Earlier this year, Tell Media Group conducted its annual survey of Nordic institutional investors and among the topics covered were expected asset allocation changes in the next 12 months. One of the biggest changes compared to previous years was the appetite for emerging market equities, where the mood has shifted from “decrease” to “increase”. About 30 per cent of Nordic investors in the survey said they are looking to increase their exposure to emerging market equities.
The discussion started with the asset managers at the table sharing their thoughts about the current investor interest in emerging markets.
JAN DE BRUIJN: “Last year was a very busy year in terms of seeing clients, so I have a pretty good feeling of what they were thinking about. The overwhelming view was not so much that they didn’t like emerging markets or that they didn’t want to be in emerging markets but rather what the trigger will be. Investors think it’s attractively valued and they understand the long-term story, but they want to know when the right time is to invest.”
CHRIS MCGOLDRICK: “I can echo that. I spent some time in New York just before Christmas, so after Trump had been elected but before he was inaugurated. The general feeling was that investors wanted to be involved but at the time, they didn’t want to take the career risk of selling the magnificent seven. There’s this old saying that you don’t get fired for buying IBM and it was the same sentiment here. Investors were aware that it was a popular place to invest but weren’t willing to change that, even though we had some powerful arguments of valuation.”
JULIANA HANSVEDEN: “We’ve been investing in emerging markets for a very long time and we have several equity strategies focused on emerging market equities, so we capture quite a broad spectrum of potential clients. And yes, there has been an increase in demand from parts of the institutional market. However, the past few years have been challenging.”
NIKLAS TELL: FROM AN OVERALL STRATEGY POINT OF VIEW, WOULD YOU SAY THAT SOMETHING HAS SHIFTED WITH REGARDS TO EMERGING MARKETS? AND HOW ARE THE LATEST DEVELOPMENTS IN THE US IMPACTING ALLOCATIONS ACROSS REGIONS?
PER HAMMARLUND: “My impression is that in the short term, there’s a realisation about the need to diversify away from the US. With regards to emerging markets, I think there are two components we need to consider. The first is the big increase in valuations in the US and the very low valuations in emerging markets, so that’s obviously a big incentive. The other thing is the US signalling that they’re pulling out from the rest of the world. I think it’s a little bit early to say if this is a trend shift. If we look historically, we’ve seen some big long-term trends benefitting emerging markets. In the 1990s, it was the fall of communism and in the early 2000s, it was the rise of China. Are we seeing something similar today? I think it’s too early to know if the US will truly pull out from the global economy. They’re signalling one thing, but who knows what will happen in four years’ time.”
JAN DE BRUIJN: “That’s a good point but I think it’s less important what the US is doing because it’s importance in global trade is much smaller today. While globalisation has slowed down, global trade continues to increase, but it’s not going to the US. What we’ve seen is the growth of a middle-income group in countries such as Brazil, Indonesia, India and China and they’re now doing more trade with each other rather than going to the West. The reason is that’s where the growth is and that’s where the consumer power is. If I’m a manufacturer making bags, why should I try to sell to the US with all the hassle with tariffs? I will focus on Brazil or Indonesia and have a growing market there.”
JULIANA HANSVEDEN: “It would be fantastic if it was a broader EM beta opportunity, on top of which one could add alpha. However, even if we don’t get that beta rally, there’s a real opportunity in recognising that it may be necessary to diversify more than initially expected away from US equities. Here, I think emerging market equities is an appealing opportunity with higher structural growth that’s not correlated with US equities. I would also argue that from an active point of view, the opportunity is very exciting because as a stock picker, you can really find exciting, mispriced ideas in this type of environment.”
NIKLAS TELL: I GUESS THERE HAVE BEEN OTHER REASONS AS WELL FOR STAYING AWAY FROM EMERGING MARKETS BESIDE VALUATIONS.
CHRISTINA BERG: “We haven’t had an exposure to emerging markets in our institutional portfolios for a long time. There are of course many reasons, but ESG concerns have absolutely been part of that. On our unit-linked platform, we have seen outflows from US equities but not into emerging markets but rather into European and Swedish equities.”
OSKAR SANDVIK: “Just as Christina mentioned, we also have EM equity funds on our platform. In our allocation portfolio, however, we’ve decided not to allocate to emerging markets and the reason is a combination of ESG concerns, performance and price. We did some backtesting and didn’t see that it would add something to the portfolio, so we currently have 70 per cent global equities and 30 per cent Swedish equities in the retail allocation portfolio.”
CHRIS MCGOLDRICK: “You mentioned performance, which of course is a function of valuations. However, one could argue that performance is backward looking, whereas valuation has the promise of the returns to come.”
OSKAR SANDVIK: “In our backtest, which covered some 20 years, the good times didn’t make up for the bad. Also, with higher volatility in addition to ESG concerns and price, we decided to stay away.”
JAN DE BRUIJN: “Global volatility has actually changed a lot since the global financial crisis. We recently did a study on this where we compared the standard deviation in EM versus DM and see that in emerging markets, you get the same risk level at a 30 per cent discount and the outlook is more favourable.”
JULIANA HANSVEDEN: “I would agree with that. We’ve also done a study on the market and top line growth hasn’t been a problem, but rather weaker EPS (earnings per share) growth compared to the US in particular. The reason behind this was excessive issuance in emerging markets as opposed to share buybacks in the US. We argue that this is unlikely to continue going forward, so on a forward-looking basis, we’re seeing buybacks coming through in emerging market equities. I remember meeting Samsung some 15 years ago and I asked them if they pay a dividend and they just looked at me. It’s not a perfectly run business today but they have some great opportunities and it’s managing its capital much better. We’re seeing this trend across emerging markets and I don’t think this shift is getting enough attention.”
LOVE NORDSTRÖM: “We have an exposure to emerging markets both in our strategic asset allocation as well as in our tactical allocation. For the latter, you’re of course always looking for that trigger point that was discussed earlier, but from a pure client demand, price momentum can be a strong driver. Aside from the general uncertainty due to the challenges we’re seeing in Ukraine and in the Middle East, I do think we’ve seen a shift in sentiment and not only because of the latest development in the US tariffs and political environment. Sustainability has been an important reason for why Swedish investors have been hesitant when it comes to emerging markets and I think that’s shifting. Especially considering the proposal of the Omnibus legislative package consolidating the CSRD, CSDDD and the EU Taxonomy. It’s of course great with more streamlining and simplification, but it might also lead to lower transparency in smaller companies. It could also have an impact on SFDR and how selectors evaluate underlying holdings as well as funds, because I think we will receive less detailed information. It might become harder for a selector to say what’s sustainable and what’s not.”
CHRIS MCGOLDRICK: “We’re entirely bottom up and the thing that I’ve observed in the last year or so is that we have more investment ideas than we have cash. If we go back some five years, we had 10 per cent of cash in our portfolios because we couldn’t find things to invest in. I’m just back from the Philippines – a country with more than 100 million people and you can buy the best companies at 10 times earnings. It’s amazing.”
JULIANA HANSVEDEN: “I agree. This is a very interesting asset class from a stockpicking point of view and to your point, Love, some of these companies can be a little bit more challenging from a sustainability point of view because data availability is poor. You really need to speak to the companies one-on-one to really understand them in their local context. That’s what we do and that helps us to build conviction in a concentrated bottom-up conviction portfolio.”
LOVE NORDSTRÖM: “With regards to sustainability, I agree that in order to really understand, you need a qualitative analysis approach, but a lot of regulation is moving towards quantitative measures. It makes it easier in a way, but I do think you miss a lot from that approach. Also, I do agree that emerging markets is probably one of the few true stockpicking environments available, which speaks for active management.”
PER HAMMARLUND: “I realise that we might be a bit different as we’ve had a positive or hopeful view on emerging markets for some time now and have a large allocation. It has of course been challenging for some time, but I still think it has been useful to have this diversification – especially in this latest turmoil. The challenge now is how to manage our EM exposure going forward. As you know, countries classified as emerging markets and lumped together in indexes are very diverse. We are currently reviewing how to approach emerging markets in the best way and whether a more granular management makes sense.”
OSKAR SANDVIK: “From a selector point of view, I think it comes down to the manager doing what he or she says they will do. Then it’s up to us to decide if we like that approach or not and if we think it’s right for our investors.”
NIKLAS TELL: WE TALKED ABOUT THE CHALLENGES RELATING TO ESG AND THAT THIS IS ONE OF THE REASONS FOR INVESTORS TO STAY AWAY FROM EMERGING MARKETS. HOW DO YOU CONVINCE INVESTORS THAT THERE ARE INDEED GOOD, SUSTAINABLE EMERGING MARKET COMPANIES WORTH INVESTING IN?
JULIANA HANSVEDEN: “We don’t see sustainability as a box-ticking exercise but rather as a way to enhance returns and deliver better outcomes for our clients. In emerging markets, I actually think that sustainability helps alpha generation because a lot of the growth opportunities are linked to sustainability challenges or opportunities. Let’s take financial inclusion as an example. Some 51 per cent of the Mexican population doesn’t have a bank account and if you can find a company that can drive that inclusion in a way that’s profitable for shareholders, it will be a fantastic growth opportunity and we think we have one of those companies in Nubank. A focus on sustainability will help us find growth opportunities and it will let us understand potential challenges, which will allow us to build conviction, find differentiated alpha opportunities and be long-term investors.”
JAN DE BRUIJN: “We have a somewhat different approach in that we actually make an adjustment in our valuation model based on material ESG factors. We have a very large sustainable investment team and they come up with all the material factors that are likely to impact a particular company within its sector and then the analyst will decide how it could impact the valuation of the company and will adjust the discounted cashflow model accordingly. That means that we come up with a valuation that reflects not only the financial drivers but also the non-financial drivers and we think that gives us a more holistic overview of what the value drivers are. On top of that, we have a sustainability rating for each country, which will have an impact on the weighted average cost of capital. One example would be Petrobras, where we’re invested in our non-sustainable funds, because even after all the adjustments, it still has a very good upside in our opinion. This also means that we very clearly can communicate with our investors why we would invest in one company and not another.”
CHRIS MCGOLDRICK: “It was said at the start that many investors have been put off emerging markets because of ESG. I think that’s going to really flip because so many of the development challenges facing the world are found in EM. We’re seeing the political wind of change in the US, which has meant that many companies have backtracked on their commitments and their standards. That’s very unlikely to happen within good quality companies in in Asia because they’re at the forefront of the flooding, the heat or the obesity crisis, so I think the solutions are more likely to come from EM because they’re much closer to the fire.”
PER HAMMARLUND: “I think we’re seeing that developing in China. You had social unrest popping up in protest to pollution and as a result, you’ve seen a shift among Chinese leaders now taking decisive steps to curb emissions.”
NIKLAS TELL: THERE HAS BEEN A LOT OF TALK ABOUT EMERGING MARKETS EX CHINA. IS THAT STILL A TREND AMONG INVESTORS?
JAN DE BRUIJN: “I think so, even if the hype is not there any longer. The reasons to exclude China will, however, differ depending on the region. It will clearly continue to be a story in the US for obvious reasons. In other places, investors might also want to exclude China from a general EM allocation. Either because they want to avoid it for political reasons or because they want a separate allocation to allow for more exposure to the rather more exciting stories outside China in their general EM allocation.”
OSKAR SANDVIK: “We should remember that there are trends to these things. Some five to seven years ago, it was all about getting an allocation to China A-shares and now we’re discussing if we should exclude the whole country.”
NIKLAS TELL: WITH ALL THAT’S CURRENTLY GOING ON WITH TARIFFS AND A POTENTIAL RECESSION IN THE US, WHAT WILL BE THE IMPACT ON EMERGING MARKETS?
JAN DE BRUIJN: “All the trends that are the reasons why we like emerging markets, both in the short and long term, are still in place. All that Trump has done is to speed up some of them, such as the intra-regional trade and so on. Earnings remain good and the discount is still there, and the macro situation still looks ok when compared to developed markets. I find it difficult to make a negative case even after what’s been going on – it has just added uncertainty.”
JULIANA HANSVEDEN: “Also, a lot of the drivers in emerging markets are internal – both in India and China for example. China’s reliance on US exports has shrunk, so the control of China’s economy sits within China, not outside of China. We shouldn’t exaggerate the impact of these tariffs on emerging markets. If anything, I think what has happened is that it has put a dent into this image that US equities are perfect.”
LOVE NORDSTRÖM: “Comparing the consumers in China and in the US, I think the Chinese consumer can more easily live without US products and subcomponents than the other way around. It will take a long time for the US to build the manufacturing base to replace what’s currently produced in China, which in turn keeps China with its existing infrastructure for labour intensive large-scale production in the game.”
CHRIS MCGOLDRICK: “And just think about how China has managed to develop and lead in so many areas despite supposedly not having access to some of the most advanced technology. I think it’s amazing to see the innovation and invention that has come out of necessity for self-reliance.”
JULIANA HANSVEDEN: “It’s possible that in in a few years’ time, the narrative has shifted and the consensus will be that you must invest in emerging market equities for structural growth.”
NIKLAS TELL: THEN WE’RE BACK TO WHAT WE DISCUSSED IN THE BEGINNING OF THIS CONVERSATION – WHAT’S THE TRIGGER TO MAKE THAT HAPPEN?
JAN DE BRUIJN: “I think that when you start to see emerging markets outperforming developed markets for a consistent period of time, that’s when investors will start to go back in. I keep hearing again and again that emerging markets are always underperforming, which of course they haven’t but that’s what’s on investors’ minds. So if we get a period where emerging markets visibly outperform, that will maybe not create a rush but a change in mindset.”
CHRIS MCGOLDRICK: “Many of the dedicated emerging market fund managers have gone out of business and some of the biggest ones in London have had to shut down. We’re very fortunate to be on all the platforms in the UK, which are major clients for us, and they all tell us they’ve never had as little allocated to emerging markets as they have today. That’s of course also why we’re able to find great companies trading on 10 times earnings.”
NIKLAS TELL: DO YOU THINK WE OVER TIME COULD COME TO A POINT WHERE A TYPICAL GLOBAL EQUITY ALLOCATION WOULD BE ONE THIRD US, ONE THIRD EUROPE AND ONE THIRD EMERGING MARKETS?
PER HAMMARLUND: “I don’t see that happening during my lifetime because there are too many challenges. They’re called emerging markets for a reason. These are countries that are relatively speaking poor in comparison to western countries and depending on what country you’re talking about, countries with poor regulation. That’s the whole point. You want to find the bright spots where you can have good performance and where you can trust the regulation. This is why we’ve seen a lower allocation to emerging markets compared to western Europe and the US. Also, EM countries tend to be moved to the DM category as they grow and develop and as they attract more capital.”
CHRISTINA BERG: “Institutional investors also often have a home bias, so Swedish investors will hold a lot of Swedish equities. So I don’t think we will reach a third of the allocation to emerging markets, but it might of course increase from current going forward.”
JULIANA HANSVEDEN: “Christina, I assume that your allocation to emerging markets is driven by the demand of your members?”
CHRISTINA BERG: “That’s correct. We have emerging market funds on the unit-linked platform and we have allocation in these funds. One reason is that these allocations are quite sticky and emerging markets was very popular some 10 to 15 years ago and a lot of that money is still there. Then, our members can have companies helping them with their allocations and we can also help them through suggestions.”
JAN DE BRUIJN: “If you look ahead some 10 to 15 years, most of the top 10 countries by GDP will be emerging market countries. It will be interesting to see if investors will continue to be massively underweight emerging markets.”
NIKLAS TELL: WHAT ARE YOUR BIGGEST WORRIES RIGHT NOW WHEN IT COMES TO EMERGING MARKETS?
JAN DE BRUIJN: “A conflict between China and Taiwan would of course completely melt the whole world down but that’s more of a global geopolitical worry. Other than that, I think it’s more related to changes in governments or changes to reform processes, which in turn could hurt the growth that we’re now seeing. But China/Taiwan would obviously be a big one.”
PER HAMMARLUND: “The main worries for me are how to keep track of event risks. That could be political, it could be credit risks or poor governance and a change of government that creates a new environment. Those types of risk are the ones that keep me awake at night when it comes to emerging markets. I’m less concerned about what’s happening in the US, even if we assume that they take a more protectionist and mercantilist path and that this is sustained over a number of years past the Trump presidency. That would mean lower potential growth in the US and that could potentially hurt companies in Latin America in particular. But in general, I do think that well run companies in emerging markets and in any other part of the world will find new avenues. It might be a period of transition for some companies that are more dependent on the US economy, but on a macro level, I’m not that worried.”
CHRIS MCGOLDRICK: “We worry about debt. There’s just too much of it everywhere. Fortunately, there are a lot of companies that are net cash in Asia and that’s one of the strongest attractions. Some 80 per cent of companies in our portfolio are net-cash businesses and we like companies that can invest countercyclically.”
JAN DE BRUIJN: “That’s a good point actually. Emerging markets only accounts for 25 per cent of world debt today, with China accounting for 55 per cent of that debt. The US part of that debt has gone down from 32 per cent to 18 per cent, so the dollar is not as important for emerging markets as it was some 15 to 20 years ago.”
NIKLAS TELL: WHAT ARE SOME OF THE MAIN CHALLENGES WHEN MANAGING MONEY IN EMERGING MARKETS AND HAS THAT SHIFTED OVER THE YEARS?
JAN DE BRUIJN: “The ever-changing nature of emerging markets, which is what makes it so fun and interesting. But at the same time, you’re constantly having to learn and over the last 30 years that I’ve been looking at it, it has evolved and changed so much. You need to constantly keep up with what’s going on in politics and economically. It’s a challenge.”
CHRIS MCGOLDRICK: “Emerging markets used to be a bank, a telecom company and maybe a supermarket. That was it. Today we’ve got some technological leaders, new business models coming out and it’s rapidly evolving and innovating and a lot of that comes down to de-emphasising the West and instead cater to the domestic demands that are there. That old saying that that when America sneezes, we all catch a cold. I don’t think that applies as much anymore.”
JAN DE BRUIJN: “The reasons to invest in emerging markets today is not the same as it was historically. Then it was about diversification, the growth prospects and catching up to the west. Today, it’s about the fundamental changes and the leap frogging of tech that we’ve already talked about. There is a powerful confluence of demographic, technological and structural factors happening.”
JULIANA HANSVEDEN: “I have a 30 to 50 stock portfolio so for me, making the wrong assessment on one or two or three companies is obviously what I worry the most about. One thing that has changed, which is helpful for us, is that the part of the market that we don’t focus on has shrunk. Emerging markets is less about extraction and more about value add today. That means there’s less noise from companies that are of no interest to us – but the stock specific risk is still there.”
JAN DE BRUIJN: “One questions that I often get is how emerging markets in general and maybe Eastern Europe in particular would be affected if we get a lasting peace between Russia and Ukraine.” PER HAMMARLUND: “In my view, it’s highly unlikely that we will see peace in Ukraine anytime soon, at least not a lasting peace or a peace worth the name. But let’s assume that unlikely scenario and let’s also assume a scenario where Russia moves towards a more open and democratic society. Then I think the whole CIS region would potentially benefit and that could be a big change for emerging markets. The EM universe would open up quite a lot, even if you exclude Russia.”
Participants
PER HAMMARLUND, Investment strategist and chief economist at AP4
LOVE NORDSTRÖM, Head of manager research at Swedbank
CHRISTINA BERG, Senior manager research analyst at Länsförsäkringar
OSKAR SANDVIK, Manager selection & asset allocation at Folksam
JULIANA HANSVEDEN, Portfolio manager at Ninety One
JAN DE BRUIJN, Client portfolio manager at Robeco
CHRIS MCGOLDRICK, Analyst & portfolio manager at Stewart Investors
