October 2012

EMERGING MARKETS EQUITIES: Where to look for hidden gems

GemsEmerging markets are said to be for stock pickers – places where one can find a precious stone among the pebbles. Stefanie Eschenbacher asks managers what stocks they have recently bought and sold. Fund managers who invest in emerging market equities ought to be good stock pickers; much of their skill is about finding hidden gems. But it turns out many of these gems – if that is what they are – are not hidden at all. Analysis of portfolio holdings shows a high degree of gravitation among emerging market fund managers. China Mobile is the most commonly held emerging market stock by emerging market fund managers in Europe, according to Lipper, and it is found in 105 funds. Samsung Electronics and Taiwan Semiconductor Manufacturing rank second and third, respectively. The ten most popular emerging market stocks, measured by the number of funds that hold them, are concentrated in two sectors – resources and financials – and three countries – Brazil, China and Russia. Measured by average percentage holdings, Samsung Electronics ranks first, followed by Vale and China Mobile. Philip Ehrmann, manager of the Jupiter China fund, is critical of so-called index-huggers. He owns China Mobile, but is underweight. He says that many of his larger holdings “have little to do with the benchmark”. Ehrmann argues that indices tend to be backward-looking, with older companies receiving a larger weight in the index. For example, China Mobile, he says, is relatively expensive given its low rate of growth, and the challenges it faces over rising capital expenditures, and being over owned as lending index stock. “China has pretty much caught up with the rest of the world,” Ehrman says, adding that the potential is now in data-focused companies when it comes to Chinese telecommunication. Telecommunications operator China Unicom is, therefore, one of his high conviction holdings, amounting to nearly six times the benchmark weighting. China Everbright International, a company that focuses on green environmental protection and alternative energy, also has a significant weighting in his fund yet nil in the index. And Hollysys Automation Technology, an automation and control systems producer, is not found in the index either. This Chinese company is listed in the US. Large-cap bias
For James Syme, manager of the Global Emerging Markets Opportunities Fund at JO Hambro Capital Management, it is part of his mandate to own the larger emerging market companies. He manages a large cap-biased portfolio of between 50 and 60 stocks. “We believe identifying the right countries in which to invest is the most important influence on portfolio performance,” he says. “Complementing our top-down view is a stock selection process that focuses on identifying quality growth stocks within our favoured countries.” Russia and Brazil are two countries that Syme has been active in recently. Last month, Syme sold two of the largest and most commonly held emerging market stocks – Russia’s Gazprom and Brazil’s Vale. He says Gazprom, though “extremely cheap” on a price/earnings basis, is threatened by a lack of domestic price reform and downward pressure from shale gas on the company’s exports. In Brazil, Syme says he sold Vale because of concerns over the outlook for cyclical commodities, and Vale is a producer of iron ore. His preferences in China includes the domestic energy and power industries, which Syme expects to benefit from demand growth and government efforts to stimulate the economy. In India, he is looking for defensive growth through the likes of HDFC Bank. The small caps
Timothy Hay, manager of Somerset Small Mid Cap Emerging Market All Country fund, seeks small and mid cap stocks – with a market capitalisation of between $750 million (€586 million) and $2.5 billion – and holds them throughout the growth cycle. Bancolombia, a commercial bank in Colombia, was recently sold because, Hay says, after three years of growth, credit expansion is likely to decline while asset quality will deteriorate. He says Wistron, a technology service company in Taiwan, was sold because it is expanding into the TV space where it is difficult for companies to make money. And NG2, a Polish shoemaker, has come under pressure because production costs in China rose, he adds. Meanwhile, Hay bought Bank of Georgia and Siam City Cement in Thailand. Another recent purchase is M. Dias Branco, a Brazilian food company, which he says “is under the radar of many managers”. He says: “We also invest in companies listed in developed markets but operating in emerging markets.” Beyond emerging markets
Many emerging market fund mandates will give the manager at least some room to capture opportunities elsewhere. Insparo Asset Management is a specialist asset management company focusing on frontier markets, though its managers have invested in local affiliates of multinational companies, such as Nestlé. The team used to invest in London Mining, a UK-based company that develops iron ore mines in Sierra Leone, Saudi Arabia, Greenland and Colombia, and Avion Gold, a West Africa-focused gold mining company based in Canada. London Mining was sold when the team became concerned over the company’s high cost of operation. And Avion Gold was bought by Endeavour Mining in an all-share transaction last month. In the emerging markets, one of Insparo’s high conviction holdings is Guaranty Trust Bank in Nigeria, which targets what the team considers to be an underbanked population. Another one is Alinma Bank, a retail and corporate bank expanding across Saudi Arabia. Mohammed Hanif, chief executive officer at Insparo Asset Management, says the surge in demand for shariah-compliant products and services was a key factor when buying the stock. “People want to bank in compliance with their faith,” he says. Elsewhere in Saudi Arabia, the team sold Sabic, a petrochemical company that specialises in manufacturing chemicals, fertilisers and metals. “We have changed our outlook for petrochemicals from cautiously optimistic to cautiously pessimistic,” says Hanif, explaining that most of the exports go to Asia, where some countries’ economies appear to be slowing down. Though Carlos de Leon, co-manager of the Allianz RCM Brazil fund, can allocate as much as 30% of his portfolio to stocks outside Brazil, none of his investments are currently outside Latin America.  “Asset quality in Brazil is deteriorating, loan growth is slowing down, average credit spreads are declining [while] average interest rates are falling.” De Leon’s fund is invested in Femsa, a Mexico-listed consumer company operating in nine Latin American countries, and Ecopetrol, a petroleum company listed in Colombia, but no investments are outside Latin America. Companhia de Concessões Rodoviárias, a private infrastructure group involved in highways and passenger transport, counts as a high-conviction Brazilian stock. For de Leon, the company is a play on economic growth with defensive and inflation-hedging qualities. There is evidence, including a recent study from Yale School of Management, that the most successful emerging market stocks are publicly traded emerging market affiliates of large multinational corporations. Most emerging market fund managers, however, insist that the gems are to be found locally. ©2012 funds europe

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