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Emerging Market Equities – Tim Love

As with global equities, emerging market stocks have been swept up in the artificial intelligence (AI) momentum. However, Tim Love looks beyond that to the opportunities within the reshoring theme and discusses the catalysts that could spark a long-term outperformance in emerging markets.

What were the major recent events and impacts on your asset class?

Emerging market equities have had a reasonable year to date up to just before the half year end, 27th of June, 4% up in dollars. That's nothing to write home about, but it's with the drag of China, which is 30% of the index, down 5% in that period. So there's, as always, a heterogeneous and a multifaceted answer to emerging markets. Has it been a good year? Well, compared to the Dow up in the same period 2%, yes. Compared to Nasdaq up 29% in the same period, no. Have there been parts of emerging markets which have kept up with the more AI momentum growth at a reasonable price (GARP) component of developed world? Yes, there have been. If you're looking at as an example, Taiwan up 19% or Korea up 16%, there's large parts of those markets which are being very influenced by the AI momentum that has caught fire on Nasdaq and dragged the S&P up. So, yes, it's all about alpha. It's all about stock selection. It's all about asset allocation. In terms of sectors, it's even more apparent that where IT is up 19%, but the value side of the market, such as an example, the energy up 7% or indeed some of the industrials up 3% or the financials on the steeper yield curve up 7%, lagged that IT component. But they were still better than the expensive defensive areas such as your utilities, healthcare or staples, which are actively down in that period. So a large discounting, if you like, of global growth coming back at some juncture after the pivot, the peak of interest rates and some sectors discounting that too far too fast, others consolidating their gains from last year and giving back some in absolute terms and some which are moved materially so by this AI momentum.

What can your asset class offer in the current environment?

I think for investors looking at frontier market exposure or secondary stocks, there's a lot of opportunity. Vietnam, Argentina, Romania or indeed some of the onshoring, reshoring opportunities in northern Mexico are all very much in that group. Secondary opportunities in the better governance plays of India, the more liquid secondaries, again, excellent hunting opportunities to go after. I think the bifurcation of world supply chains, the bifurcation of people's mindsets between Western liberal democracies and that of command economies is not necessarily a plus or a minus, but it's very much there. And as such, I think supply chains are hedging the bets and reshoring / onshoring / nearshoring is very much a theme which will capture the imagination, I think, of Western allocators for the next 5 to 10 years.

What is your outlook in the near and medium term?

I think emerging markets overall are, as always, under-loved, under-owned and undervalued and no more so now than ever. The portfolio itself that we're running is cheaper now than it was in 2004, before the massive rerating that it achieved between 2004 and 2008, which was the last meaningful outperformance of emerging markets (EM) versus developed markets (DM) on the books. We've had 15 years of choppy sideways and de-rating since then, which is illogical in some respects because you've had the earnings continue to grow and prospective earnings 16% to 18% for emerging markets is not shoddy and would justify a rerating from a portfolio valuation of 9.5 price/earnings ratio (PER) or indeed an index one of around 11. With returns on equity (ROE) of above 15% and a dividend yield well covered of 3.5 on a group of countries where the top eight out of the top 10 are investment grade now, unlike 2004, where only six were or even five in those days. It's a different offering. The earnings themselves are more resilient, modern facing, much more in the AI, robotics or indeed cyber area or consultancy, a much higher value add chain contributions, much more consistent, much more able to be a centre of excellence and compete with DM and much more integrated to DM supply chains. So in that sense, why would an asset class go sideways for 15 years when they were rewarded for that in the DM but not in the EM? I think there'll be a rerating and a material one at that, like it was in 2004 and it went on for four years and it was a monstrous outperformance to DM. So with that backdrop on the secular, what's the catalyst? It's normally liquidity related. Why would people go into a perceived, and perception is nine tenths of reality, a perceived higher risk asset class? The answer is if indeed the reality is one which is easily intangibly certifiably illustratively shown to be good on its earnings, cheap on its valuations and under owned, then that passive money and indeed that active money will come flying back in and that de-rating will evaporate. So in that sense the catalyst would be a peak in in the dollar, a peak in obviously the interest rate cycle and the recognition of the investment grade, the cross asset class attraction, the value, the growth, the yield attraction domestically and the domestic demand angle, which people are totally ignoring, i.e. the birth of a lot of pension funds and a lot of these emerging markets which themselves will stabilise and then inculcate a degree of a buffer, if you like, for foreigners leaving, it will be the slack will be picked up by domestics. And so liquidity and not being so prone to passive international hot money, but much more domestic, longer term institutional money. And that's happening in a lot of these markets. And so a buffer on liquidity, a secular and a cyclical confluence of activity, of valuation. And in sum put all that together and I think you've got an incredibly good longer term story.

Is there one chart you’re currently monitoring closely?

I think when a lot of emerging market real rates start to roll over and come back down as their domestic inflation rates fall faster than we're seeing in a more sticky world of inflation in the developed world, I think that would be a tremendously positive sign. Brazil's one of those where inflation has come down much quicker. It went up, the SELIC (Brazilian federal funds) rate went up, the domestic discount rate went up much higher and faster than the developed world initially. Perhaps a lesson and a guide for developed world central banks. But they never went into negative real rate territory, never went into quantitative easing (QE) territory, so they were more orthodox in nature. But as you see there, domestic inflation and core inflation fall faster. That's a tremendously positive sign for a crossover between allocations domestically from Brazilian pension funds in fixed, back into equity. And that will catalyse a rerating, whether it's that market or Mexico, it's a very similar story. So yes, I think that's one that I would look at core domestic inflation, real rates coming down, continuity of credit being solid on its transition to being ever higher investment grade and real effective exchange rates continuing to be very attractive. I mean, they are egregiously cheap in some of these countries after the geopolitical knock ons that you've had. So I think if you see global growth even begin to level off at the lows, if you see passive flows come back in and you see the cross asset class attraction for emerging markets, they're the kind of things that I would be looking at very closely and monitoring on a chart by chart basis daily.

Important disclosures and information
The information contained herein is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained herein may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information contained herein. Past performance is not an indicator of current or future trends. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice or an invitation to invest in any GAM product or strategy. The securities listed were selected from the universe of securities covered by the portfolio managers to assist the reader in better understanding the themes presented. The securities included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers.

No guarantee or representation is made that investment objectives will be achieved. The value of investments may go down as well as up. Past results are not necessarily indicative of future results. Investors could lose some or all of their investments.

References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in indices which do not reflect the deduction of the investment manager’s fees or other trading expenses. Such indices are provided for illustrative purposes only. Indices are unmanaged and do not incur management fees, transaction costs or other expenses associated with an investment strategy. Therefore, comparisons to indices have limitations. There can be no assurance that a portfolio will match or outperform any particular index or benchmark.

This presentation contains forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of GAM or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made.

Tim Love

Investment Director

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