Editor's note: In today's part two of coverage of Morningstar's emerging-markets roundtable, the managers discuss how they're investing in the three largest emerging markets, led by China.
Our panellists:
Chuk Wong, vice-president and portfolio manager and long-time member of the global equity team at 1832 Asset Management L.P. He has a wide range of mandates including Dynamic Global Value, Dynamic Global Value Class, Dynamic Far East Value and Dynamic Emerging Markets Class.
James Upton, senior portfolio strategist and chief strategic officer for the Global Emerging Markets Team at New York-based Morgan Stanley. The firm's extensive emerging-market mandates include TD Emerging Markets.
Matthew Strauss, vice-president and portfolio manager at Signature Global Asset Management, a division of CI Investments Inc. Strauss provides macroeconomic strategy on foreign exchange and is a specialist in emerging markets. His responsibilities include CI Signature Emerging Markets.
The discussion was convened and moderated by Morningstar columnist Sonita Horvitch, whose series began on Monday and concludes on Friday.
Q: China, the largest emerging market?
Upton: From 2004 to 2008, the ratio of debt growth to GDP growth in China was one to one. Since the global financial crisis in 2008, it has taken about four dollars' worth of debt in the economy to obtain one dollar's worth of growth. History shows that when a country's credit growth exceeds its GDP growth at this rate, the result is a slowdown in the economy's growth rate. China could slow to as much as 2% lower than the current expectations, which are calling for 7.5% per annum growth.
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| Chuk Wong | |
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Wong: China is bound to enter a slower growth phase in the next few years. The kind of growth that we saw in the 2000s is not sustainable. China was growing its GDP by double-digit percentages every year for some seven or eight years. There are some pockets in the economy where there is overinvestment. This creates problems, but it might also help China longer-term. Look at the United States and its overinvestment in infrastructure 100 years ago. My take on China is that the country's overinvestment in infrastructure will help it to continue to differentiate itself from many of its peers.
Strauss: It's important to look at China's rebalancing of its growth model. It had focused its investments on heavy industry to promote exports. China has acknowledged the need to focus more on the domestic economy and the consumer. China's weaning itself off its high credit growth will slow its economic growth. As discussed, if the slowdown happens quickly, this would negatively impact sentiment. We think that China's slowdown will be gradual. It will manage through this deleveraging, rebalancing process.
Wong: High economic growth in a country does not mean that you can make good returns on the stocks in that country. You have to look at the merits of individual companies. Even if China's overall GDP slows down, individual sectors will still do well. For example, retail sales in China are still growing at double-digit rates per year. That is one area that investors can look at. There is a need for caution about those industries where there is overcapacity, such as coal and steel. Also, there might be infrastructure overbuilding in some regions. You have to be cautious about these companies, as their return on their investments is declining. I caution about focusing only on one or two macro numbers, such as industrial production and the Purchasing Managers Index in assessing China's investment opportunities. I also look at a range of key indicators such as consumption and tourism.
Upton: In our process, we integrate top-down and bottom-up analysis. We make rigorous country-allocation decisions. In stock selection, we focus on growth and on companies that are committed to their shareholders. We have 140 names in our core global EM equity portfolio. Some 13% of our portfolio is in China, versus its 19.5% weighting in the MSCI EM Index. It is our biggest country underweight. We like the new China, information technology, health care and consumer names. Some of these companies are well run, have great profit margins and are catering to the growth areas within China. We are growth investors.
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| James Upton | |
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Wong: I don't have any information technology in China because of valuations. I am a value manager and stock picker, but I do pay considerable attention to the macro picture. I currently have 55 names in Dynamic Emerging Markets Class.
Strauss: We like the growth in the IT sector, but we are cautious about valuations in the sector. If one has to characterize our style, it would probably lead to growth at a reasonable price. We own more than 100 names in CI Signature Emerging Markets. Our process involves a combination of top-down and bottom-up analysis.
Wong: As a contrarian and value investor I have been gradually increasing the weighting in China. It's a cheap market. China is trading at nine times earnings, which is a discount to the world and to emerging-market peers. It used to trade at a premium. I have almost 20% in China in Dynamic Emerging Markets Class.
Strauss: We're a tad overweight China, which constitutes some 20% to 21% of the portfolio. One of our investment themes is the beautiful China, which includes energy conservation and clean air.
Wong: My portfolio's largest position in China is MGM China Holdings Ltd. We have held it for three years. It has done well and its valuation is less compelling. It's a pure play on Macau gaming.
Strauss: Macau is an important play. We have a different name, Galaxy Entertainment Group Ltd. It's in the top-10 holdings in CI Signature Emerging Markets.
Q: South Korea, which represents 16% of the benchmark?
Upton: This was a relative outperformer in emerging markets in 2013. We've been fans of South Korea for some time. We're close to market weight and it's our biggest absolute country weight in the global EM portfolio. There are good companies to invest in. The country has a high standard of research and development, akin to anything in Western Europe and the United States. It has value-added companies. A perfect example is Kia Motors Corp., which is doing well in both the emerging and the developed markets.
Strauss: We own Hyundai Motor Co. Ltd. for the same reason. One of my biggest holdings is Samsung Electronics Co.
Upton: It's one of my biggest holdings too.
Strauss: Samsung is a well-run company. It's more diversified than Apple Inc. AAPL. Samsung's products are sought after in Asia. In the rest of the globe the battle between Samsung and Apple continues.
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| Matthew Strauss | |
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With investors getting increasingly worried about current-account deficits in emerging economies given the change in global liquidity, South Korea stands out with a healthy current-account surplus. It's not surprising that within the emerging-market realm, its currency did pretty well last year.
Upton: South Korea's income per capita is US$24,000 per annum, which puts it among the top emerging-market countries.
Wong: I used to be enthusiastic about South Korea back in the 2000s. Over time, I have trimmed my exposure, as valuations were no longer as compelling. Developments in North Korea raise concerns about the political stability of the peninsula. The new leader in North Korea is a hardliner. Another concern is the impact of the weakening yen on South Korean companies, which tend to compete head to head with Japanese companies. In the past, the strong yen had given South Korean companies a competitive edge internationally.
Strauss: I am also underweight South Korea. It's an export play.
Q: Taiwan, which represents 12% of the MSCI Emerging Markets Index?
Upton: It also outperformed the index in 2013.
Strauss: For us, it's an export play, even more so than South Korea. We focus on Taiwan's role in the information-technology supply chain. One of the largest holdings in CI Signature Emerging Markets is Taiwan Semiconductor Manufacturing Co. TSM.
