New-look emerging markets
Emerging markets are more tech-savvy and forward-looking, according to Franklin Templeton vice-president Chetan Sehgal.
MORE stable commodity prices and better corporate earnings have whetted investors’ interest to take a peak into emerging markets.
However, returning investors may find the companies of today’s emerging markets are very different from what they were in the past.
The landscape of emerging-market corporations in general has undergone a significant transformation from the often plain-vanilla business models of the past that tended to focus on infrastructure, telecommunications, classic banking models or commodity-related businesses, to a new generation of more innovative companies that are tech-savvy and have higher value-added production processes.
Franklin Templeton has started to see the establishment of some very strong globally represented brands which originate from emerging-market countries.
Back in the late 1990s, technology-oriented companies made up only 3% of the emerging market, as represented by the MSCI Emerging Markets (EM) Index.
Much has changed since then. Today, around a quarter of the MSCI EM Index is in the IT sector, which includes hardware, software, components and suppliers.
And while much of this activity originates from Asia, similar developments in Latin America, Central and Eastern Europe and even Africa are happening.
In terms of valuations, as at May 25, the MSCI EM Index had a price-to-earnings ratio (P/E) of 15.37 times and a price-to-book value (P/B) of 1.66x, compared with a P/E of 21.53x and a P/B of 2.33x for the MSCI World index.
Frankling Templeton executive vice-president and the director of global emerging markets/small cap strategies for the Templeton Emerging Markets Group, Chetan Sehgal tells StarBizWeek why he remains positive on emerging market.
Prior to joining Franklin Templeton, Sehgal was a senior ratings analyst for the Credit Rating Information Services of India Ltd.
Sehgal earned a Mechanical Engineering degree from the University of Bombay and a post-graduate diploma in management from the Indian Institute of Management in Bangalore, where he specialised in finance and business policy and graduated as an institute scholar. Sehgal speaks English and Hindi and is a Chartered Financial Analyst holder.
SBW: What is the main thing which has changed in emerging markets today?
Sehgal:
Technology is now a much a larger part of the indice, and this was not the case earlier. Ten years back, when people were trading in emerging markets, they used to look at commodity prices, energy and material prices.
With the growth in technology (and technology itself is a secular trend in emerging markets), emerging markets today have become much more widely owned and not just dependent on money flows any more.
Remember that emerging markets then were merely outsourcing stories for the West.
It’s still happening, but now it’s not just for the West, because China has become an importer and demand driver. China is demanding a lot of goods. As a result of this, the dependence on Western policies has actually come down quite a bit.
Have emerging markets become less dependent on Western policies as a result of China’s rise?
Emerging markets have become far more diversified. It is much larger too. Its dependency on any one single factor has come down quite a bit.
Those are the two big changes that have happened over the last 10 years.
In our analysis of investing, you play emerging markets for the secular trends, hence the rise of technology and structural things like demographics, these are things that don’t change over one decade. It takes a long time to change. So structural and secular themes are there.
Third is that industrial consolidation has taken place. For example, if you go back 15 years, we used to have many companies entering the tech space, trying to make D-RAMs for phones and PCs.
Now the number of companies doing this has come down as the technology has improved. You will notice there are now more dominant players and as a result of this, these dominant players have pricing power. Thus, the price of D-RAMs has gone up quite significantly.
Another important fact is that China is also trying to consolidate some of its supply side, for example in its cement, coal and steel industries. China is initiating supply side reforms, and this augurs well for shareholder return over the long term.
Are you saying that emerging markets are also trendsetters since they no longer depend on Western policies?
Yes, that is definitely the case. Every emerging market is different and all their models are changing quite a lot. There isn’t a right or wrong mode.
And in terms of new technology, another trend that I want to highlight is that 15 years ago, the number of patents application from emerging companies were probably 25% of the global patents.
Now it is about 40%. That is a big change. So, this changes all the perceptions of emerging markets. Because in the old days, we worry that should the Fed raise interest rates, will emerging markets start to fall. All these perceptions have been there and ingrained over a period of time but we need to appreciate the fact that emerging markets are evolving.
The emerging markets of today are not what it was yesterday.
Having said all that, is there any particular sector within emerging markets that you like?
On the big cap side, we are very much overweight on the technology side. We invest in platforms such as Tencent, Alibaba and Naspers. We also invest in semiconductor companies such as Samsung and TSMC. And we are also invested in some of the services companies. We like products, platform and services.
On the small cap side, it is very distinct from large caps.
Here are some differences. For example in the large caps, you have companies in the banking, energy and materials sector. Those are large industries.
But in the small cap, you find companies run by local entrepreneurs, which are catering to local demand. Most of them are in the consumer sector. Their growth rates are also non-cyclical compared to the larger caps. Historically we found that their earnings are less cyclical.
The stock market is probably equally sensitive because people tend to rush in and rush out of small caps. Nonetheless, volatility in small cap earnings is not inferior to the volatility of big caps on an agregate basis.
We like consumer discretionary companies. For example we have one in India, they are doing the autos and the two wheelers. We also like the healthcare sector, Some Korean companies which have become very good in the pharmaceutical sector, have now started licencing their products to the global majors.
Is there any sector you like which is not a favourite just yet?
Apart from secular trends we also play cyclical themes. Two years back when the Brazilian currency was beaten down, we invested a lot in Brazil, because the currency was very devalued. Last year we invested in Mexico, where the currency also came down quite abit.
Despite the recent turmoil in Brazil, we still like it.
We do notice that there is an overwhelming demand from the people in emerging markets for better transparency and more governance.
In India, for example, when its current Prime Minister Narendra Modi came into power, it was on the back of kicking out corruption. This overwhelming trend in emerging markets is very positive.
So is it now a good time to put more money in emerging markets?
Yes, the days of tactically investing in emerging markets are probably over. At that point in time, we used to just look at what the Fed was doing. But now, we need to be strategically invested in emerging markets. Because the fact remains that this is the largest landmark, this is the largest population, the hotbed of entrepreneurship.
Political reforms have taken place. They are leapfrogging on technology.
That is very positive characteristic. The GDP growth is there, and penetration for certain things are still nascent. You can create a new brand, you can grow it. Whereas in the West, while some of these opportunities still exist, it could be saturated.
It is far more difficult to establish something new in the West because most people already have access to such products.
Most big funds are still underweight on emerging markets at the moment?
It depends on how people define it. In our assessment, people are still underweight on emerging markets because of the home country bias.
Also, we find that emerging market companies are not inferior to those in the West. We have done a lot of studies on this. The rate of return on equity for these companies are not inferior to those in the West. These are all the more reasons to buy into emerging market companies.
You told us about the things you like. What about the things you don’t like about emerging markets?
We have stayed away from companies and countries where the government has extremely strong influence on shareholder returns, We have typically avoided the utilites, where the governments don’t want them to make a lot of money.
We also try to stay away from companies where the corporate governance is bad, So for us, the number one health-check is really the corporate governance. It should be good,