Why your next investment belongs in this region

If you notice a home bias in your portfolio – and let’s be honest, that’s probably all Australians – perhaps your standard response is to buy a few extra US shares. It’s not unreasonable - after all, the US dominates global markets but there are great opportunities elsewhere. In some instances, you could even say ‘closer to home’.

At the latest CFA Australian Investment Conference, emerging market equities came up in the top three responses of asset classes that fund managers and chartered advisors intended to look at next.

Such a response comes as no surprise to Ox Capital’s Dr Joseph Lai or VanEck’s Arian Neiron, both of whom see enormous benefits from exposure to emerging markets.

So, why should investors take a closer look and how can they approach investing in these regions?

Diversification is only one part of the story

If you’ve heard it once, you’ve heard it a thousand times – diversification is finance’s only free lunch. It’s equally a good reason for you to consider emerging markets.

“They are generally in a different economic cycle than developed markets,” says Neiron.

Individual countries also tend to have their own cycles separate from each other, compared to developed markets, which tend to operate in tandem. He shares the example of India following COVID-19, which delivered consistent positive economic activity, while surging activity in Taiwan peaked in 2020 and reverted to being contractionary in 2020.

As part of this, Lai adds that “the valuation of stocks in emerging markets is generally very attractive and would benefit from the decline of the US dollar.”

On the valuation front, Antipodes’ John Stavliotis recently shared that the premium you pay for developed markets hasn’t been this high in 20 years, currently standing at 55% compared to an average of 16%. With US and Australian markets at record highs, perhaps a bit more diversification, at a large discount no less, looks appealing?

There’s also a significant growth story to watch.

“Emerging markets account for close to 80% of global economic growth, almost double their share from two decades ago, according to the International Monetary Fund. They also account for close to 85% of the growth in global consumption, more than double their share in the 1990s,” Neiron says.

There’s more growth to come when you consider the megatrends at play, such as the growth of the middle-class and urbanisation across emerging markets.

The biggest misconception about investing in emerging markets

People typically think of emerging markets as high risk – but Lai and Neiron both nominate this as one of the biggest misconceptions. It’s not to say that emerging market stocks aren’t volatile – but you shouldn’t tar all companies with the same brush.

“Given the quality companies available and the very attractive valuations, the prospect of generating significant returns without taking lots of risk is high. They key is to know which stocks to own,” says Lai.

Likewise, emerging market fixed income is not as volatile as perceived.

“Think about every crisis since the turn of the century – these have all been caused by developed market bonds: the GFC, Eurozone crisis, Liz Truss’ UK budget crisis, Japan exiting yield curve control,” says Neiron.

The opportunities to watch

Lai focuses on what he terms ‘industry champions’, identified as leaders in their field and meeting the Quality, Profitable Growth and Valuation criteria. He favours Indonesia, Vietnam, Brazil and China for investing, seeing sustainable long-term growth and attractive valuations in these countries.

Emerging markets can often be seen as risky or volatile to invest in. Lai manages this concern by avoiding countries where he sees an impaired long-term outlook.

“Have a deep understanding of the risks and opportunities in each region. Each country has a nuanced regulatory environment and ways of doing business.

Having an appreciation of the characteristics of each region helps us to take profitable opportunities and to avoid the pitfalls,” Lai says.

Emerging markets move with speed and for the coming cycle, Neiron suggests that “commodity-based emerging markets are placed to do well into the next part of the cycle.”

From a fixed income perspective, Neiron thinks “local currency bonds could do well over the medium to long term because of fiscal dominance”. He notes that emerging markets now have superior fiscal and monetary policy regimes when compared to developed markets – and are far from the heavily indebted sovereigns they were a few decades ago.

Investments the experts like

Dr Joseph Lai

1. Trip.com (NYSE: TCOM)
Chances are you’ve used Trip.com for your own travel arrangements, and Lai notes that the Chinese business has gained roughly 20% of the online travel agency market by active users over the past 8 years from global peers. It charges half the average commission (8-9% v Booking.com’s 15-19%) which achieving the same net profit margin. Lai sees plenty of future growth.

“The shares are attractive – trading at mid-teens multiple with strong earnings growth, ample cash with a solid balance sheet, and plans for share buybacks,” he says.

2. Bank Mandiri (IDX: BMRI)

One of the largest corporate banks in Indonesia, it is taking market share with its low-cost CASA deposit franchise in a structurally growing, low-debt-GDP economy. The bank’s borrowers are primarily leading corporates in Indonesia. “It expects to grow its loans at high teens in 2024, with low credit cost.

“The bank is experiencing robust growth, minimal credit issues, generating high returns on equity, trading at attractive price-to-book rations, and a ~5% dividend yield,” says Lai.

Arian Neiron

1. HCL Technologies (NSE: HCLTECH)

HCL is a multinational tech company offering software and IT infrastructure services. It has offices in 59 countries and over 220,000 employees.

2. Power Grid Corporation of India (NSE: POWERGRID)

Owned by the Government of India, it is engaged in transmission of bulk power across India. It transmits about 50% of the total power generated in India.

3. Taiwanese Quanta Computer Incorporated (TW:2382)

This is a Taiwan-based manufacturer of notebook computers and other electronic hardware. It has extended its businesses into enterprise network systems, home entertainment, mobile communication, automotive electronics and digital home markets. Its customers include large tech companies like Apple and Microsoft.

How to invest

Direct access to equities and fixed income in emerging markets can be difficult for investors leaving listed and unlisted funds as the primary option. There are active and passive options available in the market and Ox Capital and VanEck are amongst those offering expertise in this space.

When it comes to allocation size, both Lai and Neiron note that your allocation varies based on your risk tolerance.

Neiron suggests if you consider benchmarks, emerging markets are around 10% of the MSCI All Country World Index, which could be a fair starting point.

Either way, to quote Neiron, “zero allocation is not the answer” – now could be the time to start thinking about emerging markets.