MASTERCLASS: Investing in Emerging Markets

  • |
  • 51 mins 33 secs
Two experts cover ESG in Emerging Markets, multi-year trends to focus on, investing in different countries, and what makes EM markets attractive given the broader macro-economic risks. They also discuss how prior periods of stress in EM compare to this one, the possibility of further commodity shocks, and the currency risk that a strong dollar presents to EM.
  • Rand S. Wrighton, Jr., CFA, Senior Managing Director, Equity Portfolio Manager/Analyst - Barrow Hanley
  • Andrey Glukhov, Portfolio Manager for the TCW Emerging Markets Equities Group - TCW Group


Jenna Dagenhart: Hello and welcome to this Asset TV Emerging Markets Masterclass. We'll cover multi-year trends to focus on investing in different countries, what makes EM markets attractive given the broader macroeconomic risks, and much more. Joining us now, we have Andrey Glukhov, portfolio manager for the TCW Emerging Markets Equities Group, and Rand Wrighton, Senior Managing Director, Equity Portfolio Manager, at Barrow Hanley. Well, everyone thank you so much for joining us.

Rand Wrighton: Great to be with you.

Andrey Glukhov: Thank you for hosting us, cheers.

Jenna Dagenhart: Well, starting with China, Andrey, it's 30% of the index and well over 50% of the equity universe, and it strongly impacts every other EM and DM market due to strong economic linkages. We've seen the biggest negative deviation in policy path versus expectations, in that they completely fail to provide expected economic support. Where does China go from here?

Andrey Glukhov: That's a good question. I think that the challenges here that the country is facing are twofold. One, I guess, to start with the obvious is the COVID Zero Policy, right? It both weighs on the economy, and it impairs any stimulus transmission that the government is trying to make while pursuing this policy. They're certainly testing reopening with Hong Kong and Macau now. It remains to be seen how that goes, but the policy is very disruptive, even if it's moving into the right direction. More conceptually though, the government clearly decided that it needs to transition to a new growth model. So China is reaching the limits of pouring concrete and generating growth that way, and it has passed the lowest point. The government understands the dangers of the premature de-industrialization, and the loss of productivity that comes with it, and therefore it is, there are two things that it's trying to solve.

Andrey Glukhov: One, is a combination also of the demographic challenges, as well as the external challenges with the US tension. They are pursuing the common prosperity and efforts to reduce any external vulnerability. And the second shift, second challenge that they need to solve for is the current real estate challenge, which was a big driver of the economy up until now. They have decided that the sector is not supportive of the future direction they want to take the economy into, and they want to significantly decrease the importance of the sector in the economy, without losing the price anchor.

Andrey Glukhov: So what are some of the implications? Challenging, changing the model of growth is inherently very hard, and a lot of countries have had significant economic volatility trying to do that right. So China, as a result of this, is probably shifting to a structurally lower rate of growth, may not be sort of the two and a half, three and a half they're having now, but it's certainly, let's call it three to 5% going forward, and it's likely going to have to exhibit more growth volatility during this transition.

Andrey Glukhov: They are also centralizing the decision making, increasing the reliance on central government and the SOEs, which yeah, may optimize short term resource allocation but can certainly lead to greater longer term errors and hard to correct turns. So I tend to think that from here in China, the opportunities are shorter term, the typical sugar rush reopening trade that we've seen in all other markets, and eventually it will happen and one can try to time that. Or, more interestingly, you can go for more structural themes where you can take a longer view, which are the advanced manufacturing, the green tech areas, which have the government support and rely on innovation, and some of the more traditional areas of EM investing like formalization of retail, like premium consumption, like emergence of the domestic brands. So, that's kind of how I think about it.

Jenna Dagenhart: Can you talk about China specifically, Rand? Some investors are now saying that they believe China is not investible. Do you disagree with that, or where do you stand?

Rand Wrighton: Yeah, sure. And I think Andrey makes a lot of great points. We certainly think China's investible. I think when you look back over the last five, seven years when we had a very strong run in parts of the Chinese investible market, particularly the technology and the consumer discretionary areas, I think that you had a situation, which happens in a lot of bull markets, where risk gets underpriced. And I think that too many investors were too quick to draw equivalency between some of the tech champions in China, relative to the tech champions in, say the US, where you have some fundamental differences with regard to rule of law, resistance to interference from the government. China has been and always will be, at least for the investible future, in emerging markets where those things have to be taken into consideration and factored into your investment view.

Rand Wrighton: And I think, when you look over the last few years, you had sort of a toxic intersection between high valuations, and an unexpected turn in policy with a lot of investors. And so, when you step back and think about what that has meant, the government has decided to shift a little bit and to focus more on areas that they've traditionally been supportive of. If you think about infrastructure, you think about aerospace, healthcare, technology, semiconductors, and away from areas like video game technology, or excessive consumerism, or things that might inject more leverage into their system like FinTech. And so, while those rules and priorities have changed, that's nothing new to an emerging market. If you look at all the other countries across emerging markets, the rules of business frequently change and that doesn't make the market any less investible. It just highlights the importance of having your capital with a manager that's staying close to those changes, and factoring in those elements to their investment decisions.

Rand Wrighton: And so, as we sit here today, we actually still think that the future looks quite bright for China. You have to think about what's important to the government, where they're going to enable growth over the next three to five years. Where the value's in the economy and where do you think your investors can benefit the most? And from that perspective, you've had a lot of pressure applied across infrastructure, healthcare. You've obviously had a lot of sentiment shift, as some investors that were invested in the wrong area got hurt.

Rand Wrighton: And as people normalize the new policy environment alongside the pandemic overhangs that Andrey touched on, I think when you look out over the next 18 to 24 months, they're starting to loosen up a little. They're starting to float balloons around normalization of travel, reopening Hong Kong, Macau. And so, our view would be that the second derivative on things in China, both in terms of growth, in terms of opening up normalization post-pandemic are positive. And right now, you're not paying a lot when you look at the assets there to participate in those. But it'll remain important to account for the risks that center around the policy imperatives for the government. So we actually think it's as investible as ever. We think that it's also as important as ever, that you take into account the full mosaic of both individual industry and company fundamentals, as well as policy objectives for the government.

Jenna Dagenhart: I'm turning to Taiwan. Andrey, how concerned are you about escalating tensions with China?

Andrey Glukhov: I think it's fair to say that the tail risks have gone up. I think that, given where China is in its economic cycle right now, it is still unlikely to lead to any kind of tail events on a couple years view. But I think we do need to be mindful that sort of the policy path of both US and China can create some additional tail risks, let's say five to 10 years out.

Jenna Dagenhart: Rand, I would love to hear your perspective on Taiwan as well.

Rand Wrighton: Sure, yeah. No, I would agree with Andrey's point around tail risk, but to be perfectly candid, I think it's a very remote tail risk in terms of some kind of a confrontation, for a number of reasons. That the most important being that what China wants from Taiwan would be destroyed effectively, if they were to use military force to gain. If they want the technology hub, they want the people, they want what they've been able to build as far as a differentiated technology landscape, in addition to bringing them back in the fold. So, I think when you look at how the Chinese have traditionally acted, they've been very conservative, they've moved fairly slow, they're very thoughtful around their moves. And so, I guess our interpretation is that what we've seen recently is more in line with the steady sort of ratcheting up of pressure, to extract more concessions, to try to move the ball a little bit closer towards reintegration.

Rand Wrighton: I also think that given what's happened with Russia and the Ukraine and the response that they've observed for the rest of the world, I think that has now firmly come into the calculus as well. And you really can't forget about the role that Japan has to play. The long history that you have between Japan and China, and to engage Taiwan in an aggressive, sort of a military type of fashion, I think would set into motion some very big sort of geopolitical moves that I don't think they have an interest in doing. And so, as we talk about around our firm, we think it's less likely that the Taiwan situation, even in the long term will be resolved with force, but perhaps more resolved with money and co-oping. So we think that's a very, very remote tail risk, and somewhat of a red herring as we sit here today.

Jenna Dagenhart: And macro is in all the wrong zip codes these days, Andrey. Inflation, US rates, global recession, commodity shock, flight to safety flows and strong dollar. Generally this is when EM has accidents and if the UK is having one, are we also due for one in emerging markets?

Andrey Glukhov: So, I sympathize with the fact that the environment is challenging particularly, for ex-US assets. But what I would say is there's a couple of things that for EM that I would call out. If we think about what are the key challenges across the developed markets, they can be kind of grouped together in output gaps, housing and labor issues, which are leading to the situation we are in now. And across the developed markets, all three have broadly trended negative. And in EM, however, they are all broadly positive, except for housing specifically in China and Korea. We talked a little bit about China. I think it is important to recognize that EM central banks have been ahead of the DM central banks in managing the external shock. They have been proactive in increasing the rates ahead of the inflationary spike, and therefore you are already starting to see situations like Brazil, where growth is doing quite well and inflation is coming down because they were ahead of the curve.

Andrey Glukhov: In addition to that, one benefits that EM growth models do have, is the EM countries are quite accustomed to growing in the face of elevated inflation, which is not something that we've had in emerging markets. The other thing about EM that I would sort of call out in this context is, that the commodity price shock that is being experienced by the developed markets, particularly Europe, is substantially less than that, that's being experienced by EM, especially Asia EM which is a big part of the market cap. Asia EM has stayed at sort of rather arms length from the Russian Ukraine conflict, and therefore is continuing to get an ongoing flow of highly discounted oil. And that therefore, that reduces the energy pressure that they're experiencing.

Andrey Glukhov: And I guess the last point that I would make, relative to the traditional times when EM has had issues is that the problem share, the people dependent on significant amount of external capital, your Turkeys, your Argentinas, are insignificant in the context of equity markets and have largely been kind of exited by international capital. And therefore, even if they were to have issues, the transmission mechanism is not really there. The risk of spillover to a broader EM is really not there.

Jenna Dagenhart: And, Rand, I want to ask you a little bit more about currency risk and the trend against globalization in just a second, but broadly speaking, anything that you would like to add in terms of the macroeconomic environment and emerging markets?

Rand Wrighton: Sure, yeah. I mean, I do think it's a very interesting an opportune time to be looking at allocations to emerging markets. I think firstly, when you think about the last few years, the pandemic normalization really was led the US. Europe kind of lacked by six to eight months, but Asia and a lot of emerging markets really never got going as far as normalizing, post the pandemic. I think too, that they did not have the same ability to ramp up fiscal stimulus measures, which provided less of a buffer, but now I think is less of a headwind in terms of that coming down. And so, when you look at it from an investment perspective now, you've had a lot of things go badly and create a lot of headwinds and push down valuations.

Rand Wrighton: When you think about the dollar really surging, which pushes, puts a lot of pressure on the emerging markets. Obviously it creates a headwind to western investors that are in the asset class, that can be measured in a dollar. But more importantly, it squeezes the financial system. The higher, the simultaneous commodity prices with the strong dollar also, not that common of occurrence, but pressures EM. And so you've seen sentiment, you've seen valuation really come down and you also, I would argue in many instances of the investment opportunities, you see profitability levels depressed alongside fairly constructive balance sheets, and in a lot of the investment opportunities with attractive dividend yields, that will actually be even more attractive than you see a currency normalization.

Rand Wrighton: So, when you think about that relative to other asset classes you could look at, whether it's US or European equities, we think it is very attractive and all those macro risks, the headwinds, we think have been mostly discounted into the opportunity set. So we think over the next 18 to 24 months, it's a pretty appealing place to look for opportunity.

Andrey Glukhov: So I guess what to Rand's point, if I can just amplify. We think about the valuation points in the markets where we are right now. US assets have certainly enjoyed pretty significant run since the global financial crisis, and even after most recent correction, US is a market looking at the variety of valuation metrics is roughly half of deviation expensive, versus its long term averages, right? The world is probably roughly in line with long term averages, whereas the emerging markets are rapidly approaching one, the deviation's cheap.

Andrey Glukhov: So if you think about kind of, valuation is not predictable for returns or shorter horizons, but it's certainly predictable for both medium to long term returns, and Rand's absolutely right, that there is strong opportunity here. And that thinking about the dividends, looking at the trade and dividend yield right now of this level, we are the bottom decile of historical dividend yield levels. Traditionally, emerging market on a three and five year view, offer quite attractive, positive absolute dollar return. And on top of that, we've obviously under indexed, relative to kind of trendline growth returns in the much more so, than we have in the variety of developed markets.

Rand Wrighton: Yep. No, that's a great point. I mean, I think we've been in a market over the last five to seven years where dividends have not been as invoked, but over the long term, if you look at emerging markets, the impact of the compounding of cash dividends accounts for almost half of your total shareholder return. And where we are right now, there are a lot of mid-single digit dividend yields to be had, that are backed up by fairly strong balance sheets and even levels of depressed profitability that we think have pretty low risk pathways to improve on a normalization. So, that's a great point Andrey.

Jenna Dagenhart: Certainly. And, Rand, how do you think about the currency risk that a strong dollar presents to EM, or there are any opportunities being created by the currency stress?

Rand Wrighton: Yeah, well listen, I think we are at a point of max pain. I mean maybe we're not at the absolute climax, but I think historically, when you look at say with the Federal Reserve when they're in a very strong hiking cycle, I think we're going to get to where they're going relatively quickly, within six to eight months. And I think you're seeing the currency markets adjust to that, at which point, I think it's reasonable to see some relief and potentially, a more of a meaner version. If that occurs or even partially occurs, the lift to which you get on those cash dividends, particularly in the countries where you have had the weaker currencies, that'll actually turbocharge that return. You've got to get through the period of stress.

Rand Wrighton: But as Andrey pointed out, that the central banks and emerging markets have done a pretty good job in front of this and you've seen the currencies hold up better, far better than they have in other similar type crises. And in fact, it seems like for this cycle more of the pressure is really being applied in Europe and the UK on their currencies. And so, within that context, while this is a headwind, I think we're probably closer to the end than people realize, at which point the relief that they get if you're looking out 18 to 24 months, could be a really strong tailwind.

Jenna Dagenhart: Speaking of stress, not necessarily within the context of FX, but broadly speaking, Andrey, if you think about prior periods of stress and emerging markets, how is this one different?

Andrey Glukhov: Well, I guess you have two major points to consider. As we talked about in the beginning, China is no longer an anchor necessarily, right? So if in global financial crisis, they have been very aggressive with the stimulus, stabilizing both of each of them. And really, the broader global economic growth, they are unlikely to be doing that this time around. The second variable, I guess I would offer that that is more challenging is, if you think about the taper tantrum of 2013. Fed sort of rediscovered its international mandate and adjusted this policy which allowed for faster recovery in the EM assets. I think given what's going on in inflation, it's safe to say Fed is not about the turn international. So, that's certainly also a SP bump that one needs to think about. So I think from a standpoint of aggressively taking risk in EM, one needs to take a view on peak Fed or trough growth, right? EM is fundamentally a growth sensitive asset class. So once your parity pressure subsides, once you can take a better view of global growth, these are the times you really want to have over-indexing to EM assets.

Jenna Dagenhart: And, Rand, what impact do you think that the trend against globalization will have on emerging markets?

Rand Wrighton: Yeah, that's an interesting question. I mean, it's obviously been underway and is real, as the world moves more towards kind of a bipolar framework where the US on one side, China on the other side. We think that, that's going to increase the relative importance of China. We think that it's actually going to help develop some industries that are focused more on intra-Asia business. We also think that it'll sort of turbocharge some of the development of other true international companies out of China.

Rand Wrighton: If you look at what China's done, while they've been remarkable to see the domestic growth, they still fall a little bit short of creating true sort of international business champions. We think this might increase the emphasis to do that. On the other side, we think that the trend towards reshoring is, people have talked about it for a long time, we think it's actually starting to really accelerate, and that's going to benefit places like Mexico, where you've already seen some of that, but we think you could see some escalation of that. We also think there'd be some knock on effects in different parts of Asia as well.

Rand Wrighton: So, I'd say it'll be different. I don't know that it'll be the headwind that some fear it will be. I think there'll be other opportunities that come about, particularly inside of emerging markets, that counter the opportunities that are lost, perhaps from some of the developed markets point of view.

Jenna Dagenhart: Let's talk Russia for a moment, Andrey. There's obviously a possibility of further commodity shocks and to the extent that Europe gets squeezed more, what are additional risks for emerging markets from here?

Andrey Glukhov: So, I guess with the caveat that I don't necessarily have any differentiated comment on the conflict itself. If you think about the spillover effect to the rest of the world, I guess as far as the direct effect, again EM is relatively better than the developed markets. Why? Because the importing developed markets like Europe, the commodity importers are having quite, all these challenges with the energy shock. The commodity exporting developed markets like US, Canada, Australia are dealing with the inflation rate and rate dynamic that is pressuring the big assets.

Andrey Glukhov: That said, the EM commodity importers as we talked about don't have nearly as much pressure, because they're getting subsidized energy and EM commodity exporters have taken the time and adjusted the central bank policy, and therefore terms of trade have been had.

Andrey Glukhov: So what's happening from here? I think, from here we can segment it into few different buckets. As far as oil is concerned, the flows of oil out Russia have been unchanged, relative to pre pre-war level. Particularly if we do believe that China reopens next year, which I think is fairly reasonable assumption that at some point next year they will reopen, that will create significant additional demand for oil and ensure ongoing supply from Russia. So, I'm not convinced that there is a spillover effect to EM on the energy front.

Andrey Glukhov: I think that things like gas have negative implications for Eastern European emerging markets, but they are fairly limited in the context of an aggregate equity impact for EM equity. I think that what one should think about in that context is, it'll accelerate energy transition, it'll accelerate investments in renewable energy, and those really require significant investments out of north states, or China and Korea, and those industries will really benefit. I think the important dimension to watch would be food. The spike in AG prices has abated, but I would continue to be monitoring that dynamic. It is important for some of the smaller emerging markets, particularly less developed ones. Any long term view I would really think about, this might actually end up being quite beneficial for countries like Poland and Turkey, which have risen in the geopolitical importance and therefore may have substantially more fiscal support from the developed markets, which can accelerate the development.

Rand Wrighton: I might add on to Andrey's comments. I agree with the points he just made. I would come back though with the concept of tail risk, which we touched on, we were discussing Taiwan. I do think when you look at the situation in Ukraine, the spectacular failure of the Russian military, versus their own expectations, versus the world's expectations has created a very precarious situation, where you have a leader that's gone all in. That there's really no way, there's no way to back up from this, yet the military under his control appears to be collapsing. And when you think about what that could mean, they've just recalled up or calling up a bunch of reserves, but that there doesn't have to be a linear relationship between, hey just throwing more people at it and that buys you more time or success. In military operations that's not always the case.

Rand Wrighton: And so, there is the risk that you see an even faster accelerated collapse of the conventional Russian military, which starts to bring back the focus on some of the reckless threats they've made around tactical nuclear weapons. And while I don't think this is likely, I think it's a tail risk that's growing, and it's really hard to handicap. And so to Andrey's last point on the food, I think that's the bigger commodity risk. I mean, oil has always found its way out of war torn territories. Most commodities do, and food will too, barring some kind of an accident. But I think if something really comes off the rails, unexpectedly bad happens in Ukraine, most people don't realize Ukraine is really the bread basket of Europe. And if you have some kind of an accident, something where you get really ugly in there, that could disrupt and be meaningful shock to food supply and prices.

Rand Wrighton: I think when you step back, setting that aside longer term, I do think it creates a headwind to Russia's oil production when you get past the near term. Because if you look at the decline curves, where they need to grow, the emphasis is going to shift to tertiary recovery technology as it relates to their oil resources, and that's an area where they were really going to need western technology and help. And I think it's fair to say, that won't be there under the current construct. So it's a scary situation in our judgment where the tail risk has grown a lot, and the tail is pretty dangerous. And so, we're watching it closely. But I think if you're looking out the next three, four months, I think those elements that Andrey pointed about, the commodities getting out and not being a serious risk but past that, I think a lot of things are possible and there's a constant scrutiny from the investment community.

Jenna Dagenhart: Now given all of these risks that we've talked about, why are EM markets attractive, and currently given the broader macroeconomic risks, Rand?

Rand Wrighton: Well look, I think it's a combination of really cheap valuation, some great assets that produce a lot of cash flow, cash dividends that we also think are under-earning. That you'll see an acceleration of earnings and cash flow, as well as multiple valuation appreciation as some of this pressure lifts. It's a very out of favor asset class. You've seen a lot of flows come out of emerging markets. We don't think a lot of investors are there yet, where they're pushing a lot of money in.

Rand Wrighton: So it's a combination of an out of favor asset class, it's seen a lot of outflows, cheap valuation. A lot of companies that we think are under-earning, yet are paying you pretty attractive cash flow to sit and wait, as well as the kiss that you can ultimately get from a recovery and some of the currencies. So as Warren Buffet famously said, "Be fearful when others are greedy, and greedy when others are fearful." I think that applies in some measure to where emerging markets are today. I think, for investors with the longer term horizon, looking at starting to allocate some more to EM, this is a good time to start to do that.

Jenna Dagenhart: And perhaps a lot of those risks have already been priced in?

Rand Wrighton: We think so.

Jenna Dagenhart: Now with politics back in the news, Andrey, there are a number of elections over the course of 2022 and 2023 in EM countries. What are the risks and opportunities here?

Andrey Glukhov: So, I think that the overarching dynamic that we've seen in elections is sort of a COVID revenge vote. Let's vote out the guy who made us sit during the pandemic, right? We've seen this in Korea, we've seen this in Italy, we've seen this in Colombia and Chile. So I think that the near term narrative will follow that pattern. Looking at the EM elections coming up, Brazil is next up. I think everybody or the market generally assumes that the opposition candidate will win. The market generally would like that event. Beyond that, once the whomever settles in, it will come down to how much fiscal discipline he will really have. It's important to recognize, he's inheriting the country in a very good spot. This was good growth and improving inflationary dynamic.

Andrey Glukhov: Then you have effective power transition in China, which remains to be seen, and I think it'll be important to watch the composition of the politburo. How many sort of reformers versus conservatives are there. And looking at next year, I would probably call out, Turkey is happening next year. It's really in my mind an option structure. If the opposition takes it, that will be very positive for the market for a country that has been largely abandoned by EM and international investors. Then you have Argentina, which will be interesting in the entire Latin was moving left in this COVID revenge vote, and there you have a left, likely going to move to the center. Which generally is market friendly, but the center will inherit economy in very difficult shape. And so then, once you go out of next year, you have some really important elections in early 2024 with India, Indonesia, South Africa, Mexico. There, I think it's too early to comment, but the COVID revenge dynamic is probably going to subside. And, it will be really dependent on how the incumbent handles the recessionary concerns that we are going to have.

Jenna Dagenhart: Rand, would you like to weigh in as well?

Rand Wrighton: Well, listen, I think Andrey did a good job covering what's coming up in EM elections. The only thing I might add is that you do have to factor in what's going on in Europe as well, and there's clearly a very difficult six months ahead. And it's not entirely clear if they have to go into energy rationing, and you have a very severe sort of economic shock on the back of that, it's not entirely clear what that means politically. And that, to the extent that causes a lot of disruption, greater economic stress, that's an important destination for exports and that could pressure all markets, but certainly Asia EM as well. So, that also bears watching.

Jenna Dagenhart: Why would you say that value is the best place to be positioned in emerging markets in this market environment, and over the long term, Rand?

Rand Wrighton: Well look, I think we've just come through almost a 10-year growth cycle. And I think when you look at the setup for the next couple years, you've got a lot of tailwinds to areas and sectors that have traditionally been stalwarts of value products, value investors. If you think about the rise in interest rates and the flow through to financials and particularly banks in terms of net interest margins, we see a lot of opportunity there for core levels of profitability and earnings growth to pick up. We also see opportunity within the commodity spectrum, which had a fairly negative run. If you think about the energy value train, that's become a lot more constructive. I think even if you see a rapid energy transition, you're still going to need at least one more energy cycle as you're going to get tight on the back of normalization.

Rand Wrighton: And to the earlier comments we've made around the yield opportunities, they're certainly there, and in general, value assets I think, are more severely discounted when you look at those entry points that you're being presented with right now in emerging markets. So we think it's a very good entry point into the value and the EM value in particular. And we think that when you look at the underpinnings of value cycles historically and the similarities of what we're looking now over the next couple of years, that it bolsters that case pretty substantially.

Andrey Glukhov: I guess, I hold a lot of sympathy to that point of view. I would probably at a high level, respectfully disagree. Particularly in Asia EM specifically, which is a lot of the market cap in EM. Growth has been called the best returning long term factor. We're talking our whole book, we tend to be growth oriented investors. So, given where the market level evaluations is, given where older assets are, I actually think that there is handful opportunity on both sides of this.

Jenna Dagenhart: And ESG is also a rising topic of conversation, Andrey. How are you thinking about opportunities and constraints within environmental social governance factors?

Andrey Glukhov: So, we think the biggest impact is in energy transition. So specifically the E portion of ESG. It's high priority, it's high impact, it's high potential in EM. We also can't solve this problem without an EM and well basically, emerging markets, particularly China, Korea, Taiwan, are very good in producing the critical elements that are required for the world to solve that problem. And while those industries are very capital intensive and therefore need continued access to public markets, so the capital allocated there has sort of a societal purpose. I think that right now, renewables are very low single digit percentage of the global energy balance, but we just reached the point where solar is reaching cost parity with the grid. The spike in global energy prices helps. I think the adoption curves from here should not be underestimated, and you will see a lot of opportunities and technological evolution arise, in which present very attractive investment returns.

Andrey Glukhov: Looking at broader ESG governance is very important. I think it's fair to say EM has fewer institutional guardrails, and therefore any EM investor will tell you that they're spending a lot of time on management or consistency of execution accounting, just because there is sort of high risk associated with it. And then the last point I would make when talking about ESG, more generic ESG, the direction of travel is more important than the current state. I would be careful about necessarily putting a straight jacket or DM ESG standards on every EM company. I think, we're not there yet from the market maturity, talent availability, and some other institutional constraints. But as long as the companies are gravitating in the direction you want them to gravitate, the engagement is building some results. I think that this is kind of higher priority at this point.

Rand Wrighton: Yeah, I'd add to what Andrey is saying, I think his last point is a really critical one, the direction of travel. And I think when you look at the progress that's being made in EM, coming admittedly from a significantly sort of lower starting point versus the developed markets, I've been very encouraged and we're pretty active in engaging with manager teams. I think most DM companies are anxious and excited to learn about best practices. They certainly want to move forward and they want to improve on all fronts.

Rand Wrighton: And so we think about ESG and engagement, we think about is the company measuring and disclosing the key information around carbon footprint, diversity, inclusion, et cetera. We think about, do they have targets and goals, do they have enforcement mechanisms tied to KPIs, or other mechanisms? And, are they doing a good job communicating that, both to the third party creators and to investors? And I think on all those fronts frankly, that they're making significant progress. And they benefit, just as China benefited for example, as from technology transfer and know how in business recipes coming from the West. I really think emerging markets are benefiting from that transfer from the developed markets. And I think certainly we're not alone. I think most developed market investors are engaging with them and they're responding, and so I think you're going to see progress at a rate that is much than what people expect within EM. I think that's a real positive thing.

Jenna Dagenhart: Certainly. And are there any specific areas of emerging markets that you see doing well over the next one to three years, Rand?

Rand Wrighton: Yeah, I mean look, I think and I touched on a few of them within financials, what were fairly constructive as we think that directionally, particularly in the banks, you've got sort the double benefit of economic normalization on the back of pandemic lockdowns, et cetera. As well as, you have a steady sort of tail end to net interest margins while credit has remained fairly manageable. We also think real estate is an attractive area to be looking at right now. When you look at the cap rates that are available to invest in, we think those are pretty appealing.

Rand Wrighton: And actually, we think consumer staples is an area that has not traditionally been where you saw a lot of great values. The temporary move that we've seen in inflation has really pressured the margins, which in fact, has followed through pressuring the stocks and valuations. And these are very good long term businesses. We have a lot of confidence in that most of the companies in that area will be able to pass through ultimately the inflation. That you'll see a normalization of returns there. So we think that those areas are pretty constructive and we think particularly, if you have an 18 to 24 month time horizon, it's a good time to be looking in those areas.

Andrey Glukhov: I guess, yeah. Thank you. I guess it is important to take what you have a lot of volatility, what tends to need to do is extend the time horizon and take a longer view of, where does one have conviction. Again, we are a bit of a growth investors, so from our standpoint there are generally maybe four buckets of opportunities that are emerging in across EM. So one is energy transition that I've talked about, right? Climate remains a priority. We are seeing significant improvement in adoption of electric vehicles. You look at China, they're growing a hundred percent, year over year. They are 25% of marginal sales but still will be below 10% of out of park. And some of the similar trends are playing out with a bit of a lag across developed markets, and the technology's not coming from EM. Equally in renewables, poly silicon capacity is growing 55% this year, 60% next year. But solar is still 3% of Chinese energy mix, and 4% percent of the global energy mix. We're on the ground floor of the growth of this. So energy transition is one.

Andrey Glukhov: Second area that I'd focus on, you talked about de-globalization, the US China decoupling and de-globalization presents significant opportunities across EM. Be it the semis, be it the healthcare, be it some of the supply chains. You will see emergence of domestic champions and explicit preference in the number of our countries for domestic champions. So, that's something I think about. EM innovation and sort of EM tech champions. Tech is on sale globally. EM is no exception. So I think we are going to get to a level of valuations where some of the global leading technology companies present opportunities. And lastly, as Rand mentioned, I would look at EM consumption. So, whether it's a formalization of certain areas of retail, whether it is going premiumization of consumption, whether it's increased consumption of healthcare as GDP per capita raises, that continues to be quite attractive in this area.

Jenna Dagenhart: On the flip side of things, what's your largest underweight at EM, in terms of both country and sector? And can you share any thoughts about why you have this positioning? Rand, do you want to kick us off, and then Andrey, if you'd like to weigh in, please do as well.

Rand Wrighton: Sure, yeah. So when you think about a country where we have significant underweight is India, which frankly there's a good long term story in India. There are a lot of good assets there. We just think when you look at the valuations that you're being asked to pay right now in the market, that they're nearly as expensive as they've been, relative to the rest of the opportunities at emerging markets in the last 15 years or so. We're also fairly underweight in Taiwan and that ties in on a sector basis where we're less constructive, which is in information technology. We think the valuations there have not corrected enough. We think there's also some significant headwinds over the next six, eight months that you have to get through, with regard to inventories and some of the weakness that you're seeing in the technology chain. And I'd say the last region that we're underweight, is in the Middle East where we have had some exposure there.

Rand Wrighton: But given the run that you've had, and I think in part the run that you've seen oil and the knock on effects, we don't think it's as attractively valued as it once was. So I'd say in terms of the other sectors, really it's in comp services is the other area. But when you think about it holistically, it's most of the companies that are tied into information technology. So really across technology is our really big underweight, where we're using that underweight to fuel a lot of exposure in other areas. And that certainly, I think is our position now, but we're continuing to watch, as you see all this pressure applied and we'll see what the next six, eight months brings.

Andrey Glukhov: I guess we are a little bit more thematic, and therefore a little bit more agnostic on country sector. But if just to back up, we're probably a little bit, we're equally somewhat cautious on India. The market is not really corrected, unlike a lot of other places we invest in. We're equally cautious, India driven by the Middle East weight. And then in the context of more commodity tech, we are underweight Korea, where memory is going through a somewhat difficult time and still needs to adjust. We probably in aggregate, somewhat less negative information technology, although that's driven by some very specific non-commodity technology positions.

Jenna Dagenhart: Moving forward. And looking at the long view here, Andrey, what are the multi-year trends to focus on?

Andrey Glukhov: Well, so again, I'd call out energy transition, I'd call out China, US decoupling, I'd call out EM consumption as just kind of areas I really repositioned for.

Jenna Dagenhart: How about you, Rand?

Rand Wrighton: Yeah. Look, I agree with those points. I think I would add to that there's still a fair amount of urbanization that can happen, as well as there's a lot of under penetration in emerging markets, whether it's in luxury goods, financial services, credit. So I think that the promise and what people have always been excited about emerging markets is still very much there. There's a big opportunity to incrementally close the gap with more developed markets. And I think, whether that's in consumption or that's in technology, it's all there. And I think that while we've gone through a tough period in emerging markets, those longer term exciting drivers are still very much, very much in place.

Andrey Glukhov: If in can just sort of, a Hail Mary on this question on a really long term view, if you look at the composition of the EM universe, relative to like an S&P 500, it is actually quite similar with one giant exception. And that is healthcare is roughly 15%, teens percent of the US indices, and three, 4% of EM. I would venture to say that if we speak in 10 years, healthcare is not going to be two, 3%. It's going to be much larger. So from a truly long term view, that's sort of another area where I think EM will grow up. We'll see more innovation in EM, we'll see more consumption in EM.

Jenna Dagenhart: Well, as we wrap up this panel discussion and before I let you go, I'd love to take a few minutes to go around the room and let you share your final thoughts with our viewers. Rand, would you like to kick us off here?

Rand Wrighton: Sure. Listen, I think that it's easy to get caught up in the current events and look at a lot of the pressures and the headwinds, but I think savvy investors tend to think about the longer term, looking out 12, 18, 24 months. And I think, I would just encourage people to think about it within that point of view. And with that in mind, I think it's an exciting time and there are lots of great opportunities for investors that want to put some money to work for the long term.

Andrey Glukhov: I think it's a great summary. I'd just add, this is selfishly, we would always say that EM should be an anchor tenant in any portfolio allocation. But even putting that aside, given the prevailing level of valuations, both on relative to itself and relative to some of the developed markets, I would at the minimum, start looking at opportunities that are arising, given the adjustment we're seeing.

Jenna Dagenhart: Well, Rand, Andrey, thank you both so much for joining us.

Rand Wrighton: Thank you, Jenna.

Andrey Glukhov: Jenna, it's a pleasure. Thank you.

Jenna Dagenhart: And, thank you, to everyone watching this Emerging Markets Masterclass. Once again, I was joined by Andrey Glukhov, Portfolio Manager for the TCW Emerging Markets Equities Group, and Rand Wrighton, Senior Managing Director, Equity Portfolio Manager Analyst at Barrow Hanley. And, I'm Jenna Dagenhart with Asset TV.


Show More