Emerging markets equities have performed strongly since bottoming in January 2016. It has returned more than 70% (in USD terms) since then and outperformed developed markets by more than 20% to date<span style="position: relative; top: -0.5em; font-size: 80%;">1</span>. This may have led some investors to wonder if they have missed the rally and whether there is still some more room for the asset class to run?
“We are still quite early in the upcycle for emerging markets.”
Geoffrey Wong
Head of Global Emerging Markets and
Asia Pacific Equities,
UBS Asset Management
Geoffrey explains that historically, emerging market equities moved in distinct performance cycles lasting for about 5 to 7 years each. “We don’t expect this pattern to change.”
Earnings recovery is underway
So what is driving the cycle? For Geoffrey and team, the improved dynamic have been apparent for some time. “When we speak with company management, they tell us about their expansion plans. After a five year decline, many of the companies are now talking about increasing capacity through upgrading of machinery or building new factories.” This is reflected in hard data with capital expenditure increasing since around mid-2016. Indeed, companies are gaining more confidence to invest in their businesses because demand has been improving. Profitability has also improved in tandem and is up by more than 20% in 2017.
While profits may moderate from here, the UBS Emerging Markets team estimates that companies’ bottom line will continue to be supported by revenue growth.Despite the recent rally, emerging markets equities remain attractively valued at 1.8x on a price-to-book basis This remains comfortably below that of developed markets.Despite the recent rally, emerging markets equities remain attractively valued at 1.8x on a price-to-book basis This remains comfortably below that of developed markets.
Valuations are inexpensive
Despite the recent rally, emerging markets equities remain attractively valued at 1.8x on a price-to-book basis This remains comfortably below that of developed markets.
Opportunities are a domestic play now
The current upcycle for emerging markets brings about opportunities that are more attuned with the domestic economy, fueled by sectors like internet and consumption. This is a contrast from ten years ago where highly cyclical industries dominated the index. The change has essentially been driven by a growing middle class and the surge in technology and innovation. Meanwhile, manufacturing is moving up the value chain for certain emerging markets economies. “Made in China takes on a new meaning these days. Many products from China are no longer just replicas. In the technology sector especially, products are developed and designed by local talents. Very often, these are world class products with cutting edge technology,” says Geoffrey.
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Invest in quality companies at reasonable valuations
While the backdrop is positive, Geoffrey warns investors to be discerning in selecting companies. “As the cycle progresses, earnings growth will moderate. You do not want to be caught out with low quality stocks. From day one, we have focused on investing in firms with strong business models, balance sheets and look to buy them at reasonable valuations”.
The process of finding quality companies often brings the team away from their desks to various countries across the region. “These research trips are important to our investment process. It’s one thing to study the financials but there’s no substitute for on-site visits. Visiting the factories, walking around the shop space, meeting with suppliers and competitors allow us to form a 360 view of the companies’ business models.”
Geoffrey constructs his portfolio from the best ideas of a dedicated team of industry analysts. The result is a high conviction portfolio of about 30 stocks, diversified across sectors and countries. The approach has produced consistently strong results for investors over time.
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1 Source: MSCI, UBS Asset Management, based on the MSCI Emerging Markets Index from January 2016 – January 2018.
This document is a marketing communication and the information herein should not be considered investment advice or a recommendation to purchase or sell securities or any particular strategy or fund. Information and opinions have been provided in good faith and are subject to change without notice.
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