Most emerging market equities currently trade significantly below their long-term average price-to-earnings ratio, and at a significant discount to developed markets. Their valuations are at a level that presents a buying opportunity historically. BENCHMARK talks to two of Jupiter’s fund managers to see how they are equipped with the necessary talent and commitment needed to seize this opportunity.
Emerging market equities have been unpopular over recent years. Lower interest rates and a stronger dollar resulting from the tapering of quantitative easing is one reason why large cap stocks and major stock indices have been the prime beneficiaries of the current bull market. However, reform programs in major developing countries such as China and India are creating opportunities for active fund managers who possess the stock picking skills needed to operate in fast growing economies.
Emerging economies are characterized by a combination of more rapid economic and social change and less efficient markets than developed economies. Beyond the large blue chip companies that dominate equity indices, there are many companies that are evolving more rapidly than their developed market counterparts but which are, at the same time, less extensively researched and less well understood. This combination suggests potential for finding investment value and greater returns through bottom up, fundamentally-driven analysis.
Conviction Drives Performance
“Our managers try to generate portfolio performance beyond the benchmarks over a long time period, and in high growth emerging markets we are seeking companies that have the potential to be leaders in their industry sectors”, says Ross Teverson, Head of Strategy, Global Emerging Markets at Jupiter Asset Management.
Investors usually associate investments in medium sized stocks as being risky, volatile and illiquid, and Teverson points out, “We think that is a misconception, because given our experience volatility doesn’t necessarily make a good company an unattractive investment. Actually, the risk adjusted returns for these stocks outperform their benchmarks.”
When pointed out that Teverson’s portfolio is weighted towards mid-caps, he explains, “While investing in mid-cap companies is one of our strategies, and we use the definition ‘mid-cap’ to describe a company’s size, it is not our main investment criteria, and we are not limited to them. Rather, we are seeking high conviction investment ideas whether the companies are large or medium sized.”
Active managers also express particular investment preferences and biases derived from their experiences and Jupiter is no different. Teverson says, “We don’t favor companies whose prospects are highly dependent on single macro factors such as commodities. We like companies that can influence their product offerings and hence lead and innovate in their markets.”
According to Teverson, the company’s high conviction style drives their investment decision making. The company’s portfolio investments are built upon a strong conviction by the managers with winning characteristics and are not yet fully priced or recognized by the market. He says, “We will usually sell a stock once the original investment we identified has played out; the displacement of a stock by a new idea that could drive higher portfolio returns is also another possibility.”
Teverson’s long-only unconstrained portfolio is based on the relative performance of stocks and it is very bottom up driven. His team does not hedge their investments or the portfolio because there are many natural hedges based on the businesses’ activities, for example, importers versus exporters balance off some currency exposures. Teverson also chooses to be fully invested, rather than trying to market time by varying the level of cash in the fund over time.
While assuming a positive or contrarian view beyond the market consensus is important, it is not enough to support an investment decision. Teverson and his team must also identify events, catalysts and triggers that will eventually bring the market’s view of value in line with their own and drive outperformance of the stock. “These triggers can take the form of a specific event, such as a positive earnings release or a higher than expected dividend payout. Other less tangible results could be better communication of the company’s strategy or an improvement in corporate governance standards.”
Due diligence in emerging markets needs to extend beyond studying financial reports. The investor’s commitment to on-the-ground due diligence can be the difference between success and failure. Teverson explains “Jupiter may also use independent experts and consultants to corroborate management’s claims and their business operations. For example, I made numerous site visits in China as part of our investment in a listed property developer, looking at the qualities of their buyers, first time buyers versus speculators, and whether these properties are situated in prime locations as they claim. So getting out in the field and meeting people are an essential part of how we make investments.”
Avinash Vazirani, Fund Manager of Indian Equities at Jupiter describes how extensive and meticulous interviewing reveals valuable information. An interview with a supplier of a pharmaceutical company revealed unsatisfactory dealings, which encouraged Vazirani to decline investing. He said, “Subsequently, we learned that the company had significant issues with the US Food and Drug Administration in respect of their filings and the importation of their products into the US has been stopped.”
The manager must also understand the intellectual and practical limitations of his investment methodology. “It is important as an asset manager to understand the areas where you can add value, such as studying a stock’s business fundamentals, and those where you are unable to, such as determining the outcome of quantitative easing. This helps you to clearly understand what risks you are able to diversify.”
In today’s economy and market, which are heavily influenced by governments’ quantitative easing policies, Teverson remarks, “We can’t determine when and how developed market monetary policy tightens and for our style of investing that is not a constructive exercise. We prefer not to take macroeconomic risks outside of our core skill set. Rather, we focus on issues such as the US dollar interest sensitivity of our investments and how their financial performance will be impacted. We make sure that we are not taking unintended macro risks as a consequence of bringing together our best ideas in a portfolio.”
On the Social Responsibility front, Vazirani says “We do engage with controlling shareholders of companies even when that shareholder happens to be the Indian government. We like to emphasize the benefit of looking after minority shareholders. It’s something we have done and will always do. We vote on all shareholder resolutions. If we dislike something, we engage in a constructive dialogue with the company in the hope of finding a solution, but we are prepared to vote against a resolution if it is not in the interest of the company or its shareholders.”
Value in India
The Jupiter India team’s approach to the country is to invest from a genuinely unconstrained, bottom-up perspective on a stock-by-stock basis, rather than making broad sector allocations. While this represents a labor intensive style, it is an approach that aims to produce long-term growth from fundamental changes occurring in the economy and in corporate performance.
“Freedom from the benchmark allows us to fulfil our commitment to investing in growth potential wherever we find it, which means our Fund can have a slightly larger allocation than our competitors to medium sized companies”, says Vazirani.
In order for bottom up investing to work, both regulators and business leaders have to work together to significantly improve management transparency and shareholder protection. Foreign investors are highly dependent on these factors. Vazirani says, “Today, the interests and communication among the family owners, management and outside shareholders are better aligned and clearer. There is a greater understanding about corporate governance and sustainability issues.”
He adds, “In India, protection of minority shareholders rights and the authority of independent directors have both improved. Every listed company must have a female director. Quarterly reporting must be completed within 45 days and annual reports within 60 days.”
The international experience of Indian managers is manifesting itself in more sophisticated local management culture. Vazirani observes, “Information technology companies, which compete internationally and service foreign clients, are driving broad changes in the management style of domestic, Indian companies. And best practice standards are emerging as smaller companies emulate larger ones. The rise of Indian managers who now run multinational corporations has become a major influence on local management quality.”
He describes how value in Indian stocks can be realized. “Despite the effects of quantitative easing from the US, we are still finding Indian equities at reasonable prices. The pool of domestic Indian savings is substantial and there is real demand from investors to achieve balance by shifting from physical and real assets to financial assets.”
India’s internet sector is especially promising because it benefits from a combination of a large user base and low penetration to create high growth potential. The country has the third largest internet user base in the world, but an extremely small online market. With extensive experience investing in Chinese internet companies, Vazirani is expecting to make further investments in this sector as more Indian internet companies obtain listings, particularly in the US. BM