………to the latest edition of the T. Rowe Price Panorama magazine – our quarterly publication designed specifically for you and your clients in the Asia- Pacific (APAC) region.
With another year behind us and a new one just beginning, we consider the many value-oriented opportunities within emerging markets that are available in this traditionally growth-associated domain. For those prepared to look beyond the high-profile names, and instead among the many overlooked, forgotten and unwanted companies, there are exciting potential rewards on
In response to a potentially more volatile and challenging market environment in 2019, we consider the appeal of managed volatility strategies. In a more uncertain landscape, managed volatility strategies offer an option for investors to stay in the market: potentially retaining the upside opportunities if expected volatility stays low, but likely providing downside risk management if volatility
We also consider the outlook for global equities in the context of where we are within the current market cycle – are we already at the end of the cycle, or simply in the later stages?
In addition, we delve into the world of credit, looking specifically at the deterioration in the overall credit quality of investment grade credit markets. This is largely the result of an explosion in BBB-rated paper over recent years, but how worried should we actually be?
Finally, we talk at length to Robert Higginbotham, T. Rowe Price’s Head of Global Investment Management Services, about building a truly global
business. It’s not just about being big, it’s about building as diverse a business as possible. We want to be there for, and with, our clients, sustainably,
throughout their long-term investment journey.
We hope you enjoy this edition of the T. Rowe Price Panorama Magazine. As As always, we welcome any comments or feedback you might have, so please
get in touch via the contact details on the final page of the magazine.
T. Rowe Price Australia
OVERLOOKED, FORGOTTEN, UNWANTED – FINDING VALUE IN EMERGING MARKETS
EM equity valuations only reached a trough in the first quarter of 2016, meaning we are just over two years into this current EM cycle.
In the decade since the end of the global financial crisis, growth stocks have substantially outperformed their value counterparts. However, value stocks are starting to attract attention again, raising the question: are we nearing a potential inflection point in the growth/value relationship? With this in mind, we spoke to Ernest Yeung, portfolio manager of the T. Rowe Price Emerging Markets Value Equity strategy, about where he is currently finding value opportunities and also about some of the common misconceptions surrounding growth and value investing.
Trade wars, slower growth in China and monetary tightening in the U.S., are all taking a toll on investor confidence currently, resulting in increased volatility in emerging markets (EMs). Despite the headwinds, however, market fundamentals remain robust. EM equity valuations only reached a trough in the first quarter of 2016, meaning we are just over two years into the current EM cycle. A cycle within EMs usually lasts between 8–10 years, so we are not even close to the end. Encouragingly, at both the stock level and on the macro front, decisions are being made for positive reasons. Governments have recognized previous mistakes and are taking prudent decisions, while corporates remain focused on shareholders.
This is one of the major differences between developed and emerging markets. Within the former, monetary easing is being withdrawn and interest rates are rising as the cycle is much further progressed and inflationary pressure is building. However, that is not the case for EMs, where inflation remains generally contained. While EMs may temporarily be impacted by U.S. rate hikes and talk of potential trade wars, they are still moving in the right direction. Meanwhile, volatility offers the opportunity to buy good quality companies at potentially lower prices.
There is no question that the current U.S./China trade conflict is important, and that there are significant ramifications for EMs, and we are constantly reviewing the situation. However, markets have already sold off quite considerably on the back of these worries. For example, the China domestic A-Shares market is trading at near five-year lows. Encouragingly, when all the current trade tariffs being discussed are aggregated, it still only represents less than one per cent of China’s total GDP. With the economy still growing at 6% every year, we are a little more sanguine. It is also worth bearing in mind that the Chinese renminbi has depreciated by almost 7%1 year-to-date, which offsets much of the negative effects from trade tariffs.
There are those stocks that have performed well over the last two years and which now look expensive. These stocks have also become a much larger part of the EM index, so investing via an ETF means a greater exposure to these expensive companies.
Considering the EM Landscape in Two Parts
When considering EMs, the landscape needs to be broken into two parts. On the one hand, there are those stocks that have performed well over the last two years and which now look expensive. These stocks have also become a much larger part of the EM index, so investing via an ETF means a greater exposure to these expensive companies. Whereas, outside of areas like technology, biotech and advanced materials, to name a few – the so-called new economy sectors – there are many companies that look cheap in our view. However, few are taking notice of these companies as they are so focused on high growth-oriented stocks, most notably the socalled BAT stocks (Baidu, Alibaba and Tencent).
Elsewhere, in Latin America, political and economic uncertainties have created substantial headwinds for many local markets, such that most in the region are looking like good value, in our view. Overall, Latin America markets have been generally flat over the last five years. In comparison, the S&P 500 has delivered a total return of more than 50%2. Currencies are also cheap and that is an important contributor to performance. Conversely, the countries that have been more stable from a macroeconomic perspective, like Chile, look more expensive in our view opinion. This is also the true of Mexico. In both countries, we are selectively focusing on high-quality companies that have the potential to grow into their valuations.
South Africa is another largely forgotten country that nobody really talks about. Even the local entrepreneurs tend to take any profits they make and invest them outside South Africa. However, the country is home to some good quality companies, so this is another market we like currently.
A Large Opportunity Set but Selectivity is Key
More broadly, the EM opportunity set is around 3000 stocks. Many of these are not very attractive, and that is why a passive investment approach makes little sense, in our view. Nevertheless, we are excited about the opportunities we are finding within the EM value universe. For example, many people view state-owned enterprises (SOEs) as toxic investments and, over the past 10 years, this has been true as their general performance has been appalling. However, change is afoot as investors are forcing these companies to make important changes. Many are cleaning up their balance sheets, deleveraging and starting to generate decent free cash flows.
It is important to remember that between 2000 and 2009, Chinese SOEs were the best-performing asset class in EMs. A huge inflection point was reached in 2009, however, when the government stopped all stock-option programmes in China. That caused huge disruption to these companies and, since 2009, they have been a very poor asset class to be invested in, due primarily to a lack of focus on shareholders as there was no incentive for management. Following the recent reversal of that restriction, we believe that we may see a more positive inflection point for these stocks.
As a value investor and, more specifically, an emerging markets value investor, perhaps the biggest misconception is that attractive value opportunities in the EM region are few and far between.
Addressing Some Common Misconceptions
At this point, it is worth addressing some of the common misconceptions associated with growth and value investing. As a value investor and, specifically, an EM value investor, perhaps the biggest misconception is that attractive value opportunities in the EM region are few and far between.
This is not surprising, given EMs tend to be associated with high growth. Indeed, the majority of all active money flows currently into the EM universe is invested in core and growth portfolios, meaning that only a very small proportion of total EM money flows is value focused.
Given this large bias towards core/growth investments, there are many areas that are being overlooked or forgotten. This disparity between the two investment styles is perhaps the biggest disconnect between emerging and developed markets, in our view.
FIGURE 1: Strong Capex Discipline Underpins Our Positive View of Emerging Markets
As of 30 September 2018
For example, we can currently buy what we believe are some of the best franchise banks and best insurance companies within the emerging markets landscape, at historically low prices. The widely held perception is that financials are cheap for a reason. This might be true for developed markets (DM), where financials are struggling due to depressed 10-year bond yields. However, there are 30 different countries in the
emerging market universe. And unlike developed markets, the yield curve in China, as well as some central and eastern European countries, has been steepening for two years. Also, capital spending (capex) in EMs is at the lowest level in more than a decade (Figure 1), so we expect this to pick-up going forward. With increased capex comes job creation, rising wages and loan growth, so EM financials look reasonably well positioned currently, in contrast to their developed market counterparts.
Another misconception is that the same rules apply, whether investing in emerging or developed markets. However, value investing in EM is very different from value investing in DM. For example, many DM value investors will focus on buying “falling star” companies as prices decline, and then wait for some catalyst to trigger mean reversion. However, mean reversion often doesn’t occur in EMs. Cheap stocks can stay cheap for a very long time for a range of reasons, including opaque ownership structures, weaker governance practices and a prevalence of family and state-owned companies. There are also few takeover stories or leveraged buyouts in EMs. So, there are limited opportunities to buy genuinely cheap companies – on a price/earnings or price-to-book basis – and simply wait for them to pay off.
Finally, as an EM value investor, we also need to consider the potential impact of a peak in the U.S. economy. EM and U.S. stock markets have a historical correlation of around 0.75. So, if the U.S. economy rolls over EMs will not be immune to the slowdown. However, even in the event of such a headwind developing, we would work even harder to find companies with the potential to improve and outperform in a tougher market environment. A crucial point to remember is that, for investors in the EM value space, there remains the luxury of valuation multiples that are at very low levels.
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