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EM portfolio: why UBS AM allocates over 30% to China

EM portfolio: why UBS AM allocates over 30% to China

‘Every time Donald Trump tweets, it affects my investments,’ says Geoffrey Wong, the Citywire AAA-rated fund manager of the UBS Global Emerging Markets Opportunity fund.

It’s a variable that simply didn’t exist when Wong started managing money 30 years ago.

It’s not all bad, though. Wong, who has been at UBS Asset Management since 1997, says that new technologies such as social media help him to feel connected with what’s happening in current affairs – whether it’s politics, long-term changes or the latest social trends.

That drive to stay on top of world events has helped Wong keep going strong over the years.

He is now UBS’ head of global emerging markets and Asia-Pacific equities, with overall responsibility for the Asian, Japanese and Australian equity teams, strategies and research.

He leads the firm’s research efforts and oversees the management and construction of portfolios for the global emerging market strategies, while also serving as a member of the company’s equities management committee.

Making headlines

There’s certainly plenty of news for Wong to be thinking about at the moment.

Trade frictions between China and the US, sanctions against Chinese telecom equipment maker ZTE, additional sanctions against Russia, and Facebook’s data privacy worries have all shaken equity markets of late. And then US Treasury bond yields hit 3% in April.

Despite all of this, there are still pockets of opportunity for long-term investors in emerging markets, Wong says.

The stock prices of some perfectly good companies have been hit amid the current volatility, creating opportunities for fundamental investors in the long run, he explains.

Shares in Tencent experienced a sell-off in the wake of Facebook’s data privacy issues, and investors also ditched Taiwan Semiconductor in response to falling orders for mobile phones.

Wong says that chipmakers such as Taiwan Semiconductor offer good long-term prospects given that more people are investing in trends such as artificial intelligence, big data and cloud computing.

Taiwan Semiconductor, which makes many of the chips behind those latest developments, was the second-largest holding in Wong’s emerging markets portfolio as of the end of March, while Tencent was the fifth-largest position.

In terms of stock selection, Wong says he has generally tended to avoid Chinese companies that sell directly to the US.

In fact, the majority of his portfolio is focused on domestic consumption to take advantage of the strong income growth that is available in emerging markets.

However, there are some exceptions. Wong says that his portfolio is also invested in world-leading companies that export everywhere.

One such example is Samsung Electronics, which was the largest holdings in Wong’s portfolio at the end of March.

Wong explains that the major trends in emerging markets and the outlooks for these companies tend to be driven by the broader macroeconomic growth story.

‘For us, the direction of economic growth is the biggest determinant of the long-term trend of the market,’ he says.

‘Although recent geopolitical events have caused some volatility, they have typically not changed the direction of the equity markets in the medium term for the next five to seven years.’

Emerging markets are particularly attractive at this point, Wong argues, because they are still in the early stages of recovery.

‘We think we are at the beginning of the cycle. We are in about the second year of the upcycle and the economy is finally recovering.’

He adds that the current upcycle in emerging markets should continue for a few years yet, having only started back in 2016.

Meanwhile, greater capital expenditure discipline over the past few years has started to pay off, leading to better earnings growth, cash flows and profitability.

Trading up

It’s not just that wages in emerging markets are rising; the high-income proportion of the population is also expanding.

This means that consumers in emerging markets have more disposable income to spend, particularly on luxury goods, Wong says.

To take advantage of this, Wong is eyeing up companies that are targeting high-income households. In China, that means exploring sectors such as premium cosmetics.

‘As people get richer, they treat themselves – they buy better brands of cosmetics or they may buy a high-end car,’ he says.

Meanwhile, as lower-income households become richer, they may trade up to eat at restaurants such as Pizza Hut, instead of only eating at home.

‘If you look at simple things like beer, premium beer sales have been going up for the past five or 10 years, while sales of cheap economy beer have been going down.

‘People are trading up and you see that in every market,’ he says.

Wong acknowledges that every emerging country will have different patterns of income distribution, but says that investors may still be able to take advantage of those firms selling into the premium segment of the market.

Two thirds of Wong’s portfolio is currently invested in Asia, with the remainder invested in Brazil, Mexico, Russia and Hungary, as he hopes to exploit the different emerging opportunities in each country.  

Chinese dreams

Wong says he has a significant allocation to China within his emerging markets portfolio.

‘It’s the biggest benchmark weight, and we are overweight as well. We have more than 30% of the portfolio in China,’ he explains.

In the long run, China’s weighting in the portfolio will increase because it is the largest source of new companies, Wong says.

As Ernst & Young’s Global IPO Trends report for the first quarter of 2018 has found, Greater China’s stock exchanges are now the source of the greatest level of IPO activity after the US.

‘The equity market in China is getting bigger and it’s getting more weightings in people’s portfolios,’ Wong says.

He adds that the country is a very interesting and unique emerging market, generally following the path that was beaten by the East Asian Tigers in the 1970s but on a far bigger scale.

‘When I started looking at China 30 years ago, the factories I visited there were Soviet-era factories, very old-fashioned,’ Wong says.

‘Then they transitioned into making copycat products, manufacturing products that were designed in Japan, the US or Europe.

Today, those same companies are now coming out with their own original technology and designs.’  

Wong adds that these Chinese companies have gained significant market share globally and have become world leaders, particularly in manufacturing white goods such as refrigerators, air conditioners and washing machines, as well as surveillance cameras.

In China’s A-shares market, the white goods sector is looking attractive, he says, with stocks such as Gree Electric Appliances and Midea performing strongly.

‘Chinese companies have developed very rapidly, from nowhere to world leaders,’ Wong says.

Some of these Chinese companies are taking advantage of their huge home markets, generating huge profits that they can then plow back into research and development.

This will gradually increase their lead over competitors in other countries, Wong explains.

‘It’s a little bit like the American corporations after the Second World War. They had the best home market in the world,’ he says, pointing to firms such as IBM and General Motors that were able to leverage their home markets to help them become huge multinational companies.

‘Some Chinese companies are in the early stages of doing that, and that’s another trend that is pretty interesting,’ he adds.

Learning the easy way

China’s education market is one opportunity that Wong has been watching closely.

He explains that New York-listed TAL Education Group, one of China’s leading providers of after-school tutoring services, is one of the best investments his team has made so far.

The firm offers tutoring to students from preschool to the twelfth grade, through three flexible options – small classes, personalised premium services and online courses.

‘We made more than 10 times our money on that stock,’ Wong says, adding that UBS Asset Management is currently the second biggest shareholder in the company.

He has held the stock for more than seven years and is not looking to let it go anytime soon. ‘We have expected and continue to expect companies like TAL to take market share,’ he says.

He adds that what differentiates TAL Education from the traditional mom-and-pop tuition centres is its ability to integrate technology into its classes.

Video conference facilities, iPads and the very best teachers have all helped TAL build its reputation.

This in turn has enabled the firm to attract hundreds and millions of dollars in investment, which is something that mom-and-pop tuition centres simply cannot match.

However, even though TAL Education is the second biggest player in China, its market share is still less than 5%.

It has only rolled out in the biggest cities so far, and Wong says he expects the group’s market share to continue growing when they roll out to smaller cities.

‘We think they can perhaps easily hit 20% market share, which is four times their current size,’ he says.

Deeper and deeper

One other trend that Wong is also watching in emerging markets is ‘financial deepening’ – the proliferation of a wider range of financial services and their greater accessibility for ordinary consumers.

In low-income economies, the use of consumer credit is expected to increase in line with rising wages, allowing the banking sector to penetrate further into those markets.  

Currently, in countries such as India and Indonesia, a relatively low proportion of the population  will have mortgages, credit cards or consumer loans.

‘In those sort of countries, you have two tailwinds,’ Wong says. ‘First, their GDP growth is above-average because they are emerging countries, and second, the banking sector would be growing even faster than the GDP.’

Exciting times indeed.

The article was published in the June issue of the Citywire Private Wealth magazine.

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