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Edging ahead in the EMs: top managers clash on the best approach

Edging ahead in the EMs: top managers clash on the best approach

While performance from the majority of emerging market (EM) equity funds has been modest over the last few years, there are plenty that have returned more than 100% over five years.

One of the top performing managers over that period, is Citywire AA-rated Nick Price, who runs Fidelity’s EM and EM Middle East funds, see table below.

Price says he tries to identify the sustainable price of a business. ‘If I’m buying Starbucks, and I know they don’t pay much tax, I adjust for that. I look at the operating environment and the business environment.'

'I look at the numbers and try to find the appropriate multiple, looking at history, both on a relative and absolute basis. That gives us a total return figure. I’m after businesses with 15-20% upside and paying a dividend.’

Price does not tend to look too closely at what his peers are doing. Instead, he says, he tries to ‘concentrate on my own game’. His team, who have now been together for around six years, spend a great deal of time talking to companies.

‘Just this week we’ve been to Mexico, China and South Korea. We’re trying to look at opportunities and the headline concerns that give us the chance to buy good companies at a discount.'

'We have a valuation focus on total shareholder return. As we approach our price target we will then reduce exposure and recycle into other opportunities.’

‘There is an opportunity to pick up good franchises in Turkey. We’re not overly concerned about the tapering effect’ – Nick Price, Fidelity

The second half of last year delivered good stock selection across the board for the funds, says Price. ‘We saw strong performance in particular from consumer discretionary stocks, as well as Chinese internet-related companies and Macao gaming names.’

Technology boost

Technology as a sector continues to be a driver in EM, says Price. ‘The likes of Indian outsourcing company Cognizant Technology Solutions have benefited from a weaker Indian rupee and a cheaper cost base.'

'We also like internet stocks like Naspers and Baidu. Smartphones will take off in poorer emerging markets, and the content providers like Baidu are the winners here. We’re now seeing a $32 smartphone in China. The wider markets are largely penetrated now so we’ll see a move to cheaper handsets and a shift away from areas with margin pressure.’

Within the consumer discretionary sector Price points to stocks such as New Oriental Education & Technology, a leading Chinese education company which he describes as a restructuring story. ‘Within consumer discretionary we’ve been finding more stocks at better valuations. Our overweights will remain in consumer, IT and health care.’

The major underweight in his portfolios is financials, with stocks such as Turkish bank Turkiye Halk Banksi negatively impacted by tapering, the unsustainable financial situation in the country and political pressures.

However, in Price’s view, EM currencies in many cases now look oversold, and he plans to increase his exposure to some leading banks such as Bank Rakyat in Indonesia.

At a country level, Price has been cautious about his exposure to the so-called Fragile Five of Brazil, India, Indonesia, South Africa and Turkey, which look most vulnerable to US tapering. At the same time, though, his approach remains bottom up, talking to companies about doing business in their regions.

‘There is an opportunity to pick up some good franchises in Turkey, for example, with attractive stock and currency valuations. We’re not overly concerned about the tapering effect.'

'You have to put it into context and a large portion is already reflected in currencies. We’re buying into strong franchises which offer good total shareholder returns, be it from dividends or compounding earnings growth.’

Top EM equities managers by manager ratio over five years

Manager Rating TR % (USD) Manager Ratio Contributing Fund
Pekka Niemelä + 137.13 0.99 UB Emerging Markets Infra Kasvu
Knut Harald Nilsson AA 148.77 0.92 Skagen Kon-Tiki
Kristoffer Stensrud AA 148.77 0.92 Skagen Kon-Tiki
Nick Price AA 152.35 0.67 Fidelity EMEA Acc 1, Fidelity Emerging Europe MiddleEast & Africa Y Acc, Fidelity Emerging Markets Acc, Fidelity FAST Emerging Markets A-USD, Fidelity Funds - Emerging Markets A-USD, Fidelity Funds - Inst Emer Markets Eq I-ACC-USD
Will Sutcliffe + 128.12 0.57 Baillie Gifford Emer Mkts Leading Companies C Acc
Jean-Louis Scandella + 142.97 0.55 Comgest Growth Emerging Markets US Dollar, Comgest Growth GEM Promising Companies Euro, Magellan C
Julian Garel-Jones + 196.06 0.54 Polunin Capital Partners Dev Countries Master, Polunin Discovery Frontier Markets A, Polunin Emerging Markets Small Cap
Aditya Mehta + 196.06 0.54 Polunin Capital Partners Dev Countries Master, Polunin Discovery Frontier Markets A, Polunin Emerging Markets Small Cap

Citywire Manager Ratio: Manager Ratio reflects how much ‘added value’ in terms of outperformance against the benchmark the fund manager delivers for each unit of risk assumed, where risk is defined as not mirroring the index’s return. It ties together the fund manager’s personal career history with the Information Ratio of the underlying funds.

In China, Price holds no property companies and is underweight financials. ‘The Chinese do have the ability to recapitalise the banking sector. Our focus, though, is on consumer-facing areas of China and exporters which have a strong global presence.’

In India, Price says he does not like the banking system, where state banks are cheap but have directed lending and private banks look too expensive. ‘I’m happy holding high quality Indian companies such as Cognizant. Its offering is ever more compelling.’

‘There’s more dividend yield from the MSCI Emerging Markets index than in the developed world. When larger banks still recommend an underweight to EM it looks a bit surprising’ – Emmanuel Hauptmann, RAM Active Investments

It is difficult to find many opportunities in Latin America, says Price. ‘Some very big companies like Petrobras have significant issues. I don’t own them and I’m not going to. The same goes for areas such as the Mexican energy market,’ he says.

The largest contributions to his Fidelity Funds Emerging Markets fund for the six months to 31 December 2013 came from Naspers, Baidu, Galaxy Entertainment Group, New Oriental Education & Technology and Naver Corp.

Price also highlights stocks such as energy company Surgutneftegaz, whose significant cash pile is likely to be valued by the market at some point, and AIA Group, a Pan-Asian insurance company which is benefiting from the demand for savings in the region.

Three-pronged strategy

Over three years the top-ranked managers in the EM equity sector are Emmanuel Hauptmann and colleagues Thomas de Saint-Seine and Maxime Botti of RAM Active Investments, see table below. The three co-manage the firm’s Emerging Markets Equities and Emerging Markets Core funds and have a Citywire Manager Ratio of 1.13.

The trio’s investment philosophy centres on trying to capture inefficiencies in fragmented markets by applying three different blocks of strategies which are complementary and generate alpha over different time periods.

Each of the strategies has what the firm describes as ‘portable alpha’, and can generate excess returns. The managers look at 25 countries over four different continents with at least 30,000 stocks listed, then apply a filter on those stocks. Companies must have a market capitalisation in excess of $150 million (€109 million) and be sufficiently liquid.

The first strategy, Value Cash Flow, identifies stocks with strong free cash flow. This tends to be contrarian and works well when the market is discriminating against companies leaving them under-rated.

The process is systematic and the team never meets with company management.

The second approach is very defensive and based on dividend growth, predicated on the theory that defensive names have strong intrinsic value, almost like bonds, and are very interesting when there are corrections in the market. Generally their beta is very low.

The third strategy is a GARP/momentum strategy which aims to identify a niche situation or a local trend. Each fund’s allocation across these three strategies is fixed over time in order to cross market cycles.

Hauptmann says the GARP engine was the best performer last year.

‘We had some good stock picks in countries like Taiwan, which is currently the largest country overweight. There have also been some interesting IT plays in the growth strategy, with strong earnings trends and attractive valuations.’

The value and dividend strategies have also played their part in delivering performance ahead of benchmark, says Hauptmann. ‘We have had some relatively large reallocations at the end of the year at a country level.

The largest was in China. Post-Plenum, analysts have made some strong earnings revisions. We’ve seen more allocation from the GARP approach in China – we’re now close to equal weight with the benchmark on China.’

Top EM equities managers by manager ratio over three years

Name Rating TR % USD MR Contributing Fund
Maxime Botti 17.84 1.13 RAM (Lux) SF-Emerging Markets Core Eqs B USD, RAM (Lux) SF-Emerging Markets Equities B USD
Thomas de Saint-Seine 17.84 1.13 RAM (Lux) SF-Emerging Markets Core Eqs B USD, RAM (Lux) SF-Emerging Markets Equities B USD
Emmanuel Hauptmann 17.84 1.13 RAM (Lux) SF-Emerging Markets Core Eqs B USD, RAM (Lux) SF-Emerging Markets Equities B USD
Pekka Niemelä + 28.54 0.94 UB Emerging Markets Infra Kasvu
Jonathan Asante AA 17.57 0.89 First State GEM Leaders SGD, First State Global Em Mkts Leaders A GBP Acc, First State Global Emerging Markets A GBP Acc, First State Global Emerging Markets Leaders III, First State Global Emerging Markets Select III, St James's Place Global Emerging Markets Acc
Balthasar Meier AA 21.28 0.82 WMP EM Established Leaders Fund D
David Gait AAA 16.77 0.78 First State Gbl Emer Mkts Sustainability A GBP Acc
Leif Anders Frønning AA 11.65 0.75 Holberg Rurik

Citywire Manager Ratio: Manager Ratio reflects how much ‘added value’ in terms of outperformance against the benchmark the fund manager delivers for each unit of risk assumed, where risk is defined as not mirroring the index’s return. It ties together the fund manager’s personal career history with the Information Ratio of the underlying funds.

Countries making the grade

All the sector and country positions, though, come about as a result of singe stock opportunities the team finds according to its dividend, value or growth angles. ‘A number of opportunities were showing up in our GARP approach in China,’ says Hauptmann. ‘In Russia, we’re now overweight with energy plays. We’ve increased our materials exposure to that country.’

On the flip side, the fund is underweight Brazil and India as there are few stock opportunities, largely due to their high currency sensitivity.

‘We look for strong companies able to distribute dividends or those with strong cash flow or attractive valuations and good growth,’ says Hauptmann.

‘One element we focus on, at stock level, is risk; both market risk and liquidity risk. We had a taste of illiquidity in the summer last year. From a risk perspective we saw that in the form of volatility in dollar terms. The countries most affected by the tapering announcement were those with most sensitivity to the dollar, so currency risk can translate into single-stock risk.’

The fund is very liquid, says Hauptmann, but last year there was the mixed effect of lower liquidity combined with strong inflows. ‘We tend to trade less smaller-cap names than we used to.'

'For each single line of trade we estimate the impact of that. In more growth phases of the market, we favour larger caps. Then when volatility recedes, and small caps have less risk, we tend to reallocate towards small and mid caps.’

All of this is embedded in the process, says Hauptmann. ‘We try to be as disciplined as possible in the portfolio construction process. Despite doing things systematically we go quite deep into statement analysis to adjust the numbers for corporate governance issues, for example.'

'In EM, companies constantly update their earnings and cash flow. This can be above what you truly have as a shareholder on a consolidated basis – it can go to minority interests. These are the kind of things we adjust the cash flow analysis for, building in investment factors and investment criteria.’

The next step, stock selection, is where the managers try to differentiate from the numbers seen in the consensus view. ‘We rely on analysts’ estimates much more to give us an idea of the direction of a firm relative to its sector and the market as a whole,’ says Hauptmann.

‘That gives us a great proxy for current news flow on the company; things we can’t see in the statements. We’re trying to capture opportunities in a broad manner and eliminate stock-specific risk.’

‘Some very big companies like Petrobras have significant issues. I don’t own them and I’m not going to. The same goes for areas such as the Mexican energy market’ – Nick Price, Fidelity

The fund is also diversified widely at stock level, with low exposure per stock. Ultimately, says Hauptmann, it is enough to be right around 65% of the time. ‘We are doing purely stock selection and we know what we can do well.’

At a sector level, the fund has been underweight energy names since launch. ‘There are few interesting players who are strong dividend payers or with attractive valuations,’ says Hauptmann.

‘There are sometimes disproportionate amounts of capital expenditure. For them to come up in the GARP strategy we would need stronger commodity trends. We don’t find a lot of candidates. We have, though, seen a strong increase of materials exposure over the last 12 months.

We’ve seen this gradually increase in the fund, and we’re now slightly overweight the sector as positive earnings trends have been increasing.’

The benchmark weighting plays some part from a risk perspective. ‘We can be a maximum 10% overweight at sector level versus the MSCI Emerging Markets index,’ says Hauptmann.

‘There’s a fixed, stable allocation to each of the three strategies as it’s very difficult to allocate dynamically. You would need to do market timing. We manage money in different regions which is great for cross-fertilisation.’

While he is not keen on giving absolute market views, Hauptmann says emerging markets look cheaper than developed ones from a relative perspective.

‘It’s pretty striking. There’s more dividend yield from the MSCI Emerging Markets index than in the developed world. When we see larger banks still recommending an underweight to EM it looks a bit surprising.’

This article originally appeared in the February issue of Citywire Global magazine

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Nick Price
Nick Price
109/460 in Equity - Global Emerging Markets (Performance over 3 years) Average Total Return: 7.06%
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