The question we get asked most frequently by potential investors is this one: “Your fund appreciated by over 50% last year, 30% more than the broader market; surely you have done your stuff? Your stocks must be very over-valued, mean reversion means you can’t have another good year, surely the value based funds will (finally) do better this year?”
First, let’s look at the asset class itself. In broad terms, Emerging Market (“EM”) equities are still on undemanding forward multiples. Figures from Bank of America have them on a 16x forward Price to Earnings Ratio (“PER”). The sceptics may argue that this represents a 39% premium to the 10 year average, but remember that this 10 year average happens to coincide with a decade long bear market in broader EM equities which, we believe, may have just ended. It also reflects the 34% post-Covid recovery in earnings in 2021 which, in our opinion, is likely to be exceeded. Unsurprisingly, the wider analyst community remains overly cautious after their Covid-induced whiplashing of the past 12 months. In addition, that 10 year bear market has left the EM PER at a significant 26% discount to the Developed Market (“DM”) PER of 21x. On a PER to Growth (“PEG”) basis, this leaves EMs on an absurdly low 0.5x vs 0.8x for DMs.
In some ways it is surprising that the asset class is not more expensive when you look at its changing constituents. A rather imprecise view can be gleaned from the top 20 players in the MSCI EM Index. A decade ago, the Aubrey EM strategy would have struggled to own any of the top 20 stocks: the Brazilian bank, Itau, being the only one on our watchlist today. For the record there were five banks, seven commodity related stocks and three telcos in that top 20.
Even five years ago, around the time of the last mini “reflationary trade”, we could only find seven possible investments in the top 20 as Tencent, Alibaba, Baidu etc. had joined the fray. Today there are arguably 11 possible consumer stocks in the top 20 for us to consider. In other words, consumer oriented names make up a much larger portion of the benchmark, and you might expect them to be more expensive than those more traditional, “value” stocks.
Closer scrutiny of the stocks themselves, however, shows that those on our watchlist frequently appear to offer more value than those that are not. Of the two index stalwarts of the past decade - the tech giants TSMC and Samsung – the former, whilst no doubt a great business, is now twice as expensive, on almost any measure, than it has been at any point in the last decade whilst the latter, though not quite so extreme, is still well ahead of on any measure of valuation over the period. Conversely, Tencent is very much in line with its historic range, and Alibaba, although it has not been listed for the decade and has some short term issues, has never looked cheaper. Among our other large cap holdings, JD.com still looks very good value on a PEG of about 0.5x and even Meituan, which has had a strong run, and at 90x PE is not an obvious steal, has a PEG of 0.2x this year and 0.9x next.
A salutary lesson comes from the only surviving Chinese bank still in the top 20 from a decade ago, China Construction (“CCB”). CCB trades at HK$6 today, as it did in 2010. It trades at a PE of 5.3x which lies firmly in the middle of its 4.5x to 6.5x 10 year PE range. We mentioned earlier that in our view EMs may have just ended their decade long bear market. If this is so, and especially since this will initially involve another “reflation trade”, it is highly likely that CCB, and its brethren, will rally for a while. However, when we revisit this in another 10 years’ time, or even five for that matter, I shall be dumbfounded if CCB is still anywhere near the top of the EM list. Some stocks are just cheap for a reason and will remain so.
Our portfolio has a median PEG of 0.9x for 2021 on our latest numbers, and this is very much within the normal historical range of between 0.8x and 1.2x. We unashamedly hold some high PE stocks, and indeed a few who are yet to turn a profit, but in all cases we need to be confident that the earnings growth will come through to support them. We also don’t stand still, and if a stock looks stretched on valuation, which for us means a PEG of over 1.5x, we revisit the investment case, quite often trim if there are no changes to earnings, and occasionally sell. We are rarely stuck for new ideas and believe it is vital to keep a dispassionate view of our investments, and ensure the portfolio contains the very best investments at all times.
So, coming back to the key question, can we continue to outperform? In the current conditions which lend themselves so well to EMs outperforming (a weak USD, early stage reflation, strong global liquidity etc.) it would be inconceivable for commodities not to rise. It is also the perfect time to be a stodgy state owned Chinese bank: pay your depositors 0.5%, buy government bonds or lend to an SOE at 4% and put your feet up. Some of those sectors occupying the value quadrant will have their day in the sun.
But this is not 2003, or even 2016, which now seems a world away. As one of our favourite strategists and friends, David Scott, likes to say, “Peak Stuff” has been and gone in China, as it has in the West, and increasingly in developing economies as well. Once the basics such as food, clothing and shelter are taken care of, the biggest part of most of our emerging consumers’ lives today are found in the little squarish icons on their smart phone screens. These tend to be more services (entertainment, games, communication, experiences, ride sharing), than products (stuff), and even if it is “stuff”, it’s a lot smaller than it used to be! So, even as the remainder of the emerging world’s consumers get wealthier, they will not consume the same volume of material that we, or indeed the Chinese in recent years, have done. In other words, the drivers of this bull market will not be the same as the last.
Often, it is easier to outperform in a bear market, and we have certainly generated outperformance when markets have been in decline in recent years. A bull market, however, tends to lift all boats, and on occasions in that sort of environment, there may be times when our higher quality, less leveraged stocks may struggle to keep up. But that said, we have started off this bull market very strongly, our portfolio looks attractively priced and, we believe, as well positioned as any to capitalise on the opportunities which we expect to unfold over the next few years.
The really interesting question is what else will be in that top 20 in 5 years’ time. Where will the soon to be listed Kuaishou and Bytedance fit in, or Go-Jek/Tokopedia, or even Zomato? Were they to make an appearance, we would certainly not be surprised.
Please find the most recent performance figures for the Aubrey Global Emerging Markets Strategy against the MSCI TR Net Emerging Markets USD (NDUEEGF) in the below table.
Rob Brewis | Fund Manager
Rob Brewis is one of the three fund managers responsible for the Aubrey Global Emerging Market strategy.
An engineering graduate from Cambridge, Rob began his career in 1988 at Thornton Management in London before moving to Hong Kong in 1989. There he managed the Asian Special Situations Fund for Credit Lyonnais. Having been an early investor in a number of nascent Asian markets during the 1990s he also managed several single country funds investing in India, Pakistan, Indonesia and Thailand as these markets opened to foreign investment and grew in size. Rob co-founded an emerging markets investment boutique, BDT in 2000 before joining Aubrey in 2014.
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