Don’t Race the Benchmark in Blinders

Quality Growth Boutique
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Emerging markets have experienced rapid growth and change in the past 20 years. This is reflected in seismic shifts at the country, sector and even company level in the MSCI Emerging Markets Index.

  • The Index’s three largest weights have more than doubled – from 32% in 2000 to 67% today, dominated by China’s explosive economic growth and rise in market capitalization.
  • The emergence of a new middle class with growing disposable income (particularly in Asia) is driving demand, with consumer discretionary now the largest sector.
  • Some individual stocks have actually exceeded those of entire countries in the Index. Consider China’s 
    e-commerce giant Alibaba (8.7%), which has outpaced Brazil, the fifth largest country at a 4.56% weight.

As emerging markets have evolved, equity returns have been momentum driven over short time periods, with frothy valuations in times of rapid movements. As shown in Figure 1, outsized gains – albeit somewhat volatile – tend to follow a sideways moving market.

Despite the inherent volatility and periods of consolidation, emerging markets can offer great value and opportunity compared to global developed markets, so long as investors use the right strategy.



Why Investors Should Open up Their Field of Vision

Unlike horses that need blinders to keep them narrowly focused on winning a race, investors should expand their field of vision to consider the risks around them. In our view, following 5 basic principles is critical to help successfully navigate emerging markets:

  1. Diversify: While we believe in a concentrated portfolio of high conviction names, investors should also maintain a low correlation among growth drivers to alleviate the risk of unknowns.
  2. Focus on Earnings Visibility & Sustainability Given EM economies can be subject to massive gyrations over time, investors should identify companies with predictable, long-term earnings trajectories and that are sustainable franchises supported by true economic moats.
  3. Avoid Aggressive Accounting & High Leverage: Investors should look for simple, understandable business models and steer clear of companies with weak balance sheets or a lack of clarity around accounting practices.
  4. Utilize a Sound ESG Approach: ESG is critical to avoiding icebergs that can sink your portfolio performance. For instance, there are many quality companies in China, but lack of visibility in terms of governance and understanding the goals of the regulators present challenges for stock pickers.
  5. Pay Close Attention to Financials & Consumer Sectors: Investors should be cognizant of losses that could build up in banks, as well as rising consumer leverage and house prices, which could contribute to underlying imbalances in EM economies

Emerging markets can offer attractive long-tail growth as business models and large EM economies are more stable than in the past. Investors can mitigate the risks by staying the course with a time-tested manager that consistently applies their investment approach.




About the author

Matthew Benkendorf

Chief Investment Officer Quality Growth Boutique, Portfolio Manager

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