2Q 2022 Emerging Markets Equity Outlook: Unique exposure at reduced valuations

Unique exposure at reduced valuations

Portfolio manager Ramiz Chelat discusses regulatory risk in China, the impact of rising interest rates, and how to manage inflation.

• While performance of EM stocks has fluctuated between momentum and value during the COVID pandemic, pricing power and the ability to manage inflation and supply chain issues are key attributes that we monitor and look for in companies. We are skeptical that value and cyclical areas like energy, materials and certain banks can continue driving the markets.
• Oil prices are predominantly a supply issue while demand has not materially changed. This is different than in the early 2000s when rapid Chinese growth induced a commodity rally.
• Rising interest rates are generally positive for banks, although investors should be selective. In India and Indonesia, banks can benefit from higher net interest margins and lower credit costs. But with higher costs in Brazil and South Africa, rate rises can choke off growth.
• It will pay to be selective in India as higher inflation impacts the lower income population. Exposure to market leaders focused on premium products, IT service businesses that benefit from a weaker rupee, quality banks with lower credit costs, and low-cost refiners should hold up well.
• Regulation risk in China has not completely gone away. However, in sectors like e-commerce, we are increasingly able to quantify the impact and help identify the potential winners. We are cautious on gaming where the government continues to have social concerns about minors. It is possible to navigate the market with less exposure to companies and sectors in the government’s crosshairs. Investors need to be selective and pick their spots to do well in China going forward.
• Chinese regulators are now more willing to let US regulators review local audit files, a step in the right direction to preventing a de-listing. We have shifted our exposure away from ADRs over the past few years and aim to only own businesses that have a dual listing in HK which will allow investors to transition their ADR holdings.
• We believe EM gives investors exposure to unique businesses with long runways for growth. Many markets are earlier in their recovery from the effects of COVID. Additionally, EM stocks are currently trading at a discount of more than 30% versus developed markets, the largest discount since 2004.

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