A/S, which is headquartered in Denmark. "While a large percentage of its sales are in Western Europe," says Wagener, "the company has a significant stake in the Russian beer market and is successfully growing its operations in Asia."

Wagener says that in China, the Carlsberg brand is particularly popular in the western part of the country, where it has a commanding market share. "With consumer confidence growing in China, there is an increasing gravitation towards global brands."

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Alibaba Group Holding Ltd ADR74.55 USD1.64Rating
ICICI Bank Ltd ADR26.35 USD0.34
MercadoLibre Inc1,559.23 USD-1.45Rating
Tencent Holdings Ltd ADR48.92 USD1.64Rating

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Sonita Horvitch

Sonita Horvitch  

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