Are emerging markets on sale?

CI's Matthew Strauss cites widening of valuations gap with developed markets.

Sonita Horvitch 5 June, 2013 | 6:00PM
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Matthew Strauss, vice-president and portfolio manager at Signature Global Asset Management, says that it is more challenging now to invest in emerging-market equities than it was in the period between 2002 and 2011.

"Those were nine golden years, with all the stars in alignment," says Strauss, who specializes in evaluating the economies of developing countries, as well as analyzing foreign-exchange trends. "Over that period, China was growing at a rapid pace and other major emerging economies, such as Brazil and India were also doing well."

This virtuous state, he says, was reflected in the ascent of the MSCI Emerging Markets Index. From 2002 until 2011, it handily outperformed the MSCI World Index, the benchmark for developed economies.

More recently the emerging-markets index has substantially underperformed its developed-market counterpart, Strauss notes. "The gap between the valuation of the emerging-market index and the developed-market index has widened and the relative valuation on emerging-market stocks is quite compelling."

Strauss is looking for emerging-market performance to improve in the second half of 2013, provided the U.S. economy remains on track and there is no precipitous change in the Federal Reserve Board's monetary policy.

Index (total return in C$) 1 Yr. 3 Yr. 5 Yr. 10 Yr.
MSCI Emerging Markets 14.3 5.2 -0.1 12.2
MSCI World 28.3 13.4 2.9 5.2
For periods ended May 31

Of China, Strauss says that growth has slowed "partly by government design" to levels considered to be more sustainable. The expectation is that its GDP will increase at 7% to 8% per year for the next few years, he says.

Beijing's focus is now on domestic consumption, the service sector and on the manufacture of higher-value-added exports, he says. It has "engineered" an increase in wages for workers on the lower economic rungs. "This ties in to its emphasis on higher-value-added manufacturing."

The next step, says Strauss, is for China to implement another round of economic reforms. He'd like to see Beijing require local governments to extend full social services to workers who have migrated from the rural areas to the cities.

Turning to commodities, Strauss says the fundamentals are not as robust as they were from 2002 to 2011. There has been the slowdown in China coupled with lacklustre growth in most developed economies and, in some cases, an increase in supply, he says. "The commodity cycle has slowed substantially and a sharp recovery seems unlikely." This has adverse implications for major emerging-market commodity producers such as Brazil, South Africa and Indonesia, he says.

 
Matthew Strauss

Signature Global Asset Management, a separate portfolio-management team under CI Investments Inc., manages $40 billion across all asset classes. At Signature, Strauss's responsibilities include CI Signature Emerging Markets, which he co-manages with Signature's chief investment officer, Eric Bushell.

Born and raised in Namibia, Strauss has a master's degree in economics from the University of Stellenbosch, South Africa. His 17 years in the investment industry include a role as chief strategist at a major South African retail bank and, more recently, a position as senior fixed-income and currency strategist at a leading Canadian chartered bank.

CI Signature Emerging Markets, which is benchmarked against the MSCI Emerging Markets Index, currently holds 115 names. "The range is roughly from 100 to 120 names," says Strauss. He and Bushell employ a combination of macroeconomic and company-specific analysis. For the latter, "we rely on input from Signature's other portfolio managers and sector specialists."

Geographically, the fund is overweight in greater China, but underweight in the other "BRIC" countries: Brazil, Russia and India.

The sector weightings reflect, in part, two major investing themes: growing household affluence in developing countries and the need for infrastructure investment. "Increasing household wealth is boosting the domestic demand for financial services, consumer staples, consumer-discretionary products and health care," says Strauss.

As a play on the demand for emerging-market infrastructure, the fund has holdings in cement manufacturers PT Semen Indonesia (Persero) Tbk and Siam Cement Public Co. Ltd., of Thailand, which are both top-10 holdings.

The fund has a substantial underweight to materials and a more modest underweight in energy producers, in keeping with Signature's macroeconomic analysis. "There is less of a supply overhang in the oil market than for a number of base and industrial metals."

CI Signature Emerging Markets has significant holdings in global giants based in emerging economies in fields such as technology. It also has holdings in global players based in developed countries, "where emerging economies account for an increasing percentage of their revenue and earnings," says Strauss.

Here, examples are the electronics juggernaut Samsung Electronics Co. Ltd., based in South Korea, and Taiwan Semiconductor Manufacturing Co. Ltd., which has an American Depository Receipt TSM that trades in New York.

A U.S.-based global bank in the fund's top-10 holdings is Citigroup Inc. C. The bank, says Strauss, generates roughly half of its retail banking revenue from developing countries. At the time of purchase, the stock offered better relative value than the emerging-economy banks, which are "generally expensive," he says. "Citigroup's stock has rallied since we bought it, but we still like it."

Emerging-market banks in the portfolio that the Signature team continues to champion include Kasikorn Bank Public Co. Ltd. and Bangkok Bank Public Co. Ltd. of Thailand. "We have a big overweight in Thailand; the macro story and the stocks' stories have come together." Strauss reports that the two bank stocks were purchased at a time when there was skepticism about Thai banks. "They have done well and now represent fair value."

A top 10-holding in the fund is OAO Sberbank. "This is Russia's largest bank lender, with a dominant position in the domestic market," says Strauss. Sberbank's valuation is compelling, he says. "The stock trades at a discount to its emerging-market peers and loan growth remains strong."

In health care, a leading Brazilian diagnostic company that is a play on the growing demand for health-care services in "a key emerging economy" is Fleury S.A., says Strauss. "This company provides high-quality services and dominates the high-income market segment in the country." Of late, he says, it has been expanding its target market to take advantage of growing household wealth.

The Signature team has sold down its holding in a major Brazilian homebuilder, MRV Engenharia. "The company targets the low-income market." Unemployment in Brazil is rising and MRV is experiencing costs overruns, says Strauss. "This is squeezing its profit margins."

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Sonita Horvitch

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