MAY 2019 1
In this Q&A, William Palmer and Michael Levy, Co-Heads for Emerging and Frontier
Equities, discuss their approach to accessing the asset class, current trends, and why recent
headwinds may be becoming tailwinds.
William Palmer Co-Head Emerging and Frontier Equities
Michael LevyCo-Head Emerging and Frontier Equities
BARINGS CONVERSATIONS
Global Emerging Markets Equities: Where Do We Stand?
EQUITIES
BARINGS CONVERSATIONS MAY 2019 2
EM equities have started 2019 positively after a challenging end to last year. How is the asset class now positioned for investors?
Michael: The correction in equity markets last year reflected investor concerns regarding the
U.S. Federal Reserve’s tightening, and the potential implications for EM countries, especially those
with current account deficits. In addition, rising trade tensions between the U.S. and China also
contributed, raising questions on global growth. In our opinion, these two factors led investors to
demand a higher risk premium for investing in EM equities.
William: We note the risks associated with these events have fallen in the last few months.
Firstly, the Federal Reserve has become much more dovish in response to more mixed economic
data in the U.S. Secondly, there has been significant progress in the trade discussions between
the U.S. and China. The reversal of these former headwinds into potential tailwinds have been a
significant driver of markets so far this year.
Michael: As economic activity slowly improves, corporate earnings should also follow. This is likely
to provide further support for equity prices as confirmation of this earnings improvement materializes.
William: It’s also worth noting investor expectations remain depressed as reflected in the
modest consensus forecast earnings growth for 2019 and attractive relative valuation versus MSCI
world equities on both a P/E and P/B basis. This low bar gives considerable potential to positively
surprise over the course of this year, while current valuations provide an attractive entry point for
investors to build a strategic position in emerging market equities.
FIGURE 1: Emerging Markets Equities are Forecast to Continue Reporting Positive EPS Growth
SOURCES: Barings, Factset, MSCI. As of April 30, 2019.
80%
60%
40%
20%
0%
-20%
-40%2007 2009 20112008 2010 2012 2014 2016 20192018 202120202013 2015 2017
EPS Growth Foward Looking Estimates
Which equity markets in EM do you prefer?
William: As bottom-up managers, we don’t engage in top-down country selection. We want
to look across the whole investment universe in order to identify the most attractive opportunities
and build a well-diversified investment portfolio. Clearly macro risk cannot be ignored, so we
aim to capture this in our analysis through the cost of equity we set for each individual company.
China remains a country where we continue to find a wealth of exciting investment opportunities,
especially in areas such as technology and insurance.
BARINGS CONVERSATIONS MAY 2019 3
What are the potential risks and opportunities if the U.S./China trade talks don’t reach a swift resolution?
Michael: We observe the substantial progress on trade talks
between China and the U.S. over the past few months. In recognition
that a trade war is damaging to all economies and financial markets,
both sides appear willing to reach a satisfactory resolution on key
areas such as the bi-lateral deficit, intellectual property protection
and market access. Confirmation of such an agreement would clearly
lift investor, corporate and consumer confidence in China and across
emerging markets.
William: Rising protectionism naturally leads to greater uncertainty.
If there is not a relatively swift resolution, it may lead to slower global
growth in the near term, but over the medium term, growth is likely
to revert back to more normalized levels. Policymakers are well aware
of the downside risks from the trade tensions, which is why China has
announced fiscal easing measures amounting to 1.5%–2% of GDP. This
should support economic activity and corporate profit growth as we
progress through 2019 and beyond.
What long-term growth opportunities do you see in EM?
William: Whilst the EM middle class is rapidly growing, it is crucial
to look much deeper and understand the changing demographic
in order to identify what this segment is likely to consume going
FIGURE 2: The Price to Book Ratio of Emerging Markets Looks Appealing Versus Global Peers
SOURCES: Barings, Factset, MSCI. As of March 31, 2019.
Re
lati
ve V
alu
atio
n In
de
x
1.3
1.2
1.1
1.0
0.9
0.8
0.5
0.7
0.6
Mar-2019Mar-2017Mar-2015Mar-2013Mar-2011Mar-2009Mar-2007Mar-2005
One Standard Deviation BandRelative PB LT Average
forward. We see huge opportunities in areas such as financial services,
particularly pensions, life insurance and more sophisticated financial
savings products which create opportunities for equity investors
in the insurance and banking sectors. We also see opportunities in
private health care, private education and across the technology space,
including hardware, software, social media and e-commerce.
Michael: On that point regarding e-commerce and the internet, the
internet has clearly gained significant adoption in EM, and, there are
a variety of unique investment opportunities within emerging market
countries. For example, in Russia we believe that domestic players
such as Mail.Ru and Yandex are best placed to capture future growth
dynamics given respective market leading positions in social media
and on-line search. As Russia’s digital economy matures and consumer
behavior and spending patterns shift, these domestic service providers
are rapidly growing advertising revenue, e-commerce revenue and
capitalizing on new revenue opportunities in the sharing economy.
William: We also aren’t ignoring opportunities in traditional areas
of the economy; for example, there are some incredibly well-managed
companies in the resources sector that are generating impressive cash
flow, even based on conservative resource price assumptions. This is
important because as a bottom-up manager, we don’t want to have a
narrow focus. We want to look across the whole investment universe in
order to identify the most attractive investment opportunities and build
a robust and diversified investment portfolio.
BARINGS CONVERSATIONS MAY 2019 4
“We strongly believe in active investing because emerging markets are naturally very inefficient, particularly because of low analyst coverage compared to their developed market peers”
What’s the best method of accessing the EM opportunity: active or passive investing?
William: We strongly believe in active investing because emerging markets are naturally very
inefficient, particularly because of low analyst coverage compared to their developed market peers,
and also high retail investor participation. The wealth management industry hasn’t yet developed to
the same extent as the West, and as a result, people invest directly into shares as opposed to mutual
funds. The Chinese market is a good example, where retail investor participation accounts for more
than 80% of daily market turnover, according to the World Bank. This can lead to a lot of share price
overreaction, to both positive and negative news, and, as a result, create inefficiencies which can be
captured by applying a fundamental, bottom-up process.
Michael: Passive investing by nature anchors investors to a specific benchmark. In our view, the
main benchmark, the MSCI Emerging Markets Index, is not a true representation of the opportunity
set in EM, and we consistently find sources of alpha in companies outside the benchmark. Another
development in recent years is a change in regulation through MIFID II. Sell-side company research
in emerging markets has declined significantly due to a reduction in analyst coverage of equity
stocks in EM, which creates further inefficiency that an active manager can exploit, particularly over
a medium to long-term horizon such as the five-year research horizon we use at Barings.
How is Barings’ investment process different from other EM managers?
William: As a bottom-up manager, we focus on fundamental company research, but we also aim
to capture macro risks through our cost of equity calculation, differentiating the risk environment
in each country. As a result, we’re able to assess total risk for each company in our portfolio. This
essentially helps ensure that we reflect currency risk when investing in EM, which can have a
significant impact—positive or negative—on the investment return to clients. For instance, in a high
inflation country such as Turkey, quite a lot of your local currency return can be eroded by currency
depreciation when it’s translated back into U.S. dollars, so we would require a much higher expected
return before we invest to compensate for the higher risk.
BARINGS CONVERSATIONS MAY 2019 5
Michael: We also have fully integrated Environmental, Social and Governance (ESG) analysis
into our process by ensuring that a company’s ESG score automatically impacts the cost of equity,
or required return. Industry-leading ESG practices can support a positive assessment, while poor
management attitude towards ESG, or worrying environmental or social issues, is sufficient to
downgrade an assessment to such an extent that investing in the company becomes unattractive.
FIGURE 3: Our Approach to ESG
SOURCE: Barings. As of March 31, 2019.
SOURCE: Barings. As of March 31, 2019.
EXPERTISE & EXPERIENCEour research capability is supported by
located in
30 INVESTMENT PROFESSIONALS
LONDON, HONG KONG AND TAIWAN
with an average of
EM SPECIALISTS
DIFFERENT NATIONALITIES15+YEARS OF INVESTMENT EXPERIENCE
13
the team is formed by
of
Factors Considered 9 Key Topics
Franchise: Sustainability of the Business Model
• Employee satisfaction• Resource intensity• Traceability/security in supply chain
Management: Corporate Governance Credibility
• Effectiveness of supervisory/management board• Credibility of auditing arrangements• Transparency and accountability of
management
Hidden Risk: On Balance Sheet
• Environment footprint• Societal impact of products/services• Business ethics
Any final thoughts?
William: Over the long run, we believe corporate earnings should drive equity prices.
Given that long-term economic growth is higher in emerging markets versus developed
markets, it seems sensible for investors to have exposure in this asset class. As emerging markets
introduce more orthodox policy making and embrace economic reforms, this should lead to
more sustainable economic growth, which should be reflected into asset prices over time.
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