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Strategy Spotlight

Emerging Markets Discovery Equity Strategy

Finding Fortune in the Forgotten

Ernest C. Yeung, Portfolio Manager, Emerging Markets Discovery Equity Strategy

Executive Summary

  • Portfolio Manager Ernest Yeung celebrated his third anniversary at the helm of T. Rowe Price’s Emerging Markets Discovery Equity Strategy, formerly the Emerging Markets Value Equity Strategy, in September 2018. The strategy has posted positive net excess returns under his direction despite a challenging environment.
  • Favorable stock selection has been the primary driver of the outperformance of the portfolio, at both the country and sector levels, since its inception through the end of September 2018. The strategy leverages T. Rowe Price’s strength in fundamental research and long history of investing in EM. T. Rowe Price has invested in EM since 1985, developing one of the most experienced and largest research teams in the industry.
  • Unlike other value‑oriented managers who have succumbed to the temptation of adding growth companies into their portfolios to deliver performance, Mr. Yeung has remained true to his investment philosophy and does not hold any of the crowded growth‑oriented technology names. These names drove EM performance in recent times, but good value opportunities can be found outside of these sought‑after “new economy” stocks.

T. Rowe Price’s Emerging Markets Discovery Equity (EMD) Strategy, managed by Portfolio Manager Ernest Yeung, marked its third anniversary in September 2018 with positive net excess returns, despite a thriving environment for growth stocks during the period. This has been achieved by employing a differentiated investment approach that allows deeper penetration into emerging markets (EM) to find value.

Investors have been broadly skeptical of emerging markets, particularly recently as volatility spiked, and have tended to concentrate their exposure within a limited group of high‑quality growth companies. This has left a large swath of the EM opportunity set ignored. Importantly, many of these companies continue to deliver decent growth, and valuations have remained relatively inexpensive. Against this backdrop, Mr. Yeung has deftly applied a disciplined, bottom‑up framework aimed at identifying “forgotten” stocks or those that have been overlooked by investors, but which are fundamentally sound and have potential rerating catalysts.

Under Mr. Yeung’s three‑year tenure, the EMD Strategy has delivered 150 basis points (bps) of annualized excess return, net of fees, over the core MSCI EM Index Net. Over that same period, the strategy posted an annualized excess return of 231 bps, net of fees, over the MSCI EM Value Index Net. Within the global EM all‑cap value equity universe,1 the strategy ranked in the 19th, 11th, and 31st total return percentile for its trailing one‑, two‑, and three‑year results, respectively.

FIGURE 1: Positive Relative Returns

Periods Ended September 30, 2018, Figures Are Calculated in U.S. Dollars

        Annualized
  Three
Months
Year-to-
Date
One
Year
Two
Years
Since Inception
(Sep. 30, 2015)
Emerging Markets Discovery Equity Composite (Gross) 1.48% -3.96% 1.87% 14.00% 14.82%
Emerging Markets Discovery Equity Composite (Net)† 1.27 -4.58 1.00 13.05 13.86
MSCI Emerging Markets Index Net‡ -1.09 -7.68 -0.81 10.21 12.36
Value Added (Net)** 2.36 3.10 1.81 2.84 1.50
eVestment Global EM All Cap Value Equity Universe Median 0.12 -7.46 -1.82 10.14 13.63
T. Rowe Price EM Value Peer Rank 24 9 19 11 31
Number of Active EM Value Managers in the Universe 46 46 46 45 42

Past performance is not a reliable indicator future results.
Supplemental information.
Source: T. Rowe Price.
Source for MSCI data: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.
Net‑of‑fees performance reflects the deduction of the highest applicable management fee (Model Net Fee) that would be charged based on the fee schedule appropriate to you for this mandate, without the benefit of breakpoints. Please be advised that the composite may include other investment products that are subject to management fees that are inapplicable to you but are in excess of the Model Net Fee. Therefore, the actual performance of all the portfolios in the composite on a net‑fee basis will be different and may be lower than the Model Net Fee performance. However, such Model Net Fee performance is intended to provide the most appropriate example of the impact management fees would have by applying management fees relevant to you to the gross performance of the composite. Supplemental information. Please see the GIPS® Disclosure page for additional information on the composite.
Effective July 1, 2018, the benchmark for the composite changed from gross to net of withholding taxes. The change was because the firm viewed the new benchmark to be more consistent with the tax impacts of the portfolios in the composite. Historical benchmark representations have been restated.
** The Value Added is shown as Emerging Markets Discovery Equity Composite (Net of Fees) minus MSCI Emerging Markets Index Net.

Looking beyond the well-trodden path to discover value

Simply buying cheap stocks and waiting for mean reversion is a flawed approach within emerging markets, according to Mr. Yeung. This is because mean reversion does not always transpire, as EM tend to be less efficient than their developed counterparts. He prefers to be on the lookout for positive fundamental changes among stable companies that are facing unwarranted skepticism from investors.

His approach addresses the drawbacks of classic value investing, such as the risk of falling into value traps. He believes that, in EM, stocks can stay cheap for a protracted period. Without a deep understanding of a company’s execution track record and the resources to identify catalysts that could cause a stock to rerate, it is easy to be lured into these names. In EM, opaque ownership structures, weaker governance, and a prevalence of family‑ and government‑owned companies, are all factors that can conspire to keep cheap stocks cheap for an inordinate amount of time.

The EMD Strategy tends to differ from its benchmark and EM peer universe, as indicated by an active share of 85%, trumping the eVestment Global Emerging Markets Universe’s 82% average. Often, the strategy’s biggest underweights will be its competitors’ largest relative overweights. Consider that the information technology (IT) sector was the largest relative underweight for the strategy, followed by consumer discretionary, as of September 30, 2018. Meanwhile, financials was the portfolio’s biggest overweight, in both absolute and relative terms, followed by industrials and business services.

The strategy has demonstrated a downside capture ratio of 94%, as of the end of September 2018, while the upside capture ratio stood at 97%. With the fundamental, bottom‑up investment approach, the portfolio is expected to outperform during periods when stock‑specific factors primarily drive equity prices. In addition to this, the portfolio manager’s preference for fundamentally stable companies with potential catalysts for improvement should be supportive of returns during periods of market weakness. The portfolio may underperform in strong bull markets led by growth stocks, such as in 2017, and during periods of deep‑value rallies, such as the recent run led by underperforming energy stocks.

FIGURE 2: Distinguishable From Peers and Benchmark

Periods Ended September 30, 2018, Figures Are Calculated in U.S. Dollars

  Emerging Markets Discovery Equity Composite eVestment Global Emerging Markets All Cap Value Universe Average MSCI EM Index Net
Annualized Total Return
(Since Inception: September 30, 2015)
14.82% 13.46% 12.36%
Annualized Standard Deviation 14.22% 14.65% 14.09%
Historical Tracking Error, 3‑Year 3.58% 4.86%
Beta, 3‑Year 0.98 0.96 1.00
R‑squared, 3‑Year 0.94 0.89 1.00
Annualized Alpha, 3‑Year 2.50% 1.15% -
Sharpe Ratio, 3‑Year 0.97 0.86 0.81
Information Ratio, 3‑Year 0.69 0.14 -
P/B 1.4x 1.5x 2.0x
ROE,1 Year 13.40% 14.60% 14.80%
Median Market Capitalization (MM USD) 11,223 8,178 24,078
Active Share 85 82 -
Portfolio Turnover, 12‑Month 63% 50% -
Number of Holdings 57 215 1,085

Sources: T. Rowe Price, eVestment Data Alliance, and MSCI.
Statistics based on monthly gross returns. Returns would have been lower as the result of the deductions of applicable fees.

Aside from outperforming the primary benchmark, the strategy delivered higher earnings per share (EPS) growth than that of the MSCI EM Index. The strategy’s price‑to‑book ratio was also significantly lower than the index as a result of investing in fundamentally sound companies that deliver a return on equity of 13.40% as of the end of September this year.

While EM weakened during the first nine months of 2018, EM equities rallied in 2017, extending the previous year’s advance as investors favored growth stocks. Gains have largely been driven by “new economy” stocks, such as information technology names and some consumer stocks. In 2018, the trade dispute between the U.S. and China; idiosyncratic concerns in select EM countries, such as Turkey and Argentina; along with the strength of the U.S. dollar and tightening U.S. rate policy, cast a pall on EM. Lingering concerns that policy tightening in China was slowing economic growth further weighed on the markets.

Against this background, Mr. Yeung’s favorable stock selection has been the primary driver of the outperformance of the portfolio, at both the country and sector levels, since its inception until the end of September 2018. During the period, stock selection within financials, industrials, and IT provided the largest positive contribution to relative returns, despite the negative impact of the portfolio manager’s group weight in these sectors, especially in IT.

At the country level, the portfolio’s company investments in China and Brazil buoyed performance. Buying into old‑economy stocks, such as Banco Bradesco, worked for the portfolio as this large private bank in Brazil is expected to benefit from a potential acceleration in loan growth amid a consolidated market.

In the IT realm, Sina.com, a leading online portal in China and a top contributor to performance, exemplified how the depth of T. Rowe Price’s research enabled Mr. Yeung to uphold his contrarian view of a sector where overall valuations were high. His preference for high‑return, cash‑generative businesses, such as Kingboard Holdings, an electronics laminates producer, also paid off. Both of these stocks were exited in 2017, locking in strong gains.

...Mr. Yeung’s favorable stock selection has been the primary driver of the outperformance of the portfolio, at both the country and sector levels, since its inception until the end of September 2018.

FIGURE 3: Emerging Markets Discovery Equity Strategy Representative Portfolio Relative Sector Weights vs. MSCI EM Index Net

As of September 30, 2018

T. Rowe Price uses the MSCI/S&P Global Industry Classification Standard (GICS) for sector and industry reporting. Each year, MSCI and S&P review the GICS structure. The last change occurred on September 28, 2018. The telecommunication services sector was expanded and renamed communication services. Some securities previously assigned to information technology or consumer discretionary were reclassified as communication services. T. Rowe Price will adhere to all future updates to GICS for prospective reporting.
The representative portfolio is an account in the composite we believe most closely reflects current portfolio management style for the strategy. Performance is not a consideration in the selection of the representative portfolio. Information regarding the representative portfolio and, where applicable, the other accounts in the composite is available upon request. Please see the GIPS® Disclosure page for additional information on the composite.
Supplemental information.
Source for MSCI data: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.
Source: FactSet.

Finding truly undervalued companies with promising prospects in EM presents a challenge given the multiple regions, unique countries, and sectors at different stages of their life cycle. Nevertheless, EM represent a diverse opportunity set, and unlike developed markets, the quantity, and quality, of research is somewhat lacking.

The EMD Strategy leverages T. Rowe Price’s strength in fundamental research and long history of investing in EM. T. Rowe Price has invested in EM since 1980, developing one of the most experienced and largest research teams in the industry. Mr. Yeung, and recently appointed Hong Kong‑based Associate Portfolio Manager Haider Ali, have access to the firm’s 29 EM equity and 17 EM debt research analysts, who form part of the company’s 140‑strong global equity and credit research team. The close collaboration within the research team helped identify opportunities in select South African financial stocks back in early 2017, at a time when most investors shunned the country. These companies were leveraged to the macro recovery cycle in South Africa and within continental Africa, a neglected but promising region.

Environmental, social, and governance (ESG) issues can influence investment risk and return and, therefore, are important, especially in EM where corporate governance standards are often not as robust as developed markets. ESG risk considerations are integrated within the investment team’s fundamental investment analysis. In addition, dedicated ESG specialists work with analysts and portfolio managers to help them understand relevant political, governance, and regulatory risks.

Unlike other value managers who have succumbed to the temptation of adding growth companies into their portfolios to deliver performance, Mr. Yeung has remained true to his investment philosophy and does not hold any of the crowded growth‑oriented technology names. These names drove EM performance in recent times, but good value opportunities can be found outside of these sought‑after “new economy” stocks. And in finding these overlooked, quality businesses, there is money to be made.

For example, Anhui Conch, one of the portfolio’s top positions and among the biggest contributors to performance during the three-year period, generated considerable returns similar to those made by many of the crowded technology sector names.

The strategy’s investment universe includes all emerging and frontier markets across the capitalization spectrum. Emerging market mid‑cap stocks, or those with market value of less than USD $10 billion, make up the bulk of the portfolio, as the portfolio manager found a number pockets of value in mid‑cap stocks compared with the crowded larger‑capitalization stocks. Passive investment flows tend to be concentrated in larger‑capitalization stocks, creating more potential value 5 opportunities among small‑ and mid‑cap stocks. Liquidity is also an important parameter in selecting “forgotten” stocks that are poised for fundamental change, hence, the portfolio manager focuses more on liquid mid‑cap stocks and avoids very small‑cap stocks where the lack of liquidity poses a challenge and a potential risk.

Strategy Spotlight

Emerging Markets Discovery Equity Strategy: Finding Fortune in the Forgotten

Emerging Markets Discovery Equity Strategy: Finding Fortune in the Forgotten
Unlike other value‑oriented managers who have succumbed to the temptation of adding growth companies into their portfolios to deliver performance, Mr. Yeung has remained true to his investment philosophy and does not hold any of the crowded growth‑oriented technology names. These names drove EM performance in recent times, but good value opportunities can be found outside of these sought‑after “new economy” stocks.

1 eVestment, as of September 2018. EVestment collects information directly from investment management firms and other sources believed to be reliable. EVestment does not guarantee or warrant the accuracy, timeliness, or completeness of the information provided and is not responsible for any errors or omissions. Performance results may be provided with additional disclosures available on our systems, and other important considerations such as fees may be applicable. [Return to Text]


The strategy’s name was changed from Emerging Markets Value Equity Strategy to Emerging Markets Discovery Equity Strategy as of December 1, 2018. Effective the same day, the name change applied to the composite vehicle, now known as Emerging Markets Discovery Equity Composite.


The specific securities identified and described do not represent all of the securities purchased, sold, or recommended for clients in the composite and no assumptions should be made that the securities identified and discussed were or will be profitable.


Important Information
This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up.
Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.

MSCI index returns are shown with gross dividends reinvested.
Source for MSCI data: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.

eVestment: Copyright © 2018 eVestment Alliance, LLC (eVestment). All rights reserved.

It is not intended for distribution to retail investors in any jurisdiction.

USA—Issued in the USA by T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, MD, 21202, which is regulated by the U.S. Securities and Exchange Commission. For Institutional Investors only.

T. Rowe PRICE, INVEST WITH CONFIDENCE and the Bighorn Sheep design are, collectively and/or apart, trademarks or registered trademarks of T. Rowe Price Group, Inc. All rights reserved.

201812-694731

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