MASTERCLASS: Emerging Markets - October 2017

2017 marked an incredible year for Emerging Markets, as the asset class went on a huge rally. Markets like China, India and Latin America present a tremendous opportunity for future investors. How will Emerging Markets respond to geopolitical risk with North Korea, how does currency hedging work, and what impact will the U.S. dollar have on the asset class? Asset TV assembled a panel of three financial experts to discuss Emerging Market ETFs, the role of Active Management and what the future of the asset class holds.

  • Deborah Fuhr — Partner and Co-Founder at ETFGI
  • Robert Marshall Lee — Investment Leader of the Emerging and Asia Equity Team at Newton Investment Management
  • Patricia Ribeiro — Vice President and Senior Portfolio Manager, American Century

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  • 58 mins 42 secs
Gillian: Welcome to Asset TV. I'm Gillian Kemmerer. Emerging economies have been on a tear, resilient stock markets and outperforming currencies have characterized the stellar year with inflation hovering around a post crisis low. Many investors are asking themselves whether the party is coming to an end or perhaps just getting started. Today we have three experts to share their view on the future of the emerging world, highlighting the opportunities and countries poised to outperform. Welcome to the Emerging Markets Masterclass. Thank you both for joining us here in the studio today. And thank you to Rob who’s joining us from London. Rob, I’m actually going to kick off with you. Let’s start by contextualizing emerging markets performance. We have seen EM stock markers at highs we haven’t seen since 2011. We’re seeing currencies hitting a three year high. How do you contextualize this performance and is it poised to continue?

Gillian: Debbie, starting with you from the ETF perspective, give us a little bit of a sense of how emerging markets have done and what you see coming down the pipeline.

Deborah Fuhr: Yeah. So when we look at ETFs, I mean the industry in general has had a phenomenal year where we’ve seen the flows going in at 433 billion net new, compared to all of last year at 390. When we look at emerging markets, what we heard about performance year to date we see that many investors are using ETFs to gain that exposure. So what you tend to find is that many investors go to the broad EM benchmarks. And we’ve seen that, many have embraced the FTSE EM. And about equally, people have embraced MSCI EM. And so when they think about investing in emerging markets, for many it’s difficult to decide which of all those countries should I go in or which region. So that is clearly a space where you see a lot of money going into the broad EM. But we’re also seeing money going into individual countries. And so the countries where you tend to see money going in is based on people reading stories. So it’s based on performance. It’s based on political and economic news.

And it’s also based on the fact that MSCI as we know, announced that they’re going to be including the A-Shares from China into mainstream indices. And so many are looking at China and thinking, well, you know, two years ago it was a pretty bad scenario in terms of what was happening in the market. And so we are seeing people looking at investing back into China. We’re seeing some people interested in India. So the bigger economies are the ones where you see people putting money into individual countries. On a year to date basis we have seen 33 billion of net new money going into equity focused ETFs, which is higher than all of last year. And where we look at fixed income, which is also an area where we’re seeing money going into emerging market debt we have seen 13 billion of net new going in, which is about at the same level that we would have seen at this point last year. So many people are looking for yield also.

Gillian: And, Deb, when we think about anyone that’s looking to play the emerging markets wise, a lot of them as you mentioned are going to the broader indices. But there are some concerns about index construction in emerging markets, this fear that the giant state owned enterprises have this huge market cap and are really messing with the weightings of the index. How do you explain to investors what they’re getting into here?

Deborah Fuhr: Well, you know, you really do need to do your homework. So what you do find is if the index is constructed a certain way, how the actual asset manager is constructing what’s inside of it can vary, right. So you need to look at is it fully replicating? Is it buying everything? Is it buying ADRs or GDRs, which can have different performance in the local shares? Is it currency hedged? So there’s a lot of things you want to look at when you start thinking about investing in emerging markets, because as you heard, you know, currency is also playing a factor in performance. So you want to look at do you want to buy something that’s listed here in dollars, hedged or unhedged. So you are seeing that you need to do your homework and understand the difference between FTSE and MSCI. You know, we were speaking, the big difference when you look about emerging markets is, is Korea determined to be emerging or is it developed, right. So it can be differences on a country basis. It can be differences on a sector basis. And it can also be different weights in terms of the overall methodology.

Gillian: Deb brings up currency hedging. I think every EM currency is up this year. So, Patricia, from an active management perspective, when you look at the performance of EM so far year to date, how do you contextualize it and what do you see coming next?

Patricia Ribeiro: Yeah. We are still positive on the emerging space. What we see is that emerging markets have actually gone through an inflection, a positive inflection point as a whole. And it started late last year and obviously going through this year. GDP growth accelerating in emerging markets, inflation coming down significantly, in July we hit an eight year low in inflation. With that obviously it gives an opportunity for interest rates to come down in emerging markets, very good for consumption. Fiscal discipline also in emerging markets continues. So we see a lot of data points that have been really positive in the emerging space. And I think that’s what has helped the markets to respond this year. And this is coming from a very low base. We had several years of actually deceleration and data points there are actually really been worse than the prior year in emerging markets. So it’s positive. But what we see going forward is if we continue to see, you know, companies have started to show improvement in earnings. So we are seeing quite a bit of that coming through as well. If we continue to see earnings upgrades, you know, earnings revisions in the emerging space, I certainly think that emerging will continue to do well.

Gillian: So you see not just a change in terms of the economic picture, obviously a weaker dollar boosted some EM currencies earlier this year, but a change in fundamentals, they are getting better.

Patricia Ribeiro: Absolutely. That’s exactly what we’re seeing. So it starts with the macro, but then it trickles really into the economy. So we start looking bottom up, corporates, when you look at the corporate earnings what you are seeing is that they’re starting to accelerate. And that’s what we think we at least should have an opportunity to really continue for a period of time.

Gillian: And, Rob, I want to bring the conversation back to you. Do you also believe that fundamentals are strengthening enough to continue the emerging market rally?

Gillian: So let’s talk a little bit about how traditionally investors have looked at emerging markets. And I want to start with this BRICs scenario. So, Deb, starting with you, was BRICs ever a good way to group together emerging markets?
And when you look at the ETFs of Brazil, Russia, China, India, they must be incredibly different.

Deborah Fuhr: Well, they’re definitely economies, they’re different performance. But I think at the time people love something that resonates. And at the time it was introduced, it was something that clearly we saw a lot of new funds come to market. I saw a lot of investors interested in investing in that. And so, you know, if you have something that’s catchy, it makes sense. There was a story and people like stories. They want to believe in things. I think it did make sense at the time. But clearly we’ve seen very different performance when you look at those countries. Many different things have happened. You look at how Russia is today versus Brazil. You look at India. And so you see the countries all, I think, being slightly different on many different fundamental levels. So I think that that story today isn’t one that we see people looking towards. You look at the individual countries a lot more than that region. And in general you don’t even see people looking so much at Latin America as a region or Eastern Europe. It tends to be the broad or individual countries is what I see is kind of the trends, the way people look at it.

Gillian: And when I look at this classification, Patricia, Brazil versus Russia versus India, we have many factors. We have massive commodity producers, they have incredibly different fundamentals. Was it ever a good classification beyond maybe a marketing question as Deb alluded to?

Patricia Ribeiro: Yeah. Probably not, I think the way we think of emerging is every country\s different. Every country is in a different, you know, stage of the economic cycle. Some are almost obviously more geared toward exports. Or there’s much more internal consumption. So every country is different for us. And what we do is really look at each one of them individually and then obviously try to look for where we find good opportunities from a bottom up.

Gillian: When you think about the commodities producers versus the manufacturers, are you seeing a big divergence in performance this year between the two groups?

Patricia Ribeiro: No. I think for example if you look at Russia, I think there’s more than just the issue of commodity why Russia has been an underperformer this year in the emerging space. And also there are other countries, for example, like Brazil where the representation of commodities in there, you know, the stock market is much larger than what actually it is in the economy. So all of this is very different, and that’s why I think we need to focus on each country individually and not, you know, put them all together as a group.

Gillian: Rob, when you look at this BRICs classification, I want to get your point of view. Was it ever a good way to group a group of countries together or do you look at it as more of a marketing play as Deb mentioned?

Gillian: So I’m actually going to bring in a question that we received from one of our viewers. And it’s about the larger geopolitical risk scenario that we’re facing in much of the developed world, not necessarily emerging. So let’s listen.

Tim Barron: Hi! I’m Tim Barron. I’m a Chief Investment Officer of Segal Marco Advisors. And my question is what are the geopolitical risk factors in the markets today? And how will they affect the emerging markets?

Gillian: Rob, I want to get your opinion here. When you look at the landscape of geopolitical risk factors, what are the ones that are really making an impact on the emerging world?

Robert Marshall Lee: I think the reality is that political risk factors never go away. There are always some burning somewhere in the world. We’re always kind of tarred by our view of the last few months. But these things kind of ebb and flow in different countries and different times now. Right now we see North Korea; I find it very hard to believe we’re likely to see a nuclear war on the doorstep. It doesn’t suit anyone’s interests. But that’s kind of the hot topic at the moment. And that’s hitting Korean stocks, which potentially provides an opportunity in Korean stocks of course. I think what Mr. Trump’s been saying over the last month or two about Mexico is quite different to what he was saying in the run up to the election. So back in November everyone was worried about the Mexican peso and anything to do with Mexico. If you think about what we’re seeing now, actually it’s not making the headlines at all really. It’s really dampened down. And instead he’s talking about American football players. So these things kind of ebb and flow, we have to try and separate the wheat from the chaff, what’s the reality from the rhetoric. And hopefully we get opportunities because of a lot of noise to buy good companies at depressed prices. That’s what we really like as a long term fundamental investor.

Gillian: Patricia, I’m going to direct this question to you next. When you think about geopolitical risk, what is top of mind for you?

Patricia Ribeiro: Yeah. It’s actually interesting. We have gone through a period of a few months there hasn’t really been any major geopolitical issues with the emerging space. Obviously we’re talking about North Korea being a big challenge. But so far it doesn’t seem, and certainly the markets are not even responding to that either. So it doesn’t seem to be that relevant, I would say, in terms of risk at this point. There are always geopolitical challenges in the emerging space and it moves from, you know, country to country. So what we do is that we really target each one of them individually and see really what the risk is at the time. But more currently we can’t really think of anything that is actually being in the front of mind for us. So we are pretty okay.

Gillian: So would it be fair to say that perhaps it’s the developed markets that are experiencing more volatility than EM at the moment?

Patricia Ribeiro: At the moment I think that is probably correct, yes.

Gillian: And Deb, when you look at the asset flows through emerging market ETFs do you find that there are any particular geopolitical risk factors that have influenced the flows, either in or out?

Deborah Fuhr: Well, I mean clearly the situation with North Korea has influenced flows into South Korea. So again, depending on whether you say that’s emerging or developed, because the index providers have different views. So we have seen flows based on what’s happening in the news impact investors taking some money out, putting a little bit of money back in. I think earlier in the year we also saw the fear about trade negotiations happening or not happening. So clearly even Brexit is kind of impacting how the UK is going to negotiate treaties again with other countries on their own. Will Brexit happen how President Trump is talking about different countries impacts, how people see the opportunity going forward.

Gillian: I want to stay on the North Korea measure just for one more moment. And, Patricia, I’m going to bring you back in. When you look at the potential knock-on effects, even if there is no war between the US and North Korea and of course hopefully not, do you see the possibility of sanctions being put into place against Asian countries that aren’t playing ball? I mean obviously we’re all specifically thinking about China.

Patricia Ribeiro: Yeah. I mean it could, it could happen. But I think that it’s a big challenge for the US because the impact for the actually the US consumer would be very significant. So I think the US is in a bit of a difficult situation in terms of really coming with any kind of trade wars or even sanctions against the Chinese. I think that’s much harder than probably other countries. So at this point I don’t really anticipate that that will happen.

Gillian: And, Deb, you referenced South Korea, but are you seeing any move in the asset flows to China or has it just all been a lot of excitement because the market has recently opened?

Deborah Fuhr: Well, I think because of the announcement from MSCI, including the A-Shares into indices, you’ve seen some people start, or some investors start to put money into China. You’ve also seen them change some of the benchmarks they’re using. And I think we’re also seeing some innovation when you talk about indices. Because if you believe China has to move to a consumer driven economy, many of the existing benchmarks are very heavily weighted to banks or financials. And clearly that’s not where people want to put their money to work. So you’re seeing innovation happen in terms of new products coming to market. I think the other thing that some people are concerned about is, you know, the earthquake in Mexico and how will that impact the country going forward? And does it have any long term impact on how attractive that market is? So I think a lot of people will take a step back and think about do they want to continue to put money there.

Gillian: Now, on the flipside, one of the areas that I think we have already touched on, but has really been a tailwind for emerging markets has been the performance of the US dollar. I mean it has shown a fair degree of weakness. But many expect it to strengthen. Patricia, I’m curious, if the US dollar does strengthen to the levels that are expected, how will it impact this rally in EM?

Patricia Ribeiro: ] I think the challenge or what I would like to see as an emerging markets investor is to see a very gradual move in terms of interest rates in the US and then I think the dollar will respond accordingly. But it will be gradual and measured. I think the challenge is if it’s not, if it’s something that we need to accelerate rate increases in the US, or there is not a really measured or anticipated way of how the progression of interest rates will be. I think that will be a challenge for emerging markets if that happens. But at this point, from what has been said so far, it doesn’t seem that that’s the case. And even more recently we’re seeing some movement in the currencies in emerging markets these past few days. But again it’s nothing that we cannot manage through. And on the other hand, if we see in general that emerging currencies depreciate some; it creates other opportunities for investments in emerging markets as well. So probably we will see more exporters, right, sort of doing better, showing better earnings. So it’s not necessarily all bad.

Gillian: And we’ve seen both EM currencies kind of appreciate while the US dollar is depreciating. So it magnified the difference but perhaps if the dollar strengthens, we already see strengthen in EM currencies.

Patricia Ribeiro: That’s right. So I don’t think it will be, you know, significant. I think the challenge is to be measured, you know, and so, and anticipated.

Gillian: And, Rob, I want to bring this question to you as the fellow active manager. How do you look at movements in the US dollar and their impact on some of the emerging market names in your portfolio?

Gillian: I’m actually going to move down in the discussion. I know I put this a little later, but I think it’s worth talking about now. And, Deb, you actually already referred to it. When you look at how the various ETF providers hedge currencies, what are some of the best practices that you see or the most common?

Deborah Fuhr: Well, you see often people are offering currency hedged in different currencies. So here in the US it used to be nothing was currency hedged, right, and everything just traded in dollars, regardless of the underlying. And so there has been a lot of new products that have come to market that are hedged back into dollars. So when you look at ETFs that are listed in other countries you often find they’ll be available hedged into sterling, into Swiss franc, into other currencies that people might want as their base currency. Some people believe that it’s better not to use currency hedging, that it all kind of washes at the end. And others have found that the incremental cost to do so is so low that they actually have been using a lot of currency hedged ETFs over the past two years.

Gillian: Patricia, do you currency hedge in your portfolio?

Patricia Ribeiro:No, we do not. And historically actually currency has had very little impact on the portfolio. The portfolio has always been a lot more exposed to domestically driven, you know, growth as opposed to exporters and others. And so we always found that the hedging can be a challenge. It can be more expensive. And just really understanding what the exposures are in the portfolio, and then with that sort of shorter term, you know, keeping track of where the currencies are and what could be the triggers for either appreciation or depreciation has worked for us.

Gillian: If hypothetically you had currency hedged this year with the emerging market currency rally, would you have given away a couple of basis points of return? Or do you think that that would have generally been awash?
Patricia Ribeiro: [0:18:04] No, I think if I had hedged, yes, I would have given away some of it. I think some of the currencies and how much they … how well they have done this year, I don’t think the market had anticipated at the beginning of the year.

Gillian: And, Rob, what’s your approach?

Gillian: So we’ve had a good opportunity to talk a little bit about the macro picture in emerging markets. But now I want to dive deeper into some of the regions of opportunity. If there’s one market where I see the greatest divergence and opinion, it’s the future of China. So, Deb, starting with you, talk us through opening up of the China A-Shares and how you see investors approaching China via ETFs?

Deborah Fuhr: Yeah. So when we think about ETFs in China it’s been a story for me where I think China has used ETFs to open up the ability for foreigners to invest in. So very early on, we had an ETF available in Hong Kong; it was on the FTSE Xinhua A50. And many investors who didn’t have [inaudible] couldn’t get in there directly, were using the ETF to do so. And what we have seen is many of the institutions in China who were allowed to invest outside of China, the QDs, were actually using ETFs to implement exposure to other markets outside of China. So it was going both ways. And as China’s been opening up, what you’ve seen is the indices have changed. So it used to be you would either have products based on stocks listed on Shanghai or Shenzhen. The CSI 300 Index was not allowed initially in China, was offered first in Hong Kong. And what you’ve also seen, which is quite interesting is many of the Hong Kong subsidiaries of Chinese asset managers have ETFs in Hong Kong. They want to bring their asset management capability to Europe and to the US and they have partnered with issuers here in the US to bring out products. So you’ve seen how Harvest has partnered with Deutsche Bank. China Asset Management has partnered with VanEck. There’s others that are out there. We have even seen a Chinese asset manager buy into one of the ETF issuers, Krane Shares recently.

So I do think that ETFs in China have been a very good relationship for a long time. And for many, they ran out [inaudible], they wanted more exposure. So I think the challenge now, as I said, is to look at developing new and different indices. And one of the challenges is when you look at emerging markets is it’s very difficult to do kind of broad sectors across EM, right. It’s country first and then sector. So you really have to be careful when you think about how to enhance new indices. We are seeing people looking at ESG for China. We’re seeing smart beta, a term I don’t particularly like, but kind of there are factors that in developed markets have shown that over long time periods they do better than market cap. People are now starting to do smart beta for China. So I think we’re seeing a lot of the index evolution that’s happening globally, happening specifically for China too. So I’m actually quite excited. I think we’re going to see a lot of people use ETFs to invest into China because it’s actually difficult, I think, to invest directly, right. The government for the state owned companies can move management teams very easily. It’s often hard to get English written research. So I think for many, buying an ETF just makes the process easier. You decide, do you want a sector or do you want the country. And it’s pretty easy to implement. And you don’t have to worry about [inaudible] or anything else happening.

Gillian: And the sector players are interesting because very often if you want to play a sector like consumer discretionary in a developed index, it’s usually very different than playing it in EM, is that correct?

Deborah Fuhr: It definitely is. I mean when you think about developed, sectors actually are very important. It’s not the country in developed typically. When you think about EM, it’s the country first and then sector. So that goes back for a very long time. So I think thinking smart about how to come up with new indices is going to be a little bit of a challenge because the available stocks that are out there in terms of liquidity and how to construct something is actually a very important component of constructing new ETFs.

Gillian: Patricia, what’s your view on China right now? And what are you excited about specifically?

Patricia Ribeiro: We like China. We are very bottom up, so we don’t make a top down call on China. But we are finding a significant number of good investment opportunities, good companies showing good growth in China, partly driven by obviously some of the policies we have been seeing out of China. They have actually started to show some results. You know, disciplined, the government have shown in terms of the supply side. So we’re seeing the consumer coming back as well in China, which is also very positive. And we continue to also find ideas where the government is investing, continues to, you know, deploy money in certain parts of the economy, for example, the government has been very focused in sort of the whole, you know, air pollution, sort of clean air, clean water. So we find ideas to invest, for example, in gas distribution in China, you know, clean water, so water treatment companies, where the government is clearly deploying a lot of the investments as well. So there is different pockets of growth in the economy with good visibility actually going forward, which has been very positive as well. So China has been a good market and continues to show actually a very positive trend.

Gillian: You mentioned the water companies, any other particular sectors in China that you like?

Patricia Ribeiro: So we know water treatment has been one, gas distribution, railroad, we still like the whole rail space, there’s clearly still opportunities to invest in that. And those are the ones where again we’re seeing more of the fixed investment from the government. And then the consumer, we see a lot of opportunities there in the consumer space. We’re seeing the consumer coming back more on sort of that luxury sort of items. We’re seeing that on the auto sector, which has been very positive as well. We’re also seeing some exporters out of China; they’re also kind of showing good opportunities. Travel has been a good opportunity; the Chinese continue to travel, not only within China, but travelling abroad. So companies that obviously like a Ctrip for example. But china Lodging, which is a hotel, you know, a chain of hotel as well. Education continues to be very positive, you know, as we see the emerging consumer having more purchasing power they start to, you know, to spend more in places like education for their children. So that continues to be a good space, not only in China but in other countries as well.

Gillian: In Chinese tech?

Patricia Ribeiro: Yes, the Chinese tech has also been a good space to be to have exposure to. So there is a lot that’s going on in China. And we are seeing some of the results of the government, sort of some of the discipline that the government has put in place over the past few years coming through.

Gillian: And, Rob, I know that education and tech are two areas that you like in China. So tell us a little bit more about some of the holdings you have there.

Gillian: The next economy that I want to move to is India. And, Deb, I’m going to start with you again, talk to me a little bit about what the ETF space looks like there and have you seen any new regulations come to market recently in India?

Deborah Fuhr: Yeah. So India’s an interesting space where we have actually seen that the government has used ETFs to get rid of some of the stocks that they’ve held. So they’ve created some new ETFs. And they’re in the process of creating some other ones. So I think that is interesting. One of the challenges you’ve seen in India is for the early part of the ETF industry’s development, was never really clear who actually as an institution could by ETFs. And so there was a real hesitancy to invest in ETFs by insurance companies, by pension funds. And they also have a different way of the way financial advisors work. So they have some financial advisors who only sell mutual funds. And they have others who sell things like stocks and ETFs because they trade on exchange. And so one of the big challenges was … and they’re paid to sell things. So they often don’t get paid to sell ETFs and don’t use them. But what you have seen is that is all changing. So they actually had one of the early movements towards banning payment for sales of financial products, or at least transparency. Some of what we’ve seen in the UK and other markets, so we are seeing that the industry is growing quite significantly. There is clarity now. One of the big challenges though for India is foreigners are not easily allowed to buy products locally in India, or China, for that matter. And so what’s really important is to have products here in the US and Europe that also provide exposure to India, so that it’s easy for people in the US or Europe to be able to access India.

Gillian: Did you see any big changes with demonetization?

Deborah Fuhr: I think there has been some hesitancy to move forward. So people were trying to understand what does that mean. So whenever there’s changes afoot and people aren’t sure of the end implications, you always find people, I think, take a bit of a pause. And so we haven’t seen a big pullback, but we have seen people, I think, put pause on until they understood what the implications were.

Gillian: Rob, what about you, have you put on the brakes when it comes to India or is it an economy that you’re actively allocating to?

Gillian And, Patricia, lastly coming to you, when you look at India, is it an area ripe with opportunity or have you maybe taken some pause after the demonetization play?

Patricia Ribeiro: Yeah. I mean obviously there’s always opportunities in these countries. But India has been a bit more of a challenge for us. This year we had obviously demonetization as you mentioned, and then the implementation of the GST, right, the new tax regulations. And that has created a bit more difficulty in understanding and actually some of the expectations that we will see a deceleration actually in GDP growth in India. And with that sort of the corporates are having a bit of a hard time to really be able to anticipate what the impact of the GST is going to be on their own businesses for the next six months to nine months. So it’s been a bit more difficult in that respect. And probably you would say a bit more lack of visibility into sort of the earnings stream going forward within the next year. The longer term, India is actually an interesting country obviously, right.

Gillian: And, Patricia, I’m going to stay with you to talk about the next market which is Latin America. Now, we’ve had a lot of headlines of course coming out of Brazil due to the incredible performance of the [inaudible]. Is it an area that you’re looking at, or do you think there’s still some time before you play that market?

Patricia Ribeiro: Yeah. We do have some exposure obviously to Latin America and Brazil for that matter. But what I see today is there is a lot of noise in that space, on the political side. And also we’re starting to see some more positive trends on the macro side, right. Sort of it looks like GDP is actually going to move into sort of positive by the end of the year, at least that’s the expectations. But they have had some setbacks throughout the year in terms of the political side in Brazil and also some reforms that were needed and did not get passed. So it’s been a market that’s been very difficult to really understand. I would say I’m a bit surprised with how well the market has done. I think the investors are seeing that inflection and sort of more positive trends on the macro side. And assuming that, you know, Brazil will get out of the, you know, the situation where it is today. And that’s for sure; I think that is the case. But what is not there for me is the visibility or how soon that’s going to be coming through. So when you talk to corporates, it’s the same idea. You don’t see really corporates coming back to really invest in their own businesses. They are still very careful about the consumer coming back. So we have some exposure but we’ve still been careful about the expectations with Brazil at this point.

Gillian: And of course, Brazil is always the headliner of Latin America. But are there any other countries that you’re keeping a close eye on that maybe are good for right now?

Patricia Ribeiro: Yeah. Good, I’m not so sure that there is anything that we are really excited about. I think Mexico, in a completely different sort of cycle, right, in terms of the economic cycle, had to make some adjustments earlier on in the year, you know, with inflation going up, rates going up. Now it looks like that has stabilized. But more recently with, you know, the earthquake, that’s probably going to actually set back the economy for a short period of time. But we’re probably going to see that set back. So we’re a bit more careful with Mexico as well.

Gillian: Deb, what are you seeing in Latin America on the ETF side?

Deborah Fuhr: Well, it is interesting, so I think Brazil has always been complicated from a tax perspective in terms of creating products there and the locals being able to invest outside. There have been changes and now you actually see that there is an ETF in Brazil providing exposure to the S&P 500. So it’s a feeder fund into a product listed here. You also are seeing talk of creating fixed income ETFs because of some tax changes that will actually make ETFs more tax efficient for shorter term investors. The other big thing we’ve seen across Latin America is that many of the pension regulators have encouraged the local pension funds to use ETFs for foreign exposure. So if you look at a market like Chile, there’s 194 ETFs that are registered for sale and listed in Chile, that are all providing exposure outside of Chile and Latin America, which are used a lot by the pension funds and by their types of investors. Mexico also, [inaudible] were encouraged to use ETFs for a long time. That has actually loosened so they can also use mutual funds. So Columbia has some ETFs, Peru is looking at ETFs. So it is quite interesting to look at the way ETFs again are being used to allow the locals to invest outside. And many used the ETFs to get into those markets also. But all of the things you’ve heard from Patricia in terms of concerns or opportunities resonate through what you see happening with the ETF flows.

Gillian: And I’m actually going to ask the two active managers on our panel a question about due diligence. I’m going to start with you here, when you’re doing your due diligence on the various EM ETF products out on the market, what are some of the things you really need to keep an eye on?

Deborah Fuhr: Well, I think if we’re talking to an audience here in the US, you really would want to look at the products that are here domiciled as US 40 Act Funds. And make sure that you understand the benchmark, you understand what’s inside of it, you understand the fees, You understand if you’re an institutional investor you normally wouldn’t want to be more than say 10 or 20% of the assets, so size matters. Trading volume matters. And for many, you can use ETFs as a hedge because you can locate a borrower and go short. So ETFs can be quite flexibly used in many different ways. But it’s important to understand the total cost of ownership. And do you want that currency hedge or not?

Gillian: Yeah, big question. So, Rob, you already answered that you don’t currency hedge in your products. But I’d like to know a little bit more about your due diligence process. As an active manager, do you think a boots on the ground approach is necessary when investing in EM?

Gillian: So, Patricia, what about you, do you look at it as a boots on the ground approach? Obviously Rob feels that that’s not necessarily additive to his process, but what do you think?

Patricia Ribeiro: Yeah. I agree with that, with Rob, that’s exactly how we feel. If you’re, you know, if you’re on the ground there tends to be a lot more noise. And if you’re a bit, you know, distant, you shy away from that noise. But you still have the benefit of really having the information. We travel to the region quite often. You know, we are constantly visiting companies on the ground. So we are getting the benefit of getting the information. So we meet with companies, we meet with, you know, government officials, regulators, competitors in the same industry to really understand each company and also the environment where that company is operating in. So I think we get the best in terms of really doing that due diligence, but staying away from the noise that those countries tends to have.

Gillian: I want to move over to a viewer question that we received from Winnie Sun. She talks a little bit about how she speaks to her clients about adding EM names to the portfolio. So let’s have a listen to what she has to say.

Winnie Sun: Hi! My name is Winnie Sun, Managing Director of Sun Group Wealth Partners. And my question is we know that emerging markets is a great important asset for a long term client’s portfolio. What we also know with the stress coming out from some of our Latin American countries, we know some of the political unrest coming out of Asia and, you know, the Brexit news in Europe. So how is it, what’s the best strategy to get our clients comfortable?

Gillian: Rob, do you find that you’re still facing some of these headwinds with clients? Do you find that you have to really make the case for EM? And if you do, what are some of the points that you always make to anyone that’s considering allocating there?

Robert Marshall Lee: Well, I would suggest that you can have your cake and eat it in emerging markets if you’ve got the right active manager. It’s worth bearing in mind, if you’re buying an ETF, 24% of your portfolio will be state owned entities. So those are companies which are run from Mr. Putin or the Chinese Communist Party, not as profit maximizing entities. So they tend to make lower returns and they tend to have a higher risk profile as far as I’m concerned. If you get into a highly risky situation you are likely to be a very low consideration for them. So this is one of the reasons why Chinese GDP growth hasn’t turned directly into Chinese market performance. There are a lot of companies out there who will dilute that return potential because they keep investing for the benefit of Mother, yeah, Mother Russian tax revenues, not for you as a shareholder. So if you have the right active manager they will understand the context of this and they’ll try and find the right companies who actually profitably reinvest into that growth potential to turn it into capital appreciation. And then buy that stock at a price that actually allows you the potential to make substantial returns over time. So I think the key there is you can actually lower your risk profile and increase your return profile at the same time.

Equally you can make active allocation decisions. So we don’t have to invest in every sector, every geography, we just want a well diversified portfolio, but not starting with the index as a starting point. You know, we are running a benchmark agnostic strategy. So we have nothing in Brazil right now. It’s very hot for a lot of people, but actually we don’t find the best risk reward there, so we put the money elsewhere. We have no oil companies. We see little reason to own the least worst oil company if we think we’re going to make better risk adjusted rewards elsewhere, rather than speculating on the short term durations of the oil price when we’re actually quite cautious about the long term prospects of the oil price. So I think, you know, what a decent active manager can do is understand that kind of context, but most importantly, understand the companies and their corporate governance, that’s the first question you should ask of every corporate investment. And then you’re looking for the companies which are good stewards of capital to navigate through those ups and downs, to manage their business to the optimum through those situations. And you can get a dramatically different risk reward every time.

Gillian: Patricia, I’m going to direct the question to you. How do you explain the value add of EM to a portfolio when you have a lot of investors that are saying, “But, hey, wait a second, look at some of the geopolitical volatility happening right now?”

Patricia Ribeiro: Right, yeah, I think the investor needs to understand that, yes, it’s emerging markets, there’s always going to be challenges, geopolitical issues. But with the challenges there are also opportunities. And that’s what we try to obviously take advantage of. And the geopolitical issues and the challenges, they don’t last for very long. So they tend to be involved for maybe six months and then they move out, and creating tremendous amount of opportunities as they move away. So I think that’s how investors need to think of emerging markets. Yes, there are challenges, there’s always going to be challenges. Those are emerging, right, they’re developing. They are really not mature, they’re maturing. And the challenges are there, but there is a tremendous amount of opportunities as well.

Gillian: And, Deb, same question to you, but also as an add-on, I’m curious how you find investors go about gaining exposure to EM. Do you find that they’re going for the local products or those broad market vehicles?

Deborah Fuhr: Well, I think it depends a lot, but for investors who look at having a benchmark that includes developed and emerging, having none means you’re underweight. And so that is also a risk, right, if you don’t have any allocation. So for many it is easiest to go for the broad. But I think as people start to become knowledgeable, spend time, look at the news, look at what’s happening, if they feel strongly about China or they feel strongly about India or some other country, you do find that they then start to move to individual countries. So I think it’s a bit of a combination. But the broad EM is always easiest thing for many investors to go into, because at least you’re not underweight.

Gillian: Rob mentioned earlier that a lot of the reason that allocators to China are kind of shying away from ETFs has been because of the large exposure to state owned enterprises. I think he said something like 24% of the benchmark. I’m curious, when you find someone that wants to access China, wants the advantages of an ETF, how do you encourage them to bring it all together.

Deborah Fuhr: Well, I think that’s a really great question because when you think about China there’s a lot of different types of shares. So you have A-Shares and B-Shares and H-Shares. And you have securities that are listed here in the US. And so the most popular ETFs that are listed here in the US are actually not mainland Chinese securities, right. So they’re not state owned enterprises. So I think there’s an added level of due diligence that’s needed to make sure you understand the different types of shares. So buying China can mean very different things. So it’s not just a question of is it mostly financials, it’s what type of financials. So that’s a great question. And I think you really need to do your homework.
And that’s part of the reason I think often people migrate to the broader benchmarks, is it’s just easier, because often you don’t know what you don’t know. And you do have to do your homework.

Gillian: But it’s worth doing your homework?

Deborah Fuhr: Definitely, yes. I would say, you know, China’s a very interesting country. And I think there’s a lot of opportunities there.

Gillian: So I want to give you each an opportunity to give us some final thoughts. We’re coming to the end of our discussion. For anyone that’s watching this program or has watched emerging market performance this year and is interested in the market, what would you advise them to do? And how would you advise them to get the most out of their EM exposure? Patricia, I’ll start with you.

Patricia Ribeiro: Yeah. I think, you know, I believe emerging markets will continue to do well. I see the trend at this point. Yes, the market, you know, the stock market has actually had a fantastic year this year so far. But that trend should continue. We are coming from a very low base. So we’re certainly not where we were a few years back. I think if you compare valuation on the emerging markets versus developed markets, it’s still very attractive as well. So that’s another very positive. And, you know, again, it’s a tremendous amount of opportunities. There is challenges, yes, but significant amount of opportunities, companies that are showing very good growth, good, well managed companies as well, taking advantage of this massive area of consumption, right, that is evolving. So we are very positive.

Gillian: So good demographic shifts and even though these economies have appreciated, they’re not richly valued by any means?

Patricia Ribeiro: Exactly.

Gillian: Deb, final thoughts.

Deborah Fuhr: Yeah. I think you’re definitely seeing a rising middle class, right. So that’s really changing the dynamics. And so I think many of these emerging countries are going to become very powerful going forward. And so to get in earlier I think is an opportunity for many. And ETFs just make it an easy way for many who can’t find a good active fund. So many will buy active funds but also augment that with some ETFs around the edges when they want to overweight or underweight. So I think there’s room for both active and passive. And you can also generate alpha through your asset allocation using ETFs.

Gillian: A very diplomatic take too, I feel, the battle that we have seen on the headlines, they are not mutually exclusive. Rob, final thoughts, what are some of your ideas for those who are looking to gain exposure to emerging markets, what’s their best way to perform their due diligence and get the best investment?

Gillian: Thank you all so much for joining us here today, we really appreciate your point of view on emerging markets. And we look forward to having you back to assess their continued performance, or perhaps, outperformance as has been alluded to. And thank you, Rob, in London.

Robert Marshall Lee: It’s a pleasure, thank you.

Gillian: And thank you also to all of our viewers who are tuning in. From our studios in New York, I’m Gillian Kemmerer. And this was the Emerging Markets Masterclass.

Gillian: So let’s kick off just with a broad look at emerging markets. They have outperformed this year on most measures, whether we look at equities, currencies, what’s driven the stellar performance and do you think it’s poised to continue?

Robert Marshall Lee: I think it’s quite important that you understand the context. So a lot of people look at year to date measures. If you look back in November of last year we had the election of Mr. Trump, at the same time was we had the demonetization event in India, which hit that stock market specifically. So those were, you know, short term factors led to market rotation and sell-offs in emerging markets. And so I think what part of the rally we have seen year to date is just a rebound effect from that. Kind of combated on top of that, if you’re looking in US dollar terms, the US dollar had obviously been very strong in the last few years up until the end of last year, at which point everyone was a dollar bull of course. And then roll forward this year, the dollar’s given back some of those excessive gains. And so if you look in dollar terms, everything looks rather stronger this year than it does in certain other currencies, like the euro. So I think you have to understand a couple of those factors, which then makes the emerging markets rally look a little less strong than that superficiality. At the same time I think it’s important to look over the last few years when emerging markets have been very weak, particularly with a lot of currency headwinds, particularly against the US dollar. And so in that kind of context, they have been beaten up for a long time and both at the currencies and the asset level. So there’s a lot of scope for rebound before you get into any superior earnings growth.

Gillian: I have a couple of questions, the first one for me is if we’ve already, let’s say, rebounded off of very low lows, do you see fundamentals strong enough to support a continued strength in emerging markets? Or do you think that now that the rebound is over we night see it begin to abate?

Robert Marshall Lee: I think there’s a couple of aspects of that. So firstly, I think previously there’s probably excessive pessimism. So global trade had been weak, but that’s because people looking in US dollar terms, and that was, as I said before, it’s very strong. And also the oil price had been soft. And the oil price filters through all sorts of traded products. Energy’s a very significant component for all sorts of goods. So that leads to destocking behavior, so it accentuates that negative trade effect. And a lot of emerging markets are exporters, either of traded goods or of commodities. And so they get a kind of whiplash effect on the back of that. So I think there’s excessive pessimism on the back of those trade numbers and sure enough there’s the oil prices stock dropping and bounced a little bit. And the dollar’s stopped strengthening, you get probably a slightly excessive rebound on the other side of things. The other, the point I would make is there’s big divergence between emerging markets. So you have commodity economies and then you’ve got more manufacturing economies. And broadly the manufacturing economies have been quite stable, whereas the commodity ones, so the Russia’s, South Africa’s, and some of the Latin American economies have been much harder hit by the drop in the oil price and the mining prices, as China has been growing its demand for metals a bit slower. That is quite different to what we’ve seen in somewhere like India, for example, where it’s been far more robust and domestically driven. They’re actually commodity importers. So sometimes they get lumped into a single basket, but actually the asset class is very divergent with the underlying level.

Gillian: Now, when you think about the US dollar as you referenced earlier, many are expecting it to potentially strengthen through the end of this year, if not early next year. How do you see that impacting the story that you just told me about the divergence between the commodity producers and manufacturers?

Robert Marshall Lee: Well, I think we understand there is scope for the US dollar to have a little bit of a rally. At the same time I think the starting point is a lot of emerging market currencies have been very beaten up over the last five years. So if you look at the current accounts across a lot of emerging markets, you’ve seen inflections. So you had the Taper Tantrums back in 2013, you had these big sell-offs, you’ve had some internal adjustments in quite a lot of economies. And then you’ve seen this inflection in current accounts. And that was suggesting that a lot of these currencies are too cheap, so including against the US dollar. So it’s not that we see a massive rebound but we just see that historic deprecation we’ve seen over the last five years, at least flattening off. So that’s not a particular concern. Equally, the likes of US equities and bonds are generally very highly valued, whereas emerging markets have been out of favor. You’ve got a lot of very cheap assets around. Now, some of those will be attractive, some won’t be attractive. We don’t see that going away. And then if you think about the underlying long term growth drivers behind the companies available on emerging markets, there’s a very clear advantage in terms of demographics and in terms of a lower starting debt level. Whereas a lot of the western world, the UK, the US, Japan etc, you’ve got very high debt levels. That’s an impediment to future growth that we don’t see in a lot of emerging markets. So while you’ve seen this adjustment in the … over the last few years, I think we’re kind of through the worst of that adjustment and actually quite a lot of the emerging markets are much better poised for growth going forward.

Gillian: And when you look at statistics, let’s say like EM equities falling close to their 2011 peak or currencies nearing a three year high, it’s not an implication that they’re richly valued, it’s that they’re coming off of a very low low?

Robert Marshall Lee: Yeah, I mean I think if you look at through the cycle measures. The market’s always looking at one year forward PE ratios. We find that a very unhelpful measure. If you look at [inaudible] 10 year earnings measures such as the Shiller PE, that would highlight a huge divergence between US equities for example and most others in the world, and particularly emerging right at the bottom, so running at quite low levels. So bear in mind, you’ve seen a very, very strong rally in US equities over the last four or five years that we haven’t seen in emerging markets. So there’s a big gap which has opened up. Now, behind that of course is the cost of capital effect, so bond yields have dropped a long way in the western world. And you haven’t seen that quite to the same extent. But that does underpin, that’s the kind of the risk free rate for the whole world. And so if some of those risk premium come in a little bit, there’s a scope for asset price appreciation. As I mentioned previously, the scope for growth varies dramatically between emerging markets. So what we see in Columbia is completely different to what we see in some of the Asian economies. In fact even within somewhere like China you see dramatically different growth prospects between, for example, a heavy industry company and a more agile consumer service company into a very underpenetrated sector such as education.

Gillian: Now, you’ve alluded to this a few times. But I want to dive a little further into it. When we thought about emerging markets for a long time we thought of them as the BRICs. Do you find this classification completely irrelevant now when speaking about emerging markets? Is the divergence just too large?
Robert Marshall Lee: I think it was always irrelevant to be honest. I mean I think it’s one of these kinds of marketing things for a sale side broker. It’s not something we use in any sense or form. I think if you think about the fundamentals behind somewhere like Russia, which is a pure petro economy. The currency moves very directly with the petroleum price and that completely impacts the underlying consumer behavior, their purchasing power. And that’s diametrically opposed to somewhere like India, where it’s actually a commodity importer. And it’s driven by completely different demographics, completely different debt situation. So the underlying growth drivers behind some of these things are quite dramatically different. Now, 10 years ago you had a rising tide floating quite a lot of boats in emerging markets at the same time. We certainly don’t see that over the next five years or so. And so that’s a significant advantage to an active manager.

Gillian: When you think about the situation in North Korea, obviously you’ve already alluded to the fact that it may be a war of words and not much more. Are you worried about the knock-on effects? So for example, what if countries in Asia start receiving fines from the US due to their lack of, or their inactivity I should say?

Robert Marshall Lee: I think if you’re in the US shoes, you really don’t want to stimulate a trade war with China right now. I think it makes no sense. It makes no sense for the US consumer. It makes no sense for global trade. It’ll drag the whole world into a recession. That doesn’t suit the US. And the whole talk of re-shoring to the US, it’s, you know, it’s a nice thing to wish for. But the reality, I mean I was in Shenzhen three months ago, the whole global manufacturing base is now hubbed in Shenzhen. And it’s cheaper to ship things from Shenzhen into LA than from San Francisco to LA. And so much cheaper to produce stuff there, it’s just not going to move back in a hurry. There are long term effects from 3D printing and things, which, you know, in 10 or 20 years then there are parts which might move back. But it’s going to take a long time and it’s not going to create those jobs that the US would like. So we think there’s a lot of talk around some of these things which actually is quite misinformed. In terms of using fines as a bargaining chip with China, trying to exert pressure on North Korea, I think again, I mean I think there’s a lot of talk and then the reality is probably going to be different from the rhetoric. I think China has quite a few cards to play close to its chest as well. And again, it’s got North Korea on its doorstep, it doesn’t want to stimulate a geopolitical disaster on its doorstep either, or a humanitarian disaster. So I think China’s not exactly happy with the status quo, but at the same time, it’s not going to bow to the US pressure and it’s not going to be too worried about big fines from the US. I think there’s a lot of things that China could do back to the US if it wanted as well.

Gillian: Let’s just stay on the topic of China. I want to move into some of the regions and sectors of opportunities that you’re looking at. When you appreciate the full picture in China, when you look at, whether it’s currency movements, and you look at the performance of the A-Shares, and their introduction into international markets. Give me a sense of the opportunities that you see there and if there are any particular sectors within China that you think are really poised to outperform.

Robert Marshall Lee: Well, if you look at the shape of the Chinese economy, it’s quite clear over the last five or ten years, just how much the Chinese economy has been rebalancing. Some of these kind of stories go in and out of favor, the development of the middle classes. But it’s quite clearly happening in China. So reckon the, you know, if you read McKinsey reports and so on, the middle class in China has gone from something like 100 million back in 2010, to 300 or 400 million, possibly even more by now, and continues to grow. And that’s the kind of people who suddenly have $10,000 or $20,000 disposable income plus, to spend, so they have moved to a westernized lifestyle. And given that’s coming from a very low base, you have some very underpenetrated industries. So I’m talking education, private healthcare, use of internet, so the mobile internet in China has leapfrogged ahead of the bricks and mortar retail for example. So ecommerce has become very, very powerful there. And it’s happened in a way which is quite different from what we’ve seen in the western world where we had fixed broadband before that. So that’s been a huge advantage for the internet ecosystems in China. So I’m thinking of the Alibabas and Tencents of the world.

Actually some of the best opportunities have been from those industries such as education and private healthcare, where they’re growing from such a low base that you can have the scope to grow even with a slowing Chinese economy at perhaps 20, 30, 50% per annum for years and years and years, so 5, 10, 15, 20 years in a row. And that’s where you see the potential for finding some really, really interesting stock investments. And the market tends to be quite short term in its analysis. So right now for example, there’s some of the healthcare stocks have been beaten up, that’s an opportunity to buy things which can grow for the next 20 years. Equally, we fully expect the Chinese GDP number to keep decelerating now, that’s a big focus for the media. As a stock investor actually it’s quite peripheral. It doesn’t really affect the stocks. If you see a Chinese economic collapse, that’s a different matter. But we fully expect the Chinese GDP growth to slow down to 4 or 5% over the next few years, because there’s too much debt in the SOE part of the economy and fixed asset investments are likely to slow. So that will make you more wary about commodities demand going forward and particularly when you’ve seen a lot of supply addition. And that’s not so good if you’re a commodity exporter or a mining company. But it’s absolutely fine if you’re a consumer service company in an industry which is growing from a low base.
So in that kind of context we, you know, as I said, we invest in mobile internet, exposed companies. So the Chinese equivalent of Facebook or Amazon would be companies like Tencent, which has 60% of Chinese online use, which is kind of a staggering figure. And Alibaba, these are the companies we’ve held in the portfolio for quite a long time and have been fabulous performers. But the reality is there’s still quite a long way to go.

Gillian: There’s still room for growth. And even if they’re wholly dependent on let’s say domestic consumption and domestic consumers, you expect that the middle class division is only going to continue to improve?

Robert Marshall Lee: Sorry, could you repeat the question. I didn’t hear very clearly.

Gillian: Sure, sure. So you were speaking about tech companies and healthcare that primarily focus on, if not, solely focus on domestic consumers. So there is a bullishness there in terms of domestic consumers continuing to grow and consume and continuing to see strength versus, you know, China necessarily exporting these tech and healthcare names.

Robert Marshall Lee: Yes, I think that’s fair. I mean I think [inaudible] companies are equally well positioned and there are some parts of the Chinese consumer market which are very, very competitive. So we’ve had things like nappy producers and so on in China that we sold out of because it’s just become too competitive and they’re not able to turn that growth potential into capital appreciation. They can’t make the cash flows. They can’t make the profit margins. So you have to differentiate from where you just see a growth opportunity from where you can actually make the profit growth that actually drives the share prices that we invest in. And so the job of an active manager is to zero in on those best opportunities and then try and find them at a valuation that allows you significant scope to outperform on the index to generate really good risk adjusted returns for your investors.

Gillian: Let’s shift focus to India. You mentioned the monetization earlier in the conversation as [inaudible] decision for now. How have you seen the Indian economy perform? And what are some of the sectors you like there?

Robert Marshall Lee: So back in, I think it was 2011, early 2012, everyone was worried about the mints and extended current accounts and all this kind of stuff. And that gave us a good opportunity to invest in India when most people were running for the door. And the reason we had the faith of investing in India back at that time was because, firstly, there’s some great companies there. Secondly, the demographics are very attractive. So the underpinning for long term growth, the key underlying GDP driver is that demographic factor. And you’d been going through a negative credit cycle, which is quite unlike the rest of the world in terms of timing. So there was a scope to just recover from that situation. And then the preexisting government under Mr. Singh, was really caught up with bureaucracy, he had no political power. So you had a really … you had a gunning up of the political works. And that led to a collapse in industrial activity. Now, we’re still dealing with the after effects of that in terms of some of the public sector banks are struggling with and PL issues from the power sector. And that harks back to that situation five or ten years ago. But actually the consumer side of the economy has broadly got though the credit cycle and is well poised for future growth.

So if we look at things like car demand, we’re invested in a company called Maruti Suzuki and it just had volumes out the other day which were up 26% year on year, that’s in volume terms. If you compare that against somewhere like the US or Europe, we’re pretty much flat lining. It’s a very large number. Now, we don’t expect that number potentially to carry on, there’ll be some fading of it. But there’s still very significant growth potential in quite a few Indian companies, particularly on the consumer side for the years to come. Broadly, I’d remain focused on the consumer companies and we like things like consumer discretionary, so pizza companies, jewelry companies, car companies as I mentioned before. Just an array of different consumer exposures, cinemas and things like that, where there’s significant scope for them to increase their usage going forward, as the consumer recovers. And I think we’re not expecting a big CapEx recovery in a hurry. The private banks are extending credit and the housing sector’s developing. But those public sector banks are still a bit bunged up with some of the historic poor lending issues and they need some recapitalization. The government’s playing the long game, so they’re doing a lot of very good things. So GST is like their version of VAT. They’re using technology to improve fiscal spend efficacy, so social handouts to people.

And the demonetization, they’re trying to clamp down on the black market. I think those are very wise long term moves. But they cause short term disruption and a short term impact on growth, but we see that as kind of trying to lay some of the foundations for that future potential. And those kinds of opportunities, you know, particularly their rollout of technology, we have companies which have been facilitating that and then see private enterprise opportunities. And that’s quite typical of Indian companies who tend to be very entrepreneurial. We get some really good companies with substantial growth opportunities, high returns on capital. And we [inaudible] have been facilitating some of those Indian investments in technology, who are then layering on financial services into tens of thousands of villages around India, and have the scope to continue doing that very profitably in the future.

Gillian: How do you perform due diligence on your international investments? Is it a boots on the ground approach?

Robert Marshall Lee: Yeah. I mean I think it’s really important you understand what the attributes you’re looking for in the companies that you invest in. So we use themes to try and keep our focus beyond the short term noise and understand the companies on a five or ten year view, what are the key drivers behind them? How do they fit into that view of the world? Have they got structural growth drivers or challenges? Is the macro likely to be good or bad for them? And then we have to understand, have they got the potential of making high returns well above their cost of the capital on a through the cycle basis, i.e. can they turn that growth potential into substantial value generation? So that’s a very important factor. We send people travelling around the world. We have 15 or 20 global analysts. We have, I think, 7 people on my team, we all travel around to places like India and China and things very regularly. But that feet on the ground thing is probably a bit overhyped by those who happen to have offices in local jurisdiction. I mean you just generally get a lot more noise and there’s little evidence to suggest that local jurisdiction actually is a superior performance, quite the contrary.
I think we’re just looking for ways that we’re advantaged, at the same time, so I mentioned a company called [inaudible] a moment ago, when we first met them in early May, we had met the company face-to-face, it was very interesting. Then we go back over a whole load of annual reports, we have various conference calls with them to cover off important topics. We sent someone over to India to visit their operations, to go and look for ourselves. We found they’re very busy, there’s probably not enough of them. And they were providing very good services to the people that they were facilitating. And then after that we have another meeting back in London with the chairman to run through the corporate governance and so on. And so over a period of about two or three months in that case we were able to accelerate our understanding of the company and get to a comfort level where we’re happy to build a position. So as you can imagine, if you come across a Nike or something, if you’ve never come across it before, even if it’s a good company, you’ve got to understand it before you invest in it to understand the risk versus reward. The same is true of an Indian company. And there’s plenty of information around with which to make that judgment.

Gillian: And, lastly, Rob, I think one of the things that many people fear when they look at emerging markets, it has to do with currency volatility. So I’m curious whether or not you hedge your currency exposure? And I suppose this year if you did, you probably lost out on a bit of the upside.

Robert Marshall Lee: Yeah. No, we’ve never found it very helpful to hedge emerging market currencies, basically because the cost of doing so is quite high. Broadly, currencies tend to move with the inflation differential. So what you lose in the currency you tend to make up on the inflation, which goes through, if you invest in a good company they’ll have the ability to price that inflation through to their end customers. So you’d lose it on one side, you’d gain it back on the other, so net net you’re not a loser. There are times and places where you see big terms of trade adjustment, so a few years ago we understood that Brazil was running an unsustainable macro strategy at the government level. They’re pumping credit when they should have been restrained. And so we thought that the market would ultimately stamp some authority on the Brazilian government and Central Bank. And that’s kind of what happened. So we expected a big currency devaluation, we expected the cost of capital to rise. And so we took that into account when we were considering our stocks. And at that point we sold all our stockholdings because we couldn’t justify the position. And we thought the Real was going to drop by 30%, which is again broadly what happened. So we’re able to make active decisions within a portfolio allocation based on very strong views. But more often than not the currency is a secondary consideration.
The other point on that is if you think a currency’s going to drop you might want to invest in an exporter. So for example a company in Korea is selling to the US, they have dollarized earnings but they have Korean Won cost base, then if the Korean Won drops, their profit margins tend to go up. So when a currency drops you want to be more in exporters and less in domestics. And the contrary is true for the domestic companies.

Gillian: Perfect. Rob that was all of the questions I had for you. Is there anything that you wanted to get across that we didn’t cover, anything we missed?

Robert Marshall Lee: No, I think the key message from me is not all emerging markets are alike. There’s some really great companies in emerging markets, there’s some terrible companies too. A good active manager can add a lot of value and don’t believe all the hype you see in the media. There’s always a lot of noise around, and that’s not the reason to miss out on some great growth opportunities too.