Investors in emerging markets should completely ignore the 60 per cent worst performing companies when defining their investment universe. These companies bring extra risk, without rewarding you for it. In addition, investing in China is very different at the moment: great opportunities are better left aside in some cases.
This is according to portfolio manager Raj Shant of Jennison on Wednesday during an online round table for journalists. Jennison is a fund house with 240 billion dollars under management, which started out with an approach focused on growth stocks.
Shant made the statement about the investment universe based on a chart showing the earnings growth and relative returns of companies in the MSCI Emerging Markets Index. Of the five resulting quintiles, he said only the top two were worth assessing.
“This data shows that 60% of companies in emerging markets have no or negative growth in the medium term. In other words, the majority of companies are not managing to grow.”
That, plus the much better relative returns in these same two quintiles, makes Shant suggest building an investment case around only the 40 per cent fastest growing companies.
“That’s what we do. We try to figure out which companies will fall into the first or second quintile in the next three or four years. We don’t want to put time or capital into the other 60 per cent. That is value destruction.”
Shant agreed that in other regions, there is a similar trend — that is, fast-growing companies are generating more returns. “But the height of the bars in a chart of America will be lower. In emerging markets you have faster earnings growth and higher returns.”
According to the portfolio manager, there is still enough to choose from to have a diversified portfolio. Moreover, Jennison’s EM portfolio appears to be very concentrated: half of the assets under management go to ten companies.
E-commerce as favourite
The e-commerce companies Sea - ADR and MarcadoLibre have the largest weighting. Shant explained his decision: “In Europe and the Benelux, about 25 percent of every 100 euros spent is on e-commerce, in China even 30 percent. But in Latin America and South-East Asia, where these companies are located, e-commerce constitutes only 10 per cent or less of consumer spending. The markets there can double, and sometimes double again, before they are at the level of Europe.”
The portfolio manager stressed the importance of market leadership in e-commerce, as in this sector you have to have volume to get everything done logistically. “That is difficult for new parties. That is also the reason why, for example, Amazon lost in Latin America to local market leader MarcadoLibre.”
China: from 50 to 20 per cent
In response to a question from a journalist about Jennison’s rapid reduction of its position in Chinese companies, Shant replied that the team had indeed been selling off Chinese shares drastically since the second half of last year. While these stocks used to make up about 50 per cent of the portfolio, they now make up 20 per cent.
“We are cautious. We do see opportunities in China, but also risks. We sold Alibaba in its entirety in 2020, for instance, because we were very surprised by the antitrust investigation into the company, especially its timing. Why now, and not two or three years earlier?”
Something had to have changed, but what? “We concluded that above all, the way in which investigations are carried out and action taken in China has changed: without announcement or preparation. Take the Didi app, which suddenly had to be taken out of the app store. Was that a matter of dates, because Didi had made the “mistake” of listing in New York first? We don’t know.”
The Chinese companies Jennison has sold are mostly tech companies and also “fantastic” growth companies. “We can’t have confidence in the Chinese authorities for the next three years,” Shant argued.
Chinese chip and battery companies
Incidentally, that does not mean that the EM portfolio does not include any Chinese companies. In fact, number 3 Silergy is a Chinese company. Shant explained: “They make domestic chips. Logically, the Chinese government does not punish this sector - although we said that earlier about education. After all, there is a big chip shortage in China now that it receives few chips from Western companies.”
After mentioning a few more Chinese names and sectors, Shant said it is not ideal to have to think so hard about which companies are most in line with the Chinese government’s ideas. “We prefer to look at things differently. And we see other opportunities, but since the expected returns are about the same but the risks are much higher, we’ll leave those for now.”