Sustainable Equities Boutique

What’s next for emerging market equities?

Viewpoint
COVID-19 Emerging Markets
merz_roger

Roger Merz

Head of mtx Portfolio Management, Senior Portfolio Manager


While the worst of the Covid-19 pandemic appears to be over for China, another storm may be brewing for emerging economies in the form of a row over oil between Saudi Arabia and Russia, says Thomas Schaffner, the lead manager of the Vontobel Fund - mtx Sustainable Asian Leaders at Vontobel Asset Management. Still, the current double whammy shines a light on asset managers able to navigate the market.

Globally speaking, the new respiratory disease shows no sign of relenting. The US has extended a ban on incoming flights from China to air travel from Europe, citing the unchecked spread of the virus there. Italy is effectively in quarantine for the same reason. Authorities around the world are taking emergency steps ranging from school closures to massive interest rate cuts, mirroring China’s drastic containment measures.

Energy holdings trimmed before oil market rout

While there are rising hopes that countries other than China are getting the coronavirus outbreak under control, the “oil price war” has taken markets by surprise. On March 9, the Organization of the Petroleum Exporting Countries (OPEC) under Saudi Arabian leadership and non-OPEC member Russia terminated an agreement to limit production. The standoff, which sent oil prices down by 30%, will see oil-exporting nations suffering. That said, consumers and oil importers such as China, South Korea, and India look set to benefit from lower energy prices.

“We were lucky that we have reduced energy exposure right before the big drop (in oil prices), but we are still invested in oil companies,” Schaffner says in a call with investors. Besides managing the mtx China as well as Asian Leaders funds, he is responsible for the Vontobel Fund - mtx Sustainable Emerging Markets Leaders together with Roger Merz, Head of mtx Portfolio Management. The energy stocks in the mtx portfolios1 have held up relatively well but the companies face declining returns on invested capital (ROIC), which is a worry to the mtx team. However, a sale would be premature. “These companies are now trading much below average valuation, which probably is not a good time to exit these names,” Schaffner notes.

Funds relatively resilient thanks to positioning

While the mtx strategies were unable to withstand the general downward trend, they have held their own in relative terms. With no or little exposure to the worst-hit travel or Chinese gambling sectors, the Vontobel Fund - mtx Sustainable Emerging Markets Leaders and the Vontobel Fund - mtx Sustainable Asian Leaders (ex Japan) have posted a relative outperformance of 4% and 3%, respectively, between January 2020 and March 11. “Energy, materials, utilities and industrials have all underperformed. We are underweight in all these sectors with the exception of utilities, but the utility names we own have outperformed,” says Schaffner. He also cites the mtx funds’ high exposure of 26% to internet-related businesses, a sector little affected by recent market woes and quarantine lockdowns. Apart from sector positioning and stock selection, an important reason for the funds’ resilience is the team’s stringent selection criteria for portfolio candidates, according to the fund manager. These include high marks for ROIC, industry positioning, and balance-sheet solidity, as well as sustainability requirements.

Rumors of Chinese “National Team” markets support

China – the mtx funds’ most important country by far – is showing signs of stabilization. Reliable data is hard to come by, but there is anecdotal evidence that Chinese factories and the retail industry are slowly returning to normal, according to Schaffner, who spent several years working in Hong Kong. Some sectors of the economy such as online gaming and e-commerce are even thriving. Moreover, there are rumors that the so-called National Team – several large state-owned companies and Chinese authorities – stands ready to support the stock market. This may have happened already. In February, the MSCI China index gained 1.3%, a remarkable feat given the general market gloom elsewhere. In addition, the Chinese market’s inherent reliance on technology and internet stocks is beneficial. “Names in the online gaming space or in the social media space are doing well because people are sitting at home and have more time and money to spend on the internet,” Schaffner says.

Outlook hinges on Chinese normalization, oil glut fallout

For Schaffner, the outlook for emerging markets – and the mtx funds – hinges on the recovery of the Chinese economy. Assuming that other countries will need 50 to 60 days to bring the disease under control (like China), the global economy will take a first and second-quarter pandemic hit and then slowly rebound, he adds. A fresh concern is the expected oil glut following the breakdown of talks between Saudi Arabia and Russia. The spat may be transitory, but if one of these oil superpowers really aimed to bankrupt the high-cost shale producers in the US, as suggested by some market watchers, oil may remain “lower for longer”, according to the portfolio manager. This could throw overboard oil companies’ investments plans, and muddle oil equipment manufacturers’ prospects. Moreover, a longstanding price war would depress many countries’ oil revenues, thereby limiting the amount of money Middle Eastern investors are willing to spend on equities.

Markets have priced in earnings cuts, may get liquidity boost

Earnings forecasts appear too high and look set to come down. “At the same time, stock markets have already corrected by more than 20%, so these earnings cuts are partially priced in,” Schaffner says. Meanwhile, the global trend towards lower interest rates may support financial markets. The liquidity created by central banks needs to flow somewhere. “So if the situation normalizes, this money is most likely to go to the stock market,” Schaffner says.

Depending on the developments in China and elsewhere, the mtx team may continue to adjust the portfolios. Over the past few weeks, some energy and duty-free companies were sold. The portfolio managers also trimmed positions in the materials sector. On the other hand, they increased holdings in internet businesses and utilities.

1. As of February 28, 2020, the largest holdings in the Vontobel Fund - mtx Sustainable Emerging Markets Leaders were internet and technology companies such as Alibaba, Taiwan Semiconductor (both exceeding 6%), and Tencent Holdings (5.6%). In the Vontobel Fund - mtx Sustainable Asian Leaders, the top positions were Tencent, Alibaba (both over 7%), and Taiwan Semiconductor (6.4%).



 

2020-03-12_mu_covid-mtx_chart1_en

 

FUND CHARACTERISTICS
Descrition Vontobel Fund - mtx Sustainable Emerging Markets Leaders
USD I LU0571085686
Index MSCI Emerging Market TR net
Currency USD
Inception Date 15.07.2011
Time Period 15.07.2011 - 28.02.2020
Rolling 12-month net returns (in %)
  Fund Index
28.02.2020 - 01.03.2019 4.2 1.9
28.02.2019 - 01.03.2018 -9.6 -9.9
28.02.2018 - 01.03.2017 38.9 30.5
28.02.2017 - 01.03.2016 36.5 29.5
29.02.2016 - 01.03.2015 -17.4 -23.4

Past performance is no guide to future performance.
Performance data does not take account of commission or costs charged when units are issued or redeemed. Source: Vontobel Asset Management.

2020-03-12_mu_covid-mtx_chart2_en
FUND CHARACTERISTICS
Descrition Vontobel Fund - mtx Sustainable Asian Leaders (ex Japan)
USD I LU0384410279
Index MSCI AC Asia (ex Japan) net TR USD
Currency USD
Inception Date 17.11.2008
Time Period 17.11.2008 - 28.02.2020
Rolling 12-month net returns (in %)
  Fund Index
28.02.2020 - 01.03.2019 1.9 0.1
28.02.2019 - 01.03.2018 -10.7 -8.2
28.02.2018 - 01.03.2017 43.7 31.9
28.02.2017 - 01.03.2016 36.6 26.5
29.02.2016 - 01.03.2015 -20.4 -20.4

Past performance is no guide to future performance.
Performance data does not take account of commission or costs charged when units are issued or redeemed. Source: Vontobel Asset Management.

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