Editor's note: In today's second instalment of Morningstar's roundtable on emerging markets, the managers debate the prospects for the BRIC countries (Brazil, Russia, India and China). 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 discussion was moderated by Morningstar columnist Sonita Horvitch, whose three-part series began Monday and concludes on Friday.
Q: Time to talk about Brazil, Russia, India and China, starting with China.
Pinto-Basto: The Chinese model is the right one for the country. We are about to get the 12th five-year plan in the spring. The deliberate way that China has evolved is the right one for the economy. The next stage will be a greater degree of industrialization. There are risks. We have touched on inflation.
Wong: Given the strong, unexpected performance of the economy, the People's Bank of China has raised interest rates and is expected to raise rates a few more times. It is good to see China manage its economy a lot better. It is growing its economy at 10% to 11% a year, but is looking to have more balanced growth, driven not only by exports and investment, but also by domestic consumption. Going forward, the GDP growth will be more like 8%. China remains fundamentally attractive. I am excited about the less developed areas in western and central China. From a stock perspective, there are not too many pure plays on this. One example that we own is Sichuan Expressway Co. Ltd., which constructs and manages expressways.
Arbuthnot: I am cautious on China. Something does not add up. I am not saying that the country will have big problems. But China seems to start with the GDP number and work backwards. In 2009, every other economy was in a recession, bank-loan balances were not increasing significantly, but China had a huge spike in loan growth. I worry that there is a capital-allocation problem. I am finding better opportunities in other BRICs. But I recognize that from a valuation perspective, China looks attractive.
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| Chris Arbuthnot: I am finding better opportunities in other BRICs, but from a valuation perspective, China looks attractive. | |
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Pinto-Basto: What Chuk touched on is important. There is more to China than just the coastal region. It is not just Beijing and Shanghai. The development is moving into the central provinces. Also, the coastal region is starting to recognize the responsibility of allocating capital properly. The main risk that I see is that China has to grow its economy fast enough to maintain social stability.
Wong: This is key. In response to Chris's comments, I was concerned a year ago about China, with a 30% loan growth. When we look at China, we cannot look at it from a western perspective. It is not a market economy. We are dealing with an economy with a certain degree of state intervention. About a year ago, the Chinese banking regulator realized that credit was growing too fast, so it asked the state-owned banks to increase their capital.
Arbuthnot: But non-performing loans in China were down in 2009, whereas in other economies, they went up. You have to query this.
Wong: Loan quality is an issue and that is why the policy-makers were responding to this. China's GDP numbers are an area of dispute. I look at other metrics like power consumption and export figures, which are more reliable and more indicative of China's growth. The key for China is whether it can elevate itself to the next level. It must move up the value-added production chain.
Q: What about India?
Arbuthnot: It could grow 8% a year for the next 15 to 20 years. Per capita GDP will probably triple within eight to 10 years. India and China had the same GDP per capita in 1990. Now, China's number is three and a half times that of India. India is the world's largest democracy with the largest English-speaking population after the United States. Some 42% of the population is under 15. The working population is going to expand by 140 million people within 10 years. It has a stable and transparent currency system. There is a lot more money being spent by companies on infrastructure, which will benefit productivity. The stock market is not cheap, but the growth is there. There are limits on foreign investment in Indian stocks and this can cause liquidity issues. I am finding great businesses in India, with phenomenal management.
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| Chuk Wong: India is the next China -- perhaps a better China. | |
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Wong: India is the next China -- perhaps a better China. As a value investor, I have difficulty finding very cheap stocks in India. If you are willing to look at second-tier and third-tier stocks, you can find some opportunities. I find that the Indian managers are world class. A negative is that India is running a twin deficit, a fiscal and a current-account deficit. That is a risk.
Pinto-Basto. I am more cautious in my discussion with managers of Indian companies than with some other emerging-markets managers. There was a big blow-up a couple of years ago. It was Satyam Computer Services Ltd. Its chairman was involved in a massive accounting fraud. My problems with India are its inefficiencies and the questions about governance at all levels. There is government meddling in projects and in an inconsistent manner. India has enormous potential, but can it execute? My concerns are at the macro level. We have been finding good opportunities in India.
Q: Russia?
Arbuthnot: There is a corporate-governance risk, which is hard to quantify. We believe there are better opportunities elsewhere, even though valuations in Russia are attractive.
Pinto-Basto: Part of our approach is looking for companies that create shareholder value. When you look at Russia as a market, it is actually a destroyer of value. Adding to what Chris was saying, we have an issue with the rule of law in Russia. We also are finding better opportunities elsewhere.
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| Thomas Pinto-Basto: Brazil has a relatively stable inflationary environment. The country has invested in its people, in education. | |
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Wong: The other issue with Russia is that the trading in the stocks on local exchange is not transparent. This is another reason why we are not excited about Russia, despite the fact that it is one of the cheapest stock markets in the world.
Q: Brazil?
Arbuthnot: We like Brazil. It is self-sufficient in energy, materials and agriculture. It has been through so many financial crises in the past that it was able to handle 2008 very well. The companies have good management teams with high insider ownership.
Pinto-Basto: In the last eight years you have seen 20 million people being lifted out of poverty into the middle class. We own a Brazilian stock called Lojas Renner S.A., which makes and sells clothing and apparel through a chain of stores aimed at the middle class. The country has invested in its people, in education. Brazil has a relatively stable inflationary environment. It has a lot of what China needs, such as pulp, iron ore, copper. But the country needs to simplify its complex tax structure. I am uncertain whether the new president, Dilma Rousseff, will tackle this.
Wong: The working class moving up into the middle class is important in Brazil. We own a real-estate company that focuses on building low-cost housing, Direcional Engenharia S.A. It is a smaller-cap. I think that Brazil is a good, long-term story and valuations are still reasonable.
Photos: www.paullawrencephotography.com
