Emerging Market Investment Thesis

26th Aug '10 by marben100

10 comments 8910 reads

The purpose of this article is to set out an "emerging market" investment thesis that I understand a number of Stockopedia contributors follow, and allow for discussion and investment ideas within that thesis. Here in the UK and, I believe, in many "developed economies" (including the US, Eurozone and Japan) we have a pretty poor view of the economic outlook, as reflected in stock markets in those economies. What many fail to realise, however, is that large parts of the rest of the world do not see things that way. I am fortunate to have relatives and investing colleagues that are either based in "emerging economies" (EEs) or have recent direct experience of them. The message I am hearing is that whereas we experienced a "global financial crisis" (GFC) in the developed world, the GFC had relatively little impact on the emerging economies, where it was experienced as little more than a blip on a path of rapid growth which is now continuing.

The IMF's World Economic Outlook, updated July 2010, supports this thesis with the following historic & forecast chart:

I'll highlight near term growth forecasts for some selected EE countries:

Country	2010 % GDP Growth	2011 % GDP Growth

China	10.5	9.6
India	9.4	8.4
Brazil	7.1	4.2
S Korea	7.4	8.0

Many Stockopedia contributors and I invest in natural resource companies. These are indirect plays on EE growth, as a driver for demand for natural resources, as the slow pace of growth in developed economies and a strong push towards more efficient consumption of natural resources is unlikely to deliver much demand growth (if any) from those quarters.

However, it also possible to invest directly in these EE countries. In recent years the emergence of ETFs investing directly in EEs has made such investment much easier for retail investors than it was in the past. The relatively low charges of such index tracking ETFs also help to minise "frictional costs" for the investor. Some examples of such ETFs are:

Ishares Ftse Xinhua 25 (LON:FXC)
Ishares Msci Brazil (LON:IBZL)
Ishares Msci Korea (LON:IKOR)

Further details of these ETFs can be found here: http://uk.ishares.com/en/rc/funds/overview/EMEQ_CNTRY. Investment trusts such as JPMorgan Indian Investment Trust (LON:JII) also offer another means of gaining exposure.

Over…

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sirlurkalot

26th Aug '10

Anyone interested in global strategy analysts notes can read to their hearts content here:
http://financialcourier.blogspot.com/

and of course plenty of statistical forecasts available in the back pages of The Economist, downloadable here:
http://avaxhome.ws/magazines/economics_business_finances

Other interesting resources for Asian research:
Singapore
http://stockfanatic.blogspot.com/
http://www.remisiers.org/index.php?option=com_content&view=category&id=6&Itemid=16
India
http://stock-report.blogspot.com/

Anyone got any other similar useful links?

If you want to get into emerging mkt investing seriously, its also well worth changing your bookmarks/favourites so your starting point for reading the FT each day is a page like http://blogs.ft.com/beyond-brics/ so you read that every day. I've come to think of the UK from the outside as just another national market to be perhaps invested in on its own merits, and when you compare it statistically with all the other national economies and markets it's difficult to make a very enthusiastic case for it. BertEEE's non-stop enthusiasm for the UK on the Fool seems very out of place when you compare it with other international markets.

marben100

Thanks for the above, SirL.

I also find the Hong Kong Edition of FT Alphaville's 6am Cut (which is issued at 11pm UK time) useful for coverage of Asian markets. Unfortunately, though. it is now a subscription service.

Something I didn't point out in the original article is that, as with any investment, everything has its price. Based on the FT's published market P/E ratios, though India's rating looks a bit high ATM, several of the other markets seem quite reasonably priced at present, considering the growth forecasts. So this might be a good time to consider investing. As always, DYOR!

Mark

India's mkt PE is high, as is the PE of most of the companies I look at there, but many of them have high eps growth. 30%+ eps growth forecasts year after year are common. Not really my kind of investment gambit, but I can understand the high PEs.

ChristopheBassons

27th Aug '10

I have no doubt that EM GDP growth will exceed that of the developed world. I also have no doubt that there's money to be made from that growth. What's less clear to me is the best way (in a risk/return sense) to gain exposure to that. You have, in varying degrees of directness:

- Natural resources
- Secondary resource plays, e.g. Aussie Dollar, Loonie.
- Trackers, like those your mentioned
- The emerging middle-classes, and their desire to buy western brands
- Technical specialists with strong competitive postiions and high barriers to entry in their sectors, who can sell capability.

Any more?

My concern is that GDP growth in, say, China, is driven by the state, which is not necessarily concerned with efficiency and return on investment (e.g. large infrastructure projects being conceived for the betterment of society, rather than business considerations); thus, I remain to be convinced that direct investment in these economies is a good idea, particularly when compared to some of the opportunities available in the indirect beneficiaries of EM growth. My secondary concern is that the "obvious" investment rationale - EM are growing faster therefore buy an EM tracker - could lead to valuations getting out of check.

A couple of initial themes might interest you to start with:

a) the EM subsidiaries of global FMCG giants, ie Hindustan Unilever, GlaxoSmithKline Consumer, Nestle etc, which have a local EM quote for a minority of the shares (the majority held by the global parent). Arguably the global parent wouldn't let things go badly wrong in their EM subsidiary, and keeps management to international standards. Typically these sort of EM subsidiaries have sales growth in the high teens and PEs in the twenties.

b) the global outsourcers, ie Tata Consulting, Wipro etc, several of which have ADR quotes in New York so should be managed and disclosed to international standards.

Generally speaking, the consumer sectors are IMO better ones to start in as a play on the emerging consumer going middle class. There's plenty of research on the links I listed above to get your teeth into - I'm looking here at a 116 page Credit Suisse report on the Asian Small Cap sector with twenty top picks spread around Asia with PEs apparently averaging 7.6 with they say upside of 65%. If you're interested, get stuck into those links, and discuss ideas here.

Think also about themes like cement, as a play on construction (not economic to transport cement long distances) and education. I personally prefer consumer plays to resource ones in the EM-quoted space.

I fully agree with your consumer play comment, and this is the one I'm currently pursuing the most actively - I own no resource shares directly (excluding gold) compared to a good 20-25% in the consumer sector, in various guises!

I'll have a read of the CS report, and thanks for the suggestions.

haiderali

28th Aug '10

Sorry if this is OT for this board. But how does this rate as a BRIC play for those wanting to hold cash?

Starting from 9 August 2010, the RMB CD with a tenor of six months will be available to both retail and commercial banking customers at all HSBC branches. The CD, denominated in RMB, allows investors to receive interest payments of 2 per cent per annum upon maturity. Subscription will be available on a first-come, first-served basis and the minimum subscription amount is RMB50,000.

http://www.asianbankerpublication.com/A556C5/Update.nsf/0/dae466f52db525b94825777a0029585a?OpenDocument&Click=

Dunno if that is still available, but more generally I wonder what peoples' views are to holding some medium term/long-term cash in RM (for those who have bank accounts which allow this).

From some quick reading around, the impression I get is that RM is not a one way appreciation bet story, but neither have I seen anything that would suggest substantial threats to the currency.

8th Sep '10

Goldman comment reported by Bloomberg today: http://www.bloomberg.com/news/2010-09-08/emerging-nation-stocks-to-top-developed-market-by-2030-goldman-sachs-says.html

...Faster economic expansion and growing capital markets may lift emerging nations’ share of world equity capitalization to 55 percent by 2030 from 31 percent today, Goldman strategists led by Timothy Moe wrote in a research report. Institutional investors in developed nations will probably buy a net $4 trillion of emerging-market equities, lifting holdings to 18 percent of their total portfolios from 6 percent now, Moe wrote.

“The primary drivers are rapid economic growth and the maturing of equity markets that are at earlier stages of development,” Moe wrote in the report today. “Developed-market institutional asset management pools will need to increase their holdings of emerging-market equities.”

The MSCI Emerging Markets Index has more than doubled since the beginning of 2000 even as the MSCI World Index of advanced- nation shares dropped about 21 percent. Emerging economies will expand 6.4 percent as a group next year, compared with 2.4 percent in developed nations, according to forecasts by International Monetary Fund. Prospects for faster growth spurred investors to add money to emerging-market equity funds for a 14th straight week even as they pulled $6.87 billion from global stock funds, research firm EPFR Global said today...

18th Dec '10

A 247 page HSBC report, released this month, analysing China's economy in a bottom up fashion (i.e. region-by-region & city-by-city) has come into my possession... and fascinating reading it makes too, for the serious investor. Contact me via Stockopedia messaging if you would like to have it. Here is the first part of the introduction* and I hope that the stats will make every investor that reads this post sit up and take notice, as IMO this has global implications that are barely beginning to be understood by the wider community:

"The sky is high and the emperor is far away" is an old Chinese saying that refers to how much local officials can achieve themselves with little supervision from above. It is an adage that is very relevant to China's dynamic expansion today as much of the country's growth is being driven by local initiatives and developments, rather than by Beijing.

Chinese reforms have empowered local governments with unprecedented economic authority following a process of economic decentralisation that began in 1979. Indeed local officials in China's provinces and cities have occasionally reduced the effectiveness of Beijing's policies, as shown by the capital's recent difficulties in cracking down on property speculation. This brings to mind a modern rendering of the old saying, namely that "there are policies above and counter-measures below."

To try and capture the scale of this local dynamism, we have put together a 244 page guide, covering 31 provinces, municipalities and autonomous regions and 21 major cities. For each we give key economic, financial and demongraphic data, list their strengths and challenges, and provide a five-year outlook.

This "bottom up" perspective on China, rather than the usual "top down" one, has thrown up some extraordinary statistics:

By 2020, China will have six provinces with an annual GDP of more than USD1 trillion, equal to six countries the size of Russia (or Spain or Canada).

With 47% of the population now living in cities, eight Chinese cities have a population of more than 10m, and 93 have more than 5m. By comparison, in the US only New York City has a population of more than 5m.

Beijing, China's Washington D.C., is also China's Silicon Valley. Its Zhongguancun area saw 23 high-tech IPOs in 2009, against just one for Silicon Valley. There have been another 35 IPOs so far in 2010.

Kunshan, one of 2,000 county-level cities, produces more than half of the world's notebook PCs, or 85m units - and yet IT manufacturing is not even its top-ranked industry.

Suzhou, one of 280 prefecture-level cities, has a per capita GDP which is 70% and 46% higher than Bejing and Shanghai, respectively.

Jiangsu, a province little known to outsiders, is poised to overtake the much better-known southern privnce of Guangdong to become China's largest provincial economy as early as 2012.

The 1.5m inhabitants of Erdos, a city rich in natural resources in the otherwise porr western part of the country, will have a higher per capita GDP than Hong Kong in three years time.

Among the 1m villages - the lowest unit in the administrative chain - there are some extraordinary contrasts, for example, between the fiercely capitalist Huaxi, where every ex-farmer is a millionaire, and the communist Nanjie, where collective interests still prevail over those of the individuals.

*Retyped as copying is not possible, so may contain typos.

The second statistic quoted - 47% of the porpulation now living in cities - certainly gives the lie to the view that the vast majority of the population is still working on collective farms and that the "Chinese phenomenon" is a mere "bubble" with no economic basis.

China is undergoing transformational changes that will have a global impact. The report also points out the real danger of overcapacity in certain industries, which may lay the seeds for a future downturn. Investors should bear in mind that such overcapacity, where it exists, will have a global impact, not merely one confined to China. The old adage that "when America sneezes the rest of the world catches a cold" can also now be applied to China. However, ISTM that overcapacity/overinvestment will primarly affect specific industries, rather than being widespread, though a collapse (for example) of an emerging property bubble will, undoubtedly, have some impact on the wider economy by impacting domestic Chinese consumption.

Incidentally, on checking facts here, one interesting thing to emerge, which might surprise some, is that UK GDP for 2009 was USD2.2trillion vs USD1.2trillion for Russia (1.5trillion for Spain and 3.3trillion for Germany). The figures look a little different on a "purchasing power parity" basis, however.

Regards,

Emerging Market Investment Thesis

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Marben100

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