The greatest investment story told in recent financial market history is the one that John Maxwell, portfolio manager of Ivy Investment Management’s Ivy Core International Equity Fund, entitles “The Story of Three Billion People Trying to Live Like One Billion People.”
It is the story of the burgeoning middle classes in places like China, India, Brazil and across the emerging markets world who, as a result of the economic boom those countries continue to experience, now have the means to buy themselves virtually any good or service they want, from BMWs to Botox and everything in between. It’s a story that almost everyone knows by now, and one that Maxwell, like many other investors, believes still has much left to tell.
Yet Maxwell also feels that the tale of the emerging market consumer is so widespread that it’s rapidly getting too much of a readership. For value investors in particular, it is getting harder to capture the growth opportunities that the BRIC countries and other emerging market nations offer. Many investors are facing a challenge, knowing that investing in these countries is perhaps the only way to get decent returns today, yet wondering how exactly to do it without getting crowded out and paying far more than they should for assets they believe have become overvalued.
In searching for the best ways to navigate a tight and crowded space, the more astute investors believe that finding growth opportunities that are not overpriced means looking at emerging market countries in a lateral, not-so-obvious way, in order to capture the best they have to offer. In fact, a number of investors believe that the best way to capture the continued upside of the emerging markets growth story is to look entirely in the opposite direction and invest in the developed markets.
“Most investors are focused on the ‘now’ and, based on that, extrapolate what will happen in the future, but that often isn’t the right thing to do,” says Norm Boersma, (left), portfolio manager of Templeton Growth Fund and executive vice president of Templeton Global Equity Group. “Often, the future is in the assets that have been clobbered now and much less in those that are actually hot now.”
While 10% to 15% of Boersma’s global equity portfolio is directly invested in emerging markets, most of it is actually invested in the developed world, in the kinds of assets that have been clobbered over the past months. Today, growth is the farthest thing from people’s minds when they think about the United States or Europe, but Boersma’s rationale is that some very good companies on both continents suffered unduly from the market downturn and were disregarded by investors over concerns about the sovereign crisis in Europe and the recession in the United States. These companies, he says, now make for great buys at a low cost.
“Many companies in Europe, and even in the U.S. and Japan were unfairly punished because they were treated as having exposure to problem spots like Greece and Spain, but actually, that wasn’t the case at all,” Boersma says. “We had the opportunity to buy some very good companies at a great price.”
The kicker in those names is that they benefit directly from the multi-faceted emerging market growth theme. Names like Sanofi and Pfizer, for example, derive a major portion of their revenue from emerging market countries, Boersma says, as do companies like Vodafone and Siemens. He bought these and other names at what he considers to be a good price.
“We’ve struggled over the past two years to find value in the emerging markets directly because stocks have been so bid up as investors have found growth there. But if you’re looking ahead, we can still capitalize on that growth through the developed market stocks we’ve bought that are part of emerging market growth themes like, for example, the growth in pharmaceuticals, telecom and technology,” he says.
Ivy’s Maxwell also goes with the same investment rationale, but not so much out of choice, since his mandate is primarily a developed market fund (with a 15% emerging markets component). He has to look for the best opportunities in the developed market universe, but even so, most of the International Core Equity portfolio is exposed to emerging markets in some way or the other, since that is where Maxwell sees the greatest opportunity.
As such, he invests in companies that get the bulk of their revenues from emerging market countries. This enables him to add alpha and the potential for higher performance over time without paying what he believes to be an overvalued price for direct emerging market exposure.
“We’re trying to get growth at a good price and we have found that most of the companies in the developed world are growing because of their emerging market exposure,” Maxwell, (left), says. “By investing in these companies, we can get that exposure at what we think is a good price.”
Maxwell—whose overall investment theme is emerging market-related, and focuses on the increasing purchasing power of the consumer, infrastructure, M&A possibilities and dividend yields—finds good investment opportunities in companies like Credit Suisse, which has greatly increased its businesses, particularly in the field of wealth management, in countries like India and Brazil. That business is only set to grow more, Maxwell says, given the increasing number of wealthy individuals in BRICs, so buying Credit Suisse is a good way to take advantage of the growth dynamic in an affordable way.
Unilever is another example of the kind of name that Maxwell favors. The company derives 50% of its revenues from emerging markets, but more than that, Maxwell also likes it because it is a safe investment, and safety is one of his top investment criteria.
“I’m paying what I believe is a discount for a top name with strong revenues and corporate governance that has been tested over time,” he says.
For investors like Nick Kaiser, Saturna Capital’s chief investment officer, ethics and governance are also top priorities. Emerging markets are overvalued, Kaiser says, because they do present perhaps the sole growth opportunity currently available. Because most don’t have a choice but to invest in them in some way, being able to get the emerging market exposure at a low cost with the safety feature thrown in makes for a great deal, and seeking out opportunities in the developed world is the way to cover both bases.
“The advantage of using companies in the developed world is that they are subject to a far greater level of disclosure than their emerging market counterparts, so even though their revenues are coming from emerging markets, they have to uphold far greater standards,” Kaiser says. “This is important to us as investors.”
Some years ago, Saturna’s Amana Mutual Funds (which invest according to Islamic law) had invested in the notorious Indian tech giant Satyam Computer Services, which in 2009 came to be known as India’s Enron for having falsified accounts. “We sold the stock three days before the scandal happened because we saw a news story from Europe that alerted us to a problem, but after Satyam we are very careful,” Kaiser says.
As a value investor, Kaiser is looking for growth opportunities at a good price, but he prefers to find these in a more lateral manner—an approach, he believes, that also helps to minimize both risk to and volatility in his portfolio. He’s currently looking at what’s going on in the developing world to get a sense of how best to capture emerging market potential, and investing in what he calls “side themes” that he believes offer good exposure to emerging markets through stable, well-established companies in the United States.
“Usually, the U.S. works itself out of recession through consumer spending, but this time, we are seeing a clear export theme, with U.S. companies like Caterpillar Tractor selling into Latin America and other areas,” he says. “We think that playing themes such as this one is a good way of capturing global growth.”
That said, Kaiser doesn’t believe in limiting his investment horizons only to the developed world. While India, China and other emerging market countries may be getting overcrowded, they are also huge countries with many things going on and years of growth and development yet to go. Looking for opportunities in the less obvious sectors and less well-known parts of these countries is also a great way to get in on some great stories before they really get too much traction from the investment world, he says.
According to Jeffrey Towson, managing partner of the Towson Group, a private equity firm based in New York, Shanghai, and Riyadh, Saudi Arabia, and author of a recently published book entitled “What Would Ben Graham Do Now?: A New Value Investing Playbook for a Global Age,” the greatest emerging market stories to invest in are actually the millions of small service stories that are happening at a local level everywhere.
“Go to Kunming, a small city in southwestern China, and you’ll see that everyone’s getting braces,” Towson says. “You can go anywhere in the world—Asia, Africa, the Middle East—and there are thousands and thousands of small companies to own. They are the greatest investment stories.”
The problem for most investors, though, is finding these opportunities and then being able to access them, Towson says. Because it’s so hard to get to the local level in emerging market countries, most investors end up sticking with the tried and true, even if they are invested in BRICs and other emerging markets, and this leads to overvaluation. Towson believes that even those who approach these markets laterally, whether it be through investing in developed market stocks with emerging market exposure or another way, make the space more crowded. Value investors, he says, should really be seeking out the opportunities that are off the beaten track, because the best market opportunities come up most often in unexpected places.
Saturna Capital’s Kaiser also believes in looking beyond what’s easy to see, and an area that he’s got his sights on now is infrastructure companies in interior China, which are going to get busy as infrastructure development moves away from the coastal areas and into the interior of the country. Roads, highways and the like are bound to come up, so Kaiser and his team are studying these companies carefully (recently, Saturna opened up an office in Malaysia with the specific goal of getting to know the more obscure, less obvious investment opportunities in Asia).
Kaiser also believes that there are good opportunities for investors in emerging markets like Indonesia and Malaysia, countries that investors who have been carried away by the BRICs may not necessarily have looked at.
“The valuations are a lot lower in a place like Jakarta, Indonesia, than in China,” says Kaiser.
Based on this, the Amana Developing World Fund is invested in a dairy farm operation, a cement company and a telephone company in the Indonesian capital, Jakarta.
“I don’t really see in the near term that hot markets like China are going to cool down, so it’s good to look at other places, even if some of those markets are more tricky and you need to watch out for things like ethics and corruption,” Kaiser says.
Clearly, there’s still a great deal to tell in the international growth story, but in today’s world, one fundamental point that investors cannot ignore is that both the emerging markets and the developed markets are interconnected in myriad different ways. The reality is that one cannot really exist without the other, so smart investors can’t afford to ignore either one. They really need to be looking all over the world, says Paul Osterberg, (left), chief marketing officer at Al Frank Asset Management, because revenue-generating companies can be located anywhere.
Osterberg’s firm doesn’t discriminate between the developed and developing world, and the firm employs a proprietary model that screens the world on a daily basis to figure out both on a quantitative and a qualitative basis where the best equity investments are. This allows the company to rotate in and out of different markets in an active way and do the kind of tactical, granular investing that is essential for any international investor today, he says.
“Right now, Germany and France are starting to look pretty attractive in the model because we’ve seen some real improvements in the level of earnings and also the rate of change in organic growth,” Osterberg says. “The Northern European countries are also looking attractive.”