Emerging Market Stocks: The BRIC Is Just the Beginning
Many Investors have become increasingly leery of the BRIC (Brazil, Russia, India and China) nations because of their slowing growth and tight economic links to Europe. But it’s a big world out there, and Andrew Foster, previously a fund manager and chief investment officer at Matthews International Capital Management, is still discovering numerous opportunities in emerging markets. In order to take advantage of investments in regions beyond the Asian focus of his former firm, Foster recently founded Seafarer Capital Partners and is now the lead portfolio manager of Seafarer Overseas Growth and Income (SFGIX).
Ben Shepherd: What’s your view on global growth?
Andrew Foster: Growth around the world is moderating, especially in many of the emerging Asian economies. However, the nature of that moderation is misunderstood and will be for some time. Emerging economies are transitioning to a more sustainable economic model, but that transition has been murky. As a consequence, investors are fearful of such change, and the eurozone’s economic turmoil has compounded the difficulties that large, emerging economies such as China and India are navigating.
But while the growth outlook is tricky, I don’t have particular concerns for the long term. In fact, valuations are quite accommodative of the medium- and long-term investor’s outlook.
Ben: Can you describe these economic transitions in detail?
Andrew Foster: There are two transitions occurring, one of which is the shift from export-driven economies to consumption-driven economies.
Domestic consumption often gets conflated with consumers, and consumers are quickly conflated with material goods like cars and furniture. These are important areas to monitor if you’re a longer-term investor, but these themes have already received quite a bit of attention. As a result, the valuations in those sectors aren’t very favorable right now.
But I think the more important transition underway is the one from capital-intensive economies to service-oriented economies. Over the last century, the US economy shifted very dramatically from a manufacturing- and production-oriented economy toward a service-based economy. That shift has begun in emerging Asia, as well as some of the other global emerging markets.
These services include industries such as media and entertainment, tourism and leisure, as well as a host of professional services such as legal, accountancy and financial planning; these are industries that are really underpenetrated in most emerging economies.
For instance, health insurance has only recently begun to be offered in Singapore. Health maintenance organizations and health insurance just doesn’t exist in the region. That’s a basic consumer service that is largely untapped in one of the richest nations in the world. So I think the shift from external-production economies toward internal-service economies that focus more on intangibles and services, rather than consumables, is an important trend to watch.
Ben: Is the slowdown in global growth a natural consequence of that transition?
Andrew Foster: The shift among emerging economies to a new growth model is part of the story, but the slowdown has also been exacerbated by the eurozone’s debt crisis. Europe is a key export market for most emerging economies, so the Continent’s economic woes are taking a toll.
But I still believe that growth in emerging markets will be relatively robust, even if it’s not at the 10 percent to 11 percent rate that people have grown accustomed to from China, or the 7 percent to 8 percent rate that people look for from India. Growth will moderate, but it will also become more sustainable.
Ben: What countries are most attractive right now?
Andrew Foster: Vietnam is well positioned. Some investors are concerned that its growth model isn’t very healthy, since the state sector is not particularly well managed and creates distortions in the economy. But the private sector is vibrant and growing quite rapidly.
China and some of the other more developed emerging markets in Asia have been shifting their manufacturing bases to lower-cost economies. Vietnam stands to gain much of that business. Meanwhile, on the domestic front, Vietnam continues to make sound regulatory changes, even if those changes haven’t always pleased the market. For example, some investors are worried about heavy-handed regulations on Vietnam’s banking sector, but those concerns are misplaced. The regulators are acting in quite a benign way to promote medium- to long-term growth by forcing some consolidation among the banks and clamping down on certain speculative activities.
There’s also a lot to be excited about in Malaysia. Some interesting economies and sub-industries have begun to spring up there. For example, Malaysia has a growing medical equipment sector, and a number of burgeoning financial services industries. With regard to the latter, Malaysia has a leading global position in Islamic finance, predominantly serving Southeast Asia. These are intriguing niches where Malaysia has managed to secure a foothold and become quite competitive. On the other hand, the economy as a whole does have a fair bit of export sensitivity, and that could be problematic during a global downturn.
South Korea is another market that offers opportunity. Samsung Electronics (Korea: 005930, OTC: SSNLF) and Hyundai Motor (Korea: 005380, OTC: HYMTF) have become strong enough to practically dominate their industries. South Korea also has some very competitive and well-managed companies that are incredibly cash generative, but have yet to see their valuations rise to reflect their underlying fundamentals. Those stories are lost behind the excitement over the country’s export competitiveness.
There’s been a bifurcation in the market’s opinion about whether to favor companies that produce impressive top-line growth, but whose cash flows are not nearly as strong, or companies that produce strong cash flows, but have more moderate growth. That’s created a situation where investors interested in South Korea can still find defensive, undervalued names with attractive yields.
Thailand deserves attention too. We’re reasonably positive about Thailand’s political outlook, as well as the country’s recovery after last year’s floods. The economy seems to be picking up momentum after a difficult 2011, and we’ve been excited to see many Thai companies that had suffered serious setbacks regain lost ground. There’s reason to be optimistic about Thailand in that context.
Mexico also has a robust economy. It does have linkages to Europe, and there has been concern about the narcotics wars there. Despite those issues, the economy has been surprisingly stable and productive. And there are Mexican companies that offer attractive dividend yields and have healthy, unlevered balance sheets.
Ben: Do demographic trends influence your investment strategy?
Andrew Foster: Demographics can be a helpful analytical tool, but they don’t play a huge role in our investment process. Demographics only become real destiny when a society becomes very rigid about immigration and internal labor mobility. That’s a big issue in Japan, where labor mobility and immigration are fairly static. Japan’s demographics have become its destiny, and therefore its economy has been in a protracted decline.
Elsewhere in Asia, even in China, the markets are open, so even with challenging demographics, there are still enough levers they can pull to help correct the situation.
Ben: Are there any countries that should be avoided?
Andrew Foster: If Europe has a messy unwind, the financial markets will swoon, and that will have a global impact. Individual economies and financial markets are increasingly integrated at a global level, and that makes it much more difficult to escape a crisis.
That said, China will bear the brunt of the economic stresses that emerge from Europe since its integration with the eurozone is quite high. China would be hit harder than many other economies.
Ben: How should investors position themselves if Europe’s debt crisis worsens?
Andrew Foster: Although I think the eurozone will eventually unravel, and the currency will no longer exist in its present form within about five years or less, I don’t believe there will be a messy unwinds culminating with a short, sharp catastrophe.
Even so, investors interested in bolstering their portfolios against this scenario should take a look at the tremendous growth in the fixed-income markets in many emerging economies.
The valuation argument for equities in some of the smaller emerging markets is also fairly pronounced.
Outside the BRICs, there are equities that offer substantial dividend yields, even though they’re only paying out 20 percent to 30 percent of earnings. Low payout ratios provide an ample cushion for a company to sustain its dividend, even if earnings come under stress.
Such companies often have very little balance sheet leverage, so there’s not much debt to create a financial concern. Yet the equities that offer these yields aren’t particularly expensive because their prices have already been beaten down by investors concerned about waning economic growth.
Ben: Can you give a few examples of these companies?
Andrew Foster: In South Korea, Samsung Fire & Marine Insurance Co (Korea: 000815) and S-Oil Corp’s (Korea: 010955) preferred shares offer attractive yields, and their underlying companies boast solid balance sheets. They yield 5.25 percent and 8 percent, respectively, despite the fact that payout ratios for both companies are well below 50 percent.
Kimberly-Clark de Mexico (Other OTC: KCDMF.PK) is one of our larger holdings in Mexico. It’s an affiliate of Kimberly-Clark Corp (NYSE: KMB) via both economic and ownership arrangements, but it’s basically independently managed in Mexico. It offers a stable 3.5 percent dividend yield, but it does have a leveraged balance sheet. Although the company carries more debt than the two aforementioned South Korean names, management does place a high premium on paying a consistent dividend.
Ben: What’s your best piece of advice for investors over the next year?
Andrew Foster: Invest in the emerging markets on a diversified basis, and don’t be slavishly oriented toward the BRICs. Valuations are your friend, especially if you focus on income-generating equities. There may be some shocks that still emerge, however, so make sure you’re prepared to endure the ensuing volatility. And if the market does get bumpy, try to stay invested and even invest a bit more during down periods, as those offer the best opportunities to build a strong portfolio.