Emerging-markets roundtable: Part 3

 Matthew Strauss, vice-president and portfolio manager at Signature Global Asset Management, a division of CI Investments Inc. Strauss provides macroeconomic strategy on foreign exchange and is a specialist in emerging markets. His responsibilities include CI Signature Emerging Markets.

 Chuk Wong, vice-president and portfolio manager and long-time member of the global equity team at 1832 Asset Management L.P. He has a wide range of mandates including Dynamic Global Value, Dynamic Global Value Class, Dynamic Far East Value and Dynamic Emerging Markets Class.

The discussion was moderated by Morningstar columnist Sonita Horvitch, whose series began on Monday and continued on Wednesday.

Q: We have discussed China, South Korea and Taiwan. Asia accounts for roughly 60% of the benchmark. Time to explore the Americas, which represent roughly 20% of the index. Brazil (10.7%) and Mexico (5.4%) are the heftiest weights.

Upton: I've been following Mexico for more than 25 years and was skeptical that the PRI [Institutional Revolutionary Party] could institute the necessary reforms. Yet, it has. In December, the country introduced its energy reform. This is the first time since the Mexican revolution that Mexico is talking about letting foreign oil companies come in and help with exploration. Mexico has needed higher growth, greater competitiveness, more infrastructure spending and improving access to credit for consumers. All of that appears to be addressed with the reforms. The markets have been excited about some of this, but there is still more to come. We've been overweight Mexico for some time and have been increasing that overweight.

Wong: For me, it all boils down to stock valuation. Mexican stocks have done well and the market is expensive from my perspective.

James Upton

Strauss: The valuation on the stocks has also held us back from going overweight in Mexico. But we've been increasing our Mexican exposure quite significantly from a deep underweight closer toward a market weight. It's probably one of the most interesting emerging-markets stories, at this point in time. The investment side is more challenging given the valuations. One theme we are playing is infrastructure investment. I own cement producer Cemex SAB de CV CX. It has a cement business in the United States and now there is a strong domestic story as well.

Upton: We own it.

Q: Brazil?

Wong: This is our principal exposure in Latin America at 8.4% of the portfolio. We're trying to stay away from the commodity companies and are focusing on smaller-caps. One of the stocks that we like is a leading snack and pasta company, M Dias Branco SA. It's a pure Brazilian play. The company is vertically integrated, which gives it a cost advantage versus the multinationals in Brazil. We've owned the stock for more than two years. It has done well. You have to dig deeper to find underappreciated companies.

At the macro level, Brazil needs to reform. Its current reliance on commodities and on the consumer is not sustainable. The consumer has been leveraging to spend.

Strauss: It's not a compelling macro story. We're also worried about the currency. Brazil is running a big current-account deficit and is therefore dependent on foreign capital flows. We consider the currency overvalued. The political backdrop is also problematic. There are elections this October and little is expected on the policy front. We are significantly underweight Brazil and will probably continue with that underweight for some time.

Upton: We have been underweight Brazil for a long time. In the last three years, we've done well by being underweight this country. It was one of the worst performing markets last year, so a lot of the negatives have already been discounted. There are some great plays in infrastructure and health care. There are Brazilian companies that will benefit from the weakening currency.

Q: Emerging Europe?

Upton: We are overweight Eastern Europe. It is deleveraging and is in the position to cut interest rates. Countries like Poland and the Czech Republic have a highly educated work force, good companies and good management. It has all the benefits of being part of the European Union, but it is not in the Eurozone. Eastern Europe is a play on the recovery in Western Europe.

Wong: I am aware of Poland and the Czech Republic's positive macro story, but the valuations have held me back from investing there. We have a small position in Russia. It has always been a tough country to invest in. We also have a couple of Turkish names. We own Pegasus Airlines. It's a low-cost carrier, which is taking market share away from the incumbent, Turkish Airlines.

Upton: I own Pegasus. The stock is not part of the MSCI EM Index. You do have to dig deeper than the index names.

Matthew Strauss

Strauss: On Russia, it is a vast country with both a government and legislation that are very complicated. For this reason, it will continue to trade at a discount to the rest of the emerging markets. We're cautious on Russia and have limited exposure to it. The Russian economy is slowing and a lot of state-owned companies are not that well run. The one company that we do own is Sberbank of Russia. Although the government owns slightly more than 50% of the bank, it does not intervene in its day-to-day business.

Wong: Sberbank is the small exposure that I have in Russia.

Upton: We don't own it. We're concerned about its exposure to Russian steel. There are some good companies in the tech sector, again off benchmark, that we own. An example is Yandex, a Russian Internet company.

Q: Greece has been reclassified as an emerging market versus its previous status as a developed market. Chuk, you have exposure to Greece.

Wong: As a contrarian, I look at countries coming through a crisis as a means of finding value. My portfolio has investments in Greece, Egypt and Dubai, which was almost bankrupt in 2008-2009. The United Arab Emirates is going to be classified as an emerging market this year, graduating from its frontier status.

Greece was in deep trouble a few years ago. Valuations were compelling and we have added to holdings in Greece. I think that the worst is over. Despite its high unemployment rate at 27%, there have been more jobs created than lost in the last few months. The Greek banks are arguably the best capitalized in Europe. The systemic risk has subsided significantly. Stocks that we own include Alpha Bank and toy retailer Jumbo SA.

Elsewhere, I am adding to my exposure in Thailand. Yes, there is political tension there. Thailand will successfully emerge from this crisis and the correction in the share prices makes for interesting valuations. I always believe that every crisis creates opportunities.

Strauss: We went overweight Thailand into the political turmoil and we continue to maintain that overweight position.

Wong: Egypt is another example of where I have found value. The unrest in that country makes it challenging from a macro standpoint. Because of the crisis, a lot of stocks were on sale and the country does have a number of well-run companies.

Upton: Egypt outperformed the benchmark last year. When things get heavily discounted, there can be a turning point.

Q: Finally, South Africa, which has a 7.4% weighting in the MSCI Emerging Markets Index.

Upton: The politics and the macroeconomic story are problematic. We are underweight South Africa.

Strauss: In South Africa, policy paralysis is prevalent with all the negatives that go with that. It's a commodity-based economy and commodities are not out of the woods yet. The other big sector in South Africa is financial services. The South African banks are working through a period of high credit extension to the unsecured portion of the market. There will be some deleveraging and lower loan growth. There are also the continued wage problems and upheavals. Overall, it is not a country that we are excited about.

Upton: Despite all that, which we agree with, there are some of the best-managed companies in South Africa that are available in emerging markets.

Chuk Wong, Matthew Strauss and James Upton