Authored By: Peter Lampert
Given
the volatility and risks generally associated with emerging markets,
some may ask ‘why there and why now?’ There are a number of reasons.
Emerging markets, which include a wide mix of countries such as India,
Brazil, and China coming into prominence, have collectively become a
greater part of the global economy and represent a growing number of
attractive investment opportunities. These markets generally share
characteristics that have led to higher economic growth rates, such as
positive demographics, improving productivity, and capital formation.
Companies located in these countries are often well-positioned to take
advantage of these favourable dynamics.
Moreover, there are fewer investors turning over stones in emerging
markets compared to developed markets such as the U.S., so these markets
are less efficient ‒ data shows a wider dispersion of stock returns
(i.e., a greater difference between the best stock returns and the worst
stock returns). As a result, active managers have more opportunity to
add value.
Love Of Travel
My personal interest in emerging markets stems from a love of travel
and a fascination for learning how others live. Shortly after finishing
university, I went backpacking around Southeast Asia and found myself in
Laos ‒ one of the poorest countries in the world, where many people
live as subsistence farmers, cultivating just enough rice to feed their
own families. For a 24-year-old Canadian, it was eye-opening to see just
how differently these people lived compared to North Americans. But
while I loved the place and the people, from a young investor’s point of
view ‒ due to the stark contrast between our economies ‒ nothing during
this trip screamed ‘opportunity’ or ‘potential.’ That would change.
When I returned to Laos seven years later ‒ this time with a much
deeper understanding of the differences between developed and developing
economies ‒ I was shocked by the country’s transformation in such a
relatively short time span. At the time (2013-2015) I was living in
Singapore and travelling to almost every Asian country while researching
emerging markets. And the changes I witnessed in Laos since my initial
visit were dramatic. The country had very strong GDP growth and had made
some large investments in major projects such as hydroelectric power.
Now there were ATMs, bustling shops, and everyone seemed to be riding
scooters. The progress demonstrated an undeniable capacity for both
opportunity and potential as an emerging market.
I also observed that emerging markets today exhibit a lot of the same
characteristics as Canada and the U.S. did in the past. From an
investment point of view, you can foresee the trajectory of industrial
development in these markets following a similar pattern over the next
10 to 20 years, much like we experienced in North America. As many
people around the globe enjoy the Western lifestyle, this is a big
investment theme with a long runway (although we must be careful not to
expect everything to unfold in these markets in the same way it did in
North America).
Investing in emerging markets equity funds means focusing on
companies with strong business models, excellent management teams, and
attractive stock valuations. This approach differs from most mutual
funds and index funds which often invest in the largest companies ‒
companies that are not necessarily the best investment opportunities
such as Chinese state-owned banks or Russian energy companies.
Examples of the companies we look for and own include: Tencent (the
‘Facebook’ of China), Clicks (the ‘Shoppers Drug Mart’ of South Africa),
and Linx (a Brazilian software company).
Competitive Advantage
Until I went to China, I didn’t fully appreciate the impact of Google
and Facebook’s withdrawal from that market due to censorship by the
Chinese government. I experienced how much longer it took just to do
basic things like check eMail and load international websites because
everything was filtered or blocked. Tencent’s success as a domestic
internet company stems from its position as a homegrown Chinese company
and the trust afforded to it by the government ‒ a competitive advantage
I’ve witnessed firsthand.
Another holding we look on favourably is Clicks. They are quickly
becoming the dominant drug store chain in South Africa. Clicks has
already amassed a 25 per cent market share and is on track to mirror its
developed markets peers ‒ like Shoppers Drug Mart in Canada or Boots in
the UK.
In Brazil, Linx provides big retailers with software that allows them
to accept payments and interact with their credit card and inventory
systems. In developed markets, every retailer would already have this
technology, but in Brazil penetration is still very low. As a result,
the company is growing at a high rate. Their advantage is that U.S. and
international companies aren’t competing with them because it’s
difficult to do business in Brazil and the software is specialized to
adhere to local nuances (e.g., taxes, Portuguese language requirements,
etc.). So although other markets are doing the same thing as Linx,
they’re the local and more trusted option ‒ a recurring theme in these
markets.
As we evaluate companies to add to the portfolio, my years of
experience with emerging markets has taught me to leave my comparisons,
biases, and preconceived notions at home.
Take retail shopping malls for example. As a Westerner, I tend to
think of malls as a dying business model ‒ after all, isn’t Amazon
putting them all out of business? But in markets like the Philippines, I
discovered that malls are more than just a place to buy things; they
are well established hubs for extended social interaction within
Philippine society. The mall represents a safe, air-conditioned oasis
filled with restaurants, movie theatres, and activities. This is where
couples go on dates and families go for entertainment. Philippine malls
are virtually always busy because they are ingrained in the society as a
cultural destination as much as a consumer utility. Clearly my mental
model of malls being a dying business does not necessarily apply here.
Higher Risks
While traveling to exotic places can be fun for those who enjoy a
sense of adventure, investing your money there is, of course, another
matter entirely. Like any investment it’s important to know what you’re
getting into. Investors considering an addition of emerging markets to
their portfolio should expect higher risks commensurate with higher
return expectations. The investors most suited for emerging markets are
those with a higher risk tolerance and a long-term horizon, and as part
of a balanced portfolio.
And little sense of adventure wouldn’t hurt either.
Peter Lampert (CFA) is a portfolio manager at Mawer Investment Management Ltd.
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