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12. Uncovering Trusts – A closer look at Emerging Markets
48 Plays3 months ago
In this episode, our director of content, investment trusts Milosz Papst, and investment trust analyst, Michal Mordel, explore the key takeaways from Edison’s recent thematic campaign on emerging markets. They highlight that emerging market equities have been out of favour recently and are trading on average at attractive absolute and relative valuations compared with developed markets. They outline the key secular growth drivers underpinning the performance of emerging economies. They discuss some of the key beneficiaries of the changes in the global supply chain. Moreover, they discuss the state-level and corporate-level governance across the emerging markets. They conclude by commenting on the main potential triggers of a re-rating in emerging market equities.
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About ‘Uncovering Trusts’
'Uncovering Trusts': is a podcast run by Edison analysts released every two weeks. Subscribe to hear analyst interviews on how investment trusts maximise returns while managing risks for investors.
About Edison:
Edison is a content-led IR business. We believe quality investment content should inform all investors, not just brokers. Our mission: engage and build bigger, better-informed investor audiences for our clients.
Edison covers 50+ investment trusts, read about them here: https://www.edisongroup.com/equities/investment-companies/
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Transcript
Introduction to Uncovering Trusts
00:00:05
Speaker
Welcome to Uncovering Trusts, a podcast by the Edison Group, a content-led IR business integrating analyst content, digital targeting, and investor engagement. Tune in to find interesting investment ideas and stay on top of what's happening in the investment company sector.
Guest Introductions and Themes
00:00:22
Speaker
I'm your host, Will Manuel, and today I'm joined by Milos Pabst, director of investment trust contact, and Mihal Maudel, investment trust analyst at the Edison Group, for a special episode of our podcast covering the key takeaways from Edison's recent thematic campaign on emerging markets. So thanks for joining us today. Thanks, Will. Thanks for having me. Hi, guys. So rather than discussing a single investment company, ah you suggested that we talk more broadly about emerging markets today.
Edison's Thematic Campaign
00:00:52
Speaker
Indeed, we have recently concluded our thematic campaign on emerging markets, which included a thematic research note, a series of interviews with emerging market fund managers, as well as an insightful webinar with emerging market experts from ICM Group, Fidelity International, and white o investors. We feel that this is an attractive area to cover now, given that emerging market equities seem out of favor following a decade of underperformance against developed markets, US equities in particular. And equities in many EM countries are currently trading on attractive absolute and relative valuations compared with developed markets. It seems to me that investors are not fully appreciating the higher economic growth prospects offered by emerging market economies.
00:01:35
Speaker
which contributed two-thirds of global GDP growth of the last 20 years, so as well as the greater resilience of many of these markets compared to, let's say, 10 to 15 years ago.
Growth Potential in Emerging Markets
00:01:45
Speaker
For instance, Amber Gordon from Fidelity International, who is an investment director for Fidelity's global emerging markets franchise, ah highlighted during our webinar, which our listeners can find on the Edison website, the reduced vulnerability of emerging markets to capital outflows triggered by high US interest rates. Low adapt to GDP across some of the emerging economies compared to Western Europe is also worth mentioning, although um I would note that obviously higher US rates still represent a headwind to emerging market economies. ah More on that later. Higher growth potential in emerging markets has not always translated into higher corporate earnings due to, for instance, poor capital allocation or weak corporate governance, which we'll discuss in a moment.
00:02:26
Speaker
um However, I would highlight that earnings growth across Asian equities is expected to be double digit over the next two years. It's noted by Yu Zhong-Oh, one of the managers of Aberdeen Asian Income Fund in a recent interview. Despite the weakness in recent years, an allocation to EM equities historically improved the Sharpe ratio. a measure of risk adjusted returns of a global equities portfolio over the long term as discussed in our thematic piece. Also, there is arguably arguably more potential upside for a successful active EM fund given the higher market inefficiency in emerging markets, ah providing greater scope for alpha generation as highlighted during our webinar by Federik Balmaseda from White Oak Investors, the manager of the Ashoka White Oak Emerging Markets Trust.
00:03:10
Speaker
Okay, thanks for that. um so what So what might be the main growth drivers supporting emerging market economies and equities going forward?
Growth Drivers: Urbanization and Energy Transition
00:03:19
Speaker
well The major secular drivers of EM economics include urbanization, ah in some countries supported by favorable demographic trends, for example in India or Vietnam, ah which support the rise of the middle class. Fatriq highlighted during our webinar that 500 million people are expected to join the workforce across emerging markets over the next decade.
00:03:41
Speaker
Urbanization and the rising middle class in turn translate into demand for residential real estate development and infrastructure projects, as well as increased demand for higher quality goods and services such as health care insurance and wealth management products. Yes, I would add that Charles Gillings from ICM, the manager of utility emerging markets, ah pointed out that this trend is accelerated by four developments. ah The first is the energy transition and improvements in energy security. um We agree that climate change has moved up the global agenda, also in EMs, driving the development of renewable energy, battery storage, electric vehicles, and waste and water treatment.
00:04:24
Speaker
The second factor is the growth in digital infrastructure, including data centers and service suppliers in the space. um Then there is social infrastructure such as sanitation and urban transportation. And finally, global trade, including the reconfiguration of global supply chains. Right. So maybe let's ah delve a little deeper into the global trade scene, especially given the US-China tensions, as well as the lessons learned from the pandemic.
Global Trade Shifts
00:04:51
Speaker
Yes, that's an important point to discuss. One of the major beneficiaries of the resulting near-shoring and French shoring is Mexico. It takes 36 to 48 hours to sheet goods from Mexico to Chicago, compared to 25 days from China. In this context, the upcoming renegotiation of the US-Mexico-Canada Agreement in 2026 is something to watch closely.
00:05:15
Speaker
Another beneficiary is ah Vietnam due to its open trade policy, and which is well illustrated by the fact that trade represents twice Vietnam's GDP. Here I would note the country's recent comprehensive strategic partnership with the US. Investors have three UK-listed investment trusts focused on Vietnam to choose from, ah Vietnam Holding, Vena Capital Vietnam Opportunity Fund, as well as Vietnam Enterprise Investments Ltd. Investors can find out more about those trusts by exploring Edison's latest content on them.
00:05:49
Speaker
Yes, and then another country benefiting from shifting supply chains is India. ah This was emphasized by both Fedrik during the webinar as well as Gaurav Narain from India Capital Growth Fund during an interview with him back in May. The Made in India initiative, supported by Moody's government, assisted a doubling of FDIs in India over the last decade. ah For instance, India currently accounts for 14% of global iPhone production, which could double in the next few years. Gaurav highlighted several positive developments in the Indian economy, such as strong banking asset quality, healthy corporate balance sheets and profitability, as well as a significant pipeline of infrastructure investments. By 2030, India is but widely expected to have the third largest global economy behind the US and China, having overtaken Germany and Japan.
00:06:37
Speaker
ah Charles Jennings also highlighted Eastern Europe, for instance, Poland and Romania as a beneficiary of changes to global supply chains, as well as the inflow of EU funds. um However, Amber Gordon also made an important point about China in this respect. um Many investors assume that Chinese businesses are inevitably ah losers of the supply chain reconfiguration, but in fact, some of them are very innovative in well shifting manufacturing bases to countries considered friendly by Western governments. Right, thank
Governance in Emerging Markets
00:07:05
Speaker
you. and And what do you see in terms of sort of state level and corporate level governance issues across emerging markets?
00:07:13
Speaker
So, ah political stability is an issue in some emerging markets, as local governments tend to have greater decision-making power and intervene more in asset markets than policymakers in developed countries. Also, political regimes can be unstable in some countries. Political factors obviously play an important role in China, as illustrated by the regulations imposed on the local internet industry, among others. ah That said, there are also positive examples across EMs, such as India. Gareth Narain pointed out that government stability is an important factor supporting economic growth in India. He also emphasized the government's reforms aimed at improving transparency and regulatory oversight.
00:07:53
Speaker
Then ah Charles Gillings highlighted that several countries strengthen their financial institutions. For instance, Brazil has given stronger independence to the central bank. um Amber Gordon also pointed out the positive changes in management of state and enterprises in Poland amid the change of power following the ah the elections last year. Now in terms of corporate governance, the discussions we had during our emerging markets campaign have clearly shown that there is an increasing emphasis on returning capital to shareholders by public companies in EMs following the longstanding trend in developed markets. ah For instance, some investors used to consider Asia primarily in terms of capital growth potential rather than income. However, Yu Zhong Oh highlighted during our interview with her that close to 50% of the Asia Pacific X Japan benchmark now yields more than 3%.
Capital Returns in Asia and Latin America
00:08:42
Speaker
I would note that Asian corporate balance sheets tend to be stronger than those in developed markets which bodes well for continued positive income from Asian equities. Amber Godin mentions some encouraging signs in China as in January the authorities encourage state-owned enterprises to return more capital to shareholders which was accompanied by several self-initiated efforts amongst private companies, including important index constituents such as Alibaba and Tencent. ah This has encouraged some income investors, such as the Aberdeen Asian Income Fund, to initiate position performances in Tencent.
00:09:16
Speaker
Chinese listed companies also significantly stepped out of their buyback activities. um I think ah those companies understand the fact that the property market weakness and worsening demographics means that investors are looking for more than just capital growth ah when investing in the country. ah Moreover, significant the weakness of the Hong Kong equity markets, driven by large foreign capital outfalls, ah also reinforces the need to properly address any concerns of foreign investors. We also highlight in our thematic piece that the dividend yields in Latin America are very attractive at present. Right, and how about and another major emerging market, is South Korea? I believe they unveiled the corporate value up program earlier this year.
00:09:58
Speaker
Correct, the program is aimed at addressing the so-called Korea discount by enhancing the appeal of local equities through corporate governance reforms and enhanced distributions to shareholders. ah This was inspired by the recent success success in Japan. A particular emphasis is placed on a company's return on equity and price to book multiple versus its industry and peers, with those faring better to be included in a premium index tracked by exchange-traded funds. The program also may involve changes to the ah rules on treasury shares of listed companies to protect minority shareholders.
00:10:34
Speaker
all Although I have to say, though, that some investors are disappointed that the program is meant to be entirely voluntary. and Still, I would encourage our listeners to explore our latest thematic note on emerging markets, ah which includes a summary of the interesting discussion we had to on South Korean corporate governance with Andrew Daly, head of investor relations at Wise Asset Management, the the manager of Wise Korea Opportunity Fund. Right, so there are significant secular economic drivers in improving corporate governance in emerging markets. um You've touched upon the undermining valuations across emerging markets. Can you tell our listeners a bit more about this?
Valuations: Emerging vs. Developed Markets
00:11:13
Speaker
Sure. As mentioned earlier, emerging market equities are currently, on average, trading on more attractive absolute and relative valuations compared to developed markets. Let's say there is a significant dispersion in valuations between the respective countries with markets such as India and Taiwan trading above the 10-year historical average, while several other countries, including China, Hong Kong, and Brazil, are trading below the 10-year average based on ah one-year forward P ratios. ah Indian equities are currently trading at quite high valuation multiples, with the average multiple across the market close or even above the US market. But this is obviously driven by the growth you see in the economy, which looks fairly sustainable, as well as the high capital efficiency of Indian businesses, as pointed out by Gareth Narain. He therefore suggested that investors should look well beyond earnings for the next 12 months, and that valuations look more reasonable when the potential prospective multi-year growth path is taken into account.
00:12:10
Speaker
I guess it is also worth considering Indonesia with regards to the country's economic potential and probably quite undemanding valuations, for instance, compared to India. and Now, the low valuations in China are, of course, driven by macro challenges, most notably the property crisis, subdued consumer sentiment and geopolitical tensions. However, this may represent the fertile ground for contrarian investors looking for out of favor opportunities with solid fundamentals. Okay, so it seems like there's lots of value opportunities in emerging markets, but what needs to happen to drive the outperformance of emerging markets, well, emerging market equities versus developed markets?
00:12:46
Speaker
Yeah, that's a good question. I mean, when looking ahead, I believe that ah that our emerging markets campaign has shown that there are three key potential triggers of the re-rating in EM equities. A turn in the US interest rate cycle, a commodity bull market, and an economic revival in China, which are somewhat interconnected. so Monetary easing in the US has been delayed so far, as we all know. um Once and but it materializes, it should provide tailwinds for emerging markets, as it would support foreign capital inflows, but also provide ah local central banks with more headroom for rate cuts, assisting the local economies, but also encouraging local investors to maybe shift their emphasis away from fixed income ah with the current high real interest rates to local equities.
00:13:30
Speaker
ah For instance, the weakness in the Brazilian equities market may have been due to the uncertainty with respect to the path of rate cuts, which we initiated last year. Right. So um how about commodities that you mentioned just now? How important are these from emerging market equities? Actually, Amber Gordon has stressed that part of the emerging market's weakness over the last decade was due to the commodity commodity bubble bursting in 2014, which was linked to weaker demand from Chinese property market. However, she believes that the demand supply environment for several commodities has become tighter, with a notable example being copper.
00:14:09
Speaker
ah given the significant increase in demand from electrification and data centers, ah coupled with a quite muted supply backdrop, declining grades in existing mines and little new supply coming on stream. ah This should provide tailwinds for copper-exporting EM economies. On the other side of the spectrum, iron ore has a less favorable outlook, given the high reliance on the Chinese property market. It is also worth noting that the weight of energy stocks in the emerging market indices has declined over the years, ah in favor of tech and consumer stocks. ah When we think of major AI beneficiaries, you often think ah about US companies such as Nvidia, but a significant part of the AI supply chain is in Asia, most notably in Taiwan and South Korea.
00:14:57
Speaker
Right. that's That's very helpful. Thank you. So, you know, China is a very large part of the EM indices. You know, we know there's some value there or things are looking cheaper than they have been for a long time. I guess also it's is a significant trade partner of several EM countries. So can you focus a bit more on China now?
China's Economic Landscape
00:15:17
Speaker
Sure. um I mean, the ability of the Chinese government to put a floor on the property prices would be important. I would note that the government um recently announced measures to support its property sector, which involved the purchase of unsolved completed apartments from developers by local state on enterprises to convert them into social affordable housing ah supported by 300 billion yuan of cheap central bank funding.
00:15:41
Speaker
as well as the cancelling of the floor for mortgage rates and a reduction in down payment rates to 15%. However, this initiative alone may not be sufficient to stabilize the market. ah Possible continued trade tensions with the US and Europe suggest that domestic consumer plays could prove a better choice than Chinese export-orientated businesses. um Obviously, a potential victory of Donald Trump in the upcoming presidential elections is likely to result in continued US-China trade tensions, including higher tariffs, which may complicate the Chinese economic rebound. The IMF highlighted earlier this year that China's public debt dynamics is a concern, especially if the property crisis triggers a local public finance crisis. ah Still, it is worth noting that IMF projections released in July indicate that China's GDP will grow by 5% this year and ah by 4.5% in 2025, with a gradual deceleration to around 3.3% by 2029.
00:16:36
Speaker
and suggesting the country has the opportunity to benefit from secular tailwinds such as structural growth and consumption, automation, digitalization, and the green transition, among other things. When talking about respective returns, it is important to keep in mind that overall emerging markets are higher risk than developed markets with higher political risks, as as discussed earlier, ah more volatile currencies and sensitivity to to capital flows. but Finally, liquidity across EMs varies. For instance, Fedric mentioned that it has improved markedly in India on the back of the bull run, but remains more limited in Latin America beyond Brazil.
00:17:13
Speaker
Right, thank you. So assuming someone is interested in emerging market equities, what is the UK investment companies sector to have to offer?
UK Investment Opportunities in Emerging Markets
00:17:23
Speaker
Oh, there is a wide selection of investment companies to choose from, starting with the 11 funds included in the AIC global emerging market sector. And there are also several regional specialists primarily focused on Asia, including equity income and small cap funds. ah There is also one investment trust focused on Latin in America, and that BlackRock Latin American investment trust. And finally, you have country specialists focused on China, India, Vietnam, or Korea.
00:17:53
Speaker
Right. And I presume there's more details on all those trusts in our ah thematic work. So I'd encourage all listeners to go to our website at Edison Group to look at that. So thank you very much, Milos and Michal. Very interesting rundown with the emerging market team. You've been listening to Uncovering Trusts, a podcast by the Edison Group. And again, if you would like to find out more about the current state of emerging markets, please visit www.edisongroup.com. Thank you very much.