GAM Investments’ Tim Love explains why he believes an active management approach is best-suited to emerging market equities and discusses the new world of opportunity the asset class offers sustainability-focused investors.
The emerging market (EM) investment universe spans around 35 countries, with the same number of different currencies and significant levels of diversification risks and opportunities. Add huge amounts of governance differentials into the mix and it is clear that the scope for diversion and alpha opportunities within the EM equity universe is vast across many different types of strategies.
The sheer scale of the possibilities means that the investment opportunity is not easily replicable by passive vehicles. But for alpha-focused active managers EMs represent an exciting territory to add value for investors.
Capitalising on many forms of mispricings in EMs
Our investment philosophy is to aim to capitalise on the differentials of the asset class – one that produces frequent valuation mispricings that come in many different forms.
By their very nature, EMs are constantly evolving in terms of their composition, and there are frequent changes related to domestic politics as well as geopolitical factors. Add structural changes and credit factors into the equation and you get an idea of the opportunity set to regularly identify high-quality stocks that can present themselves to us at attractive valuations.
Such is the ever-changing nature of EMs and the sheer range of opportunity, we can be confident of finding enough companies that meet our criteria to fully populate our portfolio. Then, if we focus on stocks with high implied volatility – suggesting that the worst is already reflected in the prices – then we take the view that the upside for our selected stocks is extremely attractive relative to the potential downside.
We employ a combination of bottom-up stock selection with an element of top down, using an ESG overlay, in tandem with strict portfolio risk management and disciplined portfolio construction. The latter is particularly important in EMs as one country – China – makes up 28%-30% of the index weighting, meaning that any poor decisions investors make there might require good decisions in 10 other countries to make up the lost ground.
And being style agnostic has helped to cushion us from some ‘black swan’ events that have impacted on some EMs over the years, aided by our top-down overlay that has steered us towards buying high quality stocks with the added attraction of also being in undervalued currencies and improving credit environments.
Tapping into sustainability opportunities in EMs
One opportunity set that we believe is set to grow massively in EMs is sustainability investments.
For all the incredible innovation going on in the world towards building a global environment of lower emissions and a cleaner carbon environment, we simply cannot build a cleaner world environment without addressing the issues and opportunities in EMs.
Given the emergence of a growing consumer class across EMs – not least in India, which has just overtaken China as the world’s most populous country with a population of 1.4 billion, half of whom are under 30. Suffice it to say that any projected environmental savings achieved by Europe or the US are likely to be more than offset by increases in the carbon footprint of China, India or many other fast-growing EMs.
So the scale of both the problem and the investment opportunity is huge, in our view. And by investing in sustainability-focused companies that meet all our other criteria for selection in our EM portfolios, we believe investors can become part of the solution.
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