Capital has flowed into emerging markets over the past two decades as institutional and retail investors have flocked to the growth story in search of investment returns and yield. Many of these countries are forecast to grow significantly over the decades to come. According to the International Monetary Fund (IMF), over the long term, developing economies are set to incrementally increase their share of global GDP on a purchasing power parity (PPP) basis.
Since the global financial crisis, however, emerging economies have started to experience slower growth, suffering a net outflow of capital over the past 18 months for the first time since the 1980s. It’s unsurprising that the end of quantitative easing in the US and subsequent strength of the US dollar along with the US Fed raising interest rates has led to the flight of capital out of emerging markets, with both retail and institutional investors opting to reduce their direct exposure.
Where does this leave emerging markets in terms of an allocation within offshore portfolios? At Sanlam Private Wealth (SPW), our fundamental research process for global equities is driven purely by bottom-up stock selection, yet we acknowledge that emerging markets enjoy better demographics and more attractive valuations than many developed markets. The water is muddied by the fact that many global multinational businesses already have significant exposure to many of these regions.
The question should be one of determining intrinsic value, and assessing this against the market price. It is then crucial to have the conviction and discipline to take advantage of any price dislocations, should they arise. We ask ourselves whether an individual company’s stock price is attractive enough to justify the greater level of risk in deploying our clients’ capital into a direct emerging market company.
Cast your eyes back towards the start of the year, when there was much negative investor sentiment towards emerging markets. At that time, we started to see opportunities arise in direct emerging market-listed stocks and subsequently started to increase our direct exposure by initiating positions in Hengan (consumer goods), NetEase (technology) and more recently Baidu (technology).
From our perspective the most important point is not where a stock is listed, but the breakdown of where it generates its revenue from. Our style bias towards owning quality businesses with high free cash flow conversion ratios, attractive operating margins and high returns on capital at reasonable valuations has tended to lead us away from direct emerging market investments.
But even though we have only modest direct emerging market exposure, on a revenue look-through basis, we have over 20% exposure through the multinational companies we hold in the Sanlam Private Wealth Global High Quality Fund. In summary, we’ve been gradually increasing both our direct and indirect exposure to emerging markets so far this year as we seek the most attractive risk and reward trade-off in deploying our clients’ capital.
MORE ABOUT THE SANLAM PRIVATE WEALTH GLOBAL HIGH QUALITY FUND
The Sanlam Private Wealth Global High Quality Fund aims to achieve long-term outperformance primarily through taking high-conviction positions in well-managed, high-quality businesses that are attractively valued. The process views risk at both a portfolio and security level within the framework of understanding the risk-reward trade-off of position sizes.
This unconstrained fund invests in companies with strong market positions and solid balance sheets, generating attractive levels of free cash flow that should prove appealing for long-term investment opportunities.
FUND HIGHLIGHTS TO THE END OF AUGUST 2016
The fund has increased 9.6% year-to-date, outperforming the MSCI World Index, which returned 5.0% – both in US dollar terms. The Sanlam Private Wealth Global High Quality Fund remains ranked in the top quartile since inception having returned 21.3% compared to the MSCI World Index, which rose 8.0% over the same time period.
