Editor's note: In today's final instalment of Morningstar's roundtable on emerging markets, the managers discuss their funds' strategies and exposure to these high-growth markets. Our panellists: Chuk Wong, vice-president and portfolio manager at Goodman & Co., Investment Counsel Ltd., which sponsors the Dynamic family of mutual funds; Thomas Pinto-Basto, associate portfolio manager and a member of the global equity team at AGF Investments Inc.; and Chris Arbuthnot, a Boston-based portfolio manager at Manulife Asset Management (U.S.) LLC and a member of its intrinsic-value team. The moderator was Morningstar columnist Sonita Horvitch, whose three-part series began Monday, followed by part 2 on Wednesday.
Q: Time to discuss your disciplines and portfolios.
Pinto-Basto: We are bottom-up stock pickers and we continue to find great companies trading at reasonable valuations in the emerging markets, despite my caution about these markets as a whole. We are growth-at-a-reasonable-price (GARP) managers. We have a three- to- five-year investment horizon.
Arbuthnot: We are bottom-up stock pickers. We use a value approach in developed countries and a more GARP approach in emerging markets. We look at the companies' fundamentals, but do layer a macro view on top of that. In emerging markets, a margin of safety is particularly important. We are not necessarily investing in the cheapest or the most distressed stocks in emerging markets. We look for high-quality companies with great management and good reinvestment opportunities. These are not necessarily the cheapest stocks. We look out three years.
Wong: I am a value manager and stock picker, but I do pay attention to the macro picture in the countries I invest in. My job is to exploit inefficiencies in the global markets. Emerging markets are a lot better researched than they used to be. Big-cap stocks, well known companies like Petro-China Co. Ltd. PTR and China Mobile Ltd. CHL are well researched and probably trade at good, if not high valuations. But if you look at the second-tier or third-tier stocks in emerging markets, there is still a lot of value to be found in under-researched situations.
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| Chuk Wong: Emerging markets are a lot better researched than they used to be. | |
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Arbuthnot: There is a lot more money flowing to emerging markets and this typically goes into the big, benchmark names reinforced by the ETFs (exchange-traded funds) on these indexes, rather than into the second-tier companies. This is where the inefficiencies and opportunities arise.
Q: Please discuss your global portfolios.
Arbuthnot: In Manulife Global Opportunities Class, the emerging-markets allocation ranges between 25% and 40%. Currently we are about 33% to 34%. My biggest weighting is in Brazil with 13.5%, India is 11%, China represents 5% and we have zero exposure to Russia. The BRICs collectively represent about 28%. I have roughly 50 names in the portfolio. We have reduced our holdings in Brazil, as some of the names have done well. It is a bottom-up approach and not a macro call about Brazil.
Our biggest holding in Brazil is OGX Petroleo NM. It is an energy company that has excellent offshore oil and gas assets. Eike Batista, who is one of the wealthiest people in the country, controls OGX. There is a big catalyst on this stock. Batista is selling off minority stakes in some of OGX's exploration blocks in its Campos Basin assets, probably in the next six months.
Pinto-Basto: We own Petroleo Brasileiro SA PBR. As for OGX, Batista has created a number of successful businesses in Brazil.
Wong: In Dynamic Global Value, we have 40% in emerging markets. The four BRIC markets represent about 21%. It is a concentrated portfolio of 50 names. I like to own locally listed pure plays, for example, China's 361 Degrees International Ltd. which focuses on mid-market sporting goods including running shoes. It has 7,000 retail outlets in China and covers the whole country. In the next five years, there will be a huge number of people in China entering the middle class and not everyone will wear Nike or Adidas.
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| Chris Arbuthnot: Second-tier companies are where the inefficiencies and opportunities arise. | |
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The latest addition -- we do not change the portfolio very much -- is a controversial stock, the Agricultural Bank of China or ABC. It's a commercial bank. The stock was listed in July. The bank had 25% of its loan portfolio in non-performing loans five years ago and this caused concern. But, like the other state-owned banks, ABC was told by the government to lend money to financially distressed enterprises in the '90s. But like the others, it went through a restructuring and now is a normal commercial bank. ABC is exposed to the fastest growing western part of China. At the time we bought the stock a few months ago, it was a steal.
Q: Thomas, please discuss the weighting in the BRIC countries in your emerging-markets portfolio.
Pinto-Basto: In AGF Emerging Markets , we have nothing in Russia, 14% in Brazil, which is an underweight relative to the MSCI Emerging Markets Index, 18% in China/Hong Kong, a market weight, and 10% in India, a slight overweight relative to the index. Of the total emerging-markets portfolio, we have about 42% in the BRICs. We have 30 companies in the BRICs out of total holdings of 77.
A recent addition to the portfolio is Bharti Airtel Ltd., a telecommunications company in India. It is a dominant wireless operator in the country and the market is growing. It has its infrastructure spending in place, which is a plus. A company's ability to generate free cash flow is important to us. Cash-flow return on capital employed is a key component of the screens that we use.
Arbuthnot: Mobile penetration is so very low in India.
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| Thomas Pinto-Basto: There are some transparency issues. You need to do your due diligence. | |
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Pinto-Basto: In emerging markets, finding the growth is a little easier because of the fundamentals that we have been discussing. There are some transparency issues, depending on which market you invest in. You need to do your due diligence.
Q: What percentage of their total equity portfolios should Canadian investors have in emerging markets?
Pinto-Basto: Conservatively 5% to 10% of a portfolio can go into emerging markets directly. It comes back to the basic principles of risk tolerance, investment time horizon and objectives. If the retail investor is very aggressive, he or she can go up to 15%.
Arbuthnot: If your time horizon is more than five years, say 10 years or longer, you are going to do on a relative basis very well in emerging markets versus developed markets. The developed economies are going to have low economic growth for the foreseeable future. They face real headwinds. You can see the growth in emerging economies. Does that translate into higher stock prices? The longer the horizon, the more confident you can be.
Q: In summary, the case for emerging markets?
Wong: We are entering a new paradigm where emerging economies are taking the driver's seat and the mature economies, the passenger's seat. The volatility gap between the two markets is narrowing. The growing middle class in the emerging economies is an important development. From a global stock picker's perspective, there is more opportunity to find good companies before they become great in the emerging world, than in the developed one.
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