“The relative performance of emerging markets versus developed markets is in cycles. At the moment we are in a downward cycle. Today almost everyone is negative, but certainly in China there are companies with huge cash flows that are very innovative and offer opportunities for an active manager,” said Gino Delaere (photo), emerging markets specialist and fund manager at Econopolis, from Singapore, where he has been living and working for years. He is much more positive than Jan Longeval, who spoke yesterday and weighs emerging markets in a neutral way at best in a diversified portfolio.
“When you look at the relative performance of emerging markets versus developed markets, you can clearly see that it evolves in upward and downward cycles. After China joined the World Trade Organisation in 2001, the most recent upward cycle began. There was no end to it and the sky was the limit.”
“The emerging markets then performed much better than the developed markets until around 2010-2011. At that point, the market had extrapolated all the positives of the past few years to infinity, so to speak, with the result that valuations were no longer cheap and capacity was building up as if most emerging markets were going to continue at this scorching pace. Of course, that was the (relative) top, because then everybody was positive!”
Delaere emphasised that today we are in a totally different situation. ”Today, almost everyone is negative and we see almost exactly the opposite picture, which is not illogical in terms of sentiment after about ten years of relative underperformance. The current low allocation of global managers to emerging markets illustrates this sentiment. He also argues that valuations have become much cheaper, but as so often after a period of underperformance, there is little interest.”
“Don’t forget that at much higher valuations there was a lot of interest, now at lower valuations there is less interest. To get a lower valuation and a definitive bottom, you need bad news. That is certainly the case today with the regulatory uncertainty in China. However, it is not really unexpected, the most unexpected or surprising thing is how the market has reacted to this as the measures are fully in line with the previously announced policy objectives (among others, more attention to inequality, the environment, etc.).”
Not exceptional
It is always darkest before the dawn, but Delaere stressed that what we are experiencing in China at the index level is by no means exceptional.
“That is simply the volatility of the MSCI China Index. Corrections of 35-40 percent are not at all as exceptional as people think. Not every correction was immediately followed by a strong rally, but they were always buying opportunities for the investor looking a little longer than the end of the year.”
Active investment
Delaere said he advocates active investment in these markets. “With stock picking, you can of course do good business even in this negative cycle.”
“Anta Sports, for instance, has been a 12-bagger (i.e. multiplied twelvefold) in our portfolios since we picked up the share; even very big names like TSMC have done well. So there are always interesting individual stories to be found, but admittedly with a lot of headwinds -in the downward relative cycle- that can be quite difficult, which is why we found it necessary to have a permanent local presence in Asia (particularly in Singapore) to be able to keep our finger on the pulse. That gives us a competitive advantage over other asset managers. From Belgium, it is much more difficult to get in touch with the market and the companies” said Delaere.
Education sector
Finally, the specialist commented on the worst affected sector in China: the education sector. He had no investment in it and has no intention of doing so because these business models will indeed be drastically changed (unlike the JDs, Alibabas, Tencents, Baidus etc. where the ultimate impact on profit growth will be relatively limited).
“Here in Singapore, you see this too: children go to a tutor for extra lessons even before they start school, so that they are ahead of the other students when school actually starts. Then through primary school, it is a matter of constantly collecting money with the (extended) family to be able to pay for extra evening classes for the children.“
“Because parents fear that if they don’t and other parents do, their own child will fall behind,” said Delaere. “And only the best students pass the strict exams, which then immediately provide job security at government companies, among others, and a guaranteed job for life, so to speak.””
“The big disadvantage of this is that children can never really be “children” again and that the family is constantly stressed, because these exams immediately determine what the future prospects of the child are”, he explained. “That costs a lot of money and is therefore a heavy burden for the family.”
“Those who want two or three children usually just can’t afford it nowadays”, Delaere continued. “That is why abolishing the one-child policy was probably not going to have too great an impact, a huge long-term problem for China.”
“That is why it was important to take away the stress and money worries so that people would have more than one child again. So this is what has been put in place.“
“In fact, it is a very good measure for the people, families, children and society in general, although for the time being it was not immediately reflected in the mainstream press.”
“Even at these lower levels, we are not interested in Chinese education companies, because as I have already indicated, that sector is now being completely changed for the benefit of the consumer, to the detriment of the companies that offered that extra education,” concluded Delaere.
Read more: Jan Longeval is sceptical and neutral on emerging markets.