Invesco Canada blog

Insights, commentary and investing expertise

Jeff Feng | March 18, 2016

Emerging markets: The “trade of a decade”?

In a recent Bloomberg article, Research Affiliates LLC called emerging markets (EM) “the trade of a decade.” The article noted that long-term investors are currently presented with an “exceptionally cheap” opportunity, as the MSCI Emerging Markets (EM) Index has declined 30% over the past three years.1

I agree, and the Trimark Global Equities team views EM as one of the most compelling opportunities in today’s markets. Conviction in this belief has led us to selectively increase the EM exposure in our funds over the past few years based on valuations, long-term growth prospects and the opportunity to buy high-quality companies at extremely attractive prices. We believe developing economies should not be overlooked – based in part on their compelling demographics, in particular a rising middle class, coupled with the shift toward consumption-based economies. All told, I believe that this is an ideal time for truly active managers, like the Trimark team, to add value.

As I mentioned in previous blog posts, I moved to Hong Kong last year – along with Danilo Martins, an investment analyst on my team – in order to be closer to the markets in which we invest (developing countries in Asia represent approximately 70% of the MSCI EM Index2). Visiting companies, meeting with management teams and acquiring on-the-ground knowledge is a key part of our investment process – all of which can be accomplished much more effectively when living and working in the region.

The EM opportunity

Over the past three years, developing economies have significantly underperformed those in developed countries. Cumulatively, the MSCI EM Index has underperformed the S&P 500 Index and MSCI World Index by 39% and 29%, respectively (see figure 1).

figure_1
Source: Morningstar Research Inc., as at February 29, 2016.
Data is expressed in local currencies.

This underperformance has resulted in EM’s cheapest valuations in over a decade. The long-term historical average discount to the MSCI World Index is approximately 18% (see figure 2). Today, the discount has increased to 26% (see figure 3).

figure_2
Source: FactSet Research Systems Inc., as at February 29, 2016.
Based on forward 12-month consensus estimates.
Note: Long-term historical average discount takes the monthly forward 12-month price-to-earnings (P/E) ratios of the MSCI EM Index and the MSCI World Index and then uses a simple average to calculate what the average discount has been over the entire period. Forward 12-month P/E is a common ratio used for determining the value of a company. It measures the current share price relative to its forward 12-month consensus estimates of earnings-per-share.

figure3
Source: FactSet Research Systems Inc., as at February 29, 2016.
Based on forward 12-month consensus estimates.

Conviction is key in times like these

Emerging markets have been severely punished lately for a number of reasons including, but not limited to, China’s slowing growth, a catastrophic dive in commodity prices and Brazil’s Petrobras corruption scandal. I believe this market sell-off has created opportunities. The reality is that the EM-equity universe is still relatively inefficient and information can be priced in slowly. In addition, a high percentage of stocks in the EM space have little or no analyst coverage. This provides opportunities for active managers like us to add value through stock picking.

There is a widespread belief that exposure to developing countries opens the door to increased risk; however, at Invesco, we believe that focusing on quality companies in EM provides the potential for greater returns. For example, the most universally known EM index is the MSCI EM Index, which has significant exposure to state-owned entities. My experience has led me to believe that state-owned entities have poor track records when it comes to capital allocation, and that this, combined with a lack of focus on shareholders’ interests, leads to lower returns on capital overall.

Active management in practice

We invest in companies – not countries, sectors or regions. We carefully select these companies using business-quality criteria we refer to as “FORS”. Our FORS approach focuses on four main elements of a business:

  • Free cash flow
  • Organic growth
  • Returns on invested capital
  • Sustainable competitive advantage

When a business meets our requirements in these areas, we then analyze the company’s management team and valuation to determine if, and when, an investment may be right for one of our funds. I wrote in more detail about FORS in a post entitled What does volatility in China mean for our funds?

By taking advantage of opportunities and doing company-by-company research, the EM team has been able to outperform the index by a wide margin (see figure 4), which, for me, simply shows that sticking to the discipline works.

fig_4
Sources: Invesco and Morningstar Research Inc., as at February 29, 2016.
The dates listed represent the time period that the current portfolio management team has been managing the fund.

Different investors have different needs when it comes to EM. We understand this, and our Trimark global fund lineup has varying levels of EM exposure (see figure 5).

fig_5
Source: Invesco, as at February 29, 2016.
Note: Regional exposure is unconstrained and is a by-product of the portfolio management team’s bottom-up investment process.

Jeff Feng is Head of Emerging-Markets Equities at Invesco Hong Kong Limited (IHKL). Invesco Canada has entered into a sub-advisory agreement with IHKL to manage certain Trimark funds.

Sources: Morningstar Research Inc., FactSet Research Systems Inc. and Invesco Canada.
1 Bloomberg Business, February 24, 2015.

2 Source: MSCI, as at January 31, 2016.

Trimark Global Fundamental Equity Fund, Series A provided the following performance returns as at February 29, 2016: 1-year, -2.96%; 3-year, 12.62%; 5-year, 11.92%; and 10-year, 3.18%.

Trimark Emerging Markets Class, Series A provided the following performance returns as at February 29, 2016: 1-year, -8.27%; 3-year, 5.32%; 5-year, 0.33% and since inception (January 2011), -1.16%.††

Trimark International Companies Fund, Series A provided the following performance returns as at February 29, 2016: 1-year, -5.04%; 3-year, 13.18%; 5-year, 10.69%; and 10-year, 2.94%.

Trimark Fund, Series A provided the following performance returns as at February 29, 2016: 1-year, -1.86%; 3-year, 12.75%; 5-year, 11.87%; and 10-year, 4.46%.

Trimark Global Dividend Class, Series A provided the following performance returns as at February 29, 2016: 1-year, -2.97%; 3-year, 9.53%; 5-year, 10.39%; and since inception (April 2007), 2.68%.

†† On April 5, 2013, the Fund’s investment strategies and portfolio advisor were changed. The performance of this Fund for the period prior to this date would have been, and the quartile rankings may have been, different had the current investment strategies and portfolio advisor been in place during that period

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