• Defensive stocks have quietly outperformed over time, meeting key metrics like consistent earnings and dividend growth, low valuation multiples, and strong total returns. We think these businesses have proven resilient in challenging markets and may offer steady, durable earnings growth while being undervalued compared to the broader market.
• Defensive sectors like utilities, staples, and healthcare are trading at multi-decade lows relative to the S&P 500 and European indices, while market enthusiasm is concentrated in AI-driven stocks. This significant valuation gap creates a “coiled spring” effect, offering the potential for strong relative upside if valuations normalise, driven by steady fundamentals rather than speculative trends.
• Defensive stocks can provide stable cash flows, consistent dividends, and reliable earnings growth, making them attractive in absolute terms but particularly so in momentum-heavy markets dominated by speculative narratives like AI. We think their resilience positions them as a compelling investment for compounding returns over time, particularly if market leadership shifts and their weight in broad market indices normalises.

If asked to identify a stock that has achieved over a 500% total return, compounded earnings at an annualized growth rate of 10% or greater, traded at an earnings multiple of less than 15x, and maintained or raised its dividend for over 20 consecutive years, what names come to mind?

If you answered Microsoft, Apple, Alphabet, or Nvidia, you would only be partially correct. While each of these gilded tech names met at least one of those criteria, none satisfied all four metrics at the same time.

The companies that did were relatively boring, unglamorous staples and insurance names, like Kroger and Allstate. These businesses were not only durable in difficult markets but compounded through them, generating outstanding long-term returns for some investors while others seemed distracted by the market’s loudest theme.

Today, that distraction is AI. When one narrative becomes the market’s primary engine—with headlines, capital flows, valuations, and index weights all pointing in the same direction—we have found that opportunity often builds quietly where most investors are ignoring. Today, we believe the classically defensive areas within developed markets not only offer the potential for steady returns but also present a true “coiled spring” setup.

An underappreciated opportunity

A broad swath of defensive stocks is currently trading near multi-decade lows on key relative measures, notably their relative forward P/E and weight in the S&P 500. Meanwhile, index concentration has surged: today roughly half of the S&P 500’s market cap is tied to AI-related exposure, and the “Mag 7” alone represent approximately 35% of the index. This rally, supercharged since ChatGPT’s release in November 2022, has reshaped the index and widened the valuation gap versus defensives to create an opportunity we rarely see.

To characterize our view of a coiled spring setup, one helpful theoretical lens grounded in nearly 40 years of history is the relationship between defensives’ share of the S&P 500 and their coincident relative performance. Empirically, every 1% change in defensives’ share in the S&P 500 has tended to align with roughly 10% of relative performance. With defensives today representing about 17% of the S&P 500 versus a long-term average of 26%, that 9% gap implies a potential relative upside of 90% if the composition were to revert to the long-term average. While we do not underwrite that outcome, we view it as optionality on top of returns we believe are already achievable and attractive on fundamentals alone.

To be clear, we never buy anything on the basis of mean reversion. Our process is rooted in assessing business quality, visibility, and durability of earnings, and what we view as a reasonable path for generating high-single-digit to low-double-digit returns. That said, when gaps get this wide, we believe it is impossible to ignore that any normalization has the potential to be additive—and markets rarely normalize “politely.”

While the market is captivated by flashy technology, we are more galvanized than ever about staying true to our philosophy: high-quality businesses with durable earnings power at defensible valuations. In our view, the opportunity today is not chasing what has already been bid up, it is about owning what meets our minimum hurdle rate on fundamentals and can rebound sharply when capital rotates, concentration breaks, and valuations mean-revert. The current dispersion between defensives and the broader market does not just suggest upside; it suggests the potential for a swift, powerful snapback when the story changes, in our opinion.

Consistency beats trendy

Defensive stocks offer steady growth, high visibility, and attractive returns through dividends and buybacks, making them resilient investments often overlooked by the market.

While their growth may not match the rapid revenue or earnings expansion seen in companies like Nvidia or early-stage software businesses, it is consistent and almost formulaic. For instance, utilities like Duke Energy project long-term EPS growth of 5% to 7% through 2029 coupled with a ~4% dividend yield, delivering a total return potential of around 9% to 11% with minimal valuation risk, in our view.^[1]

But in momentum-heavy markets, steady and visible cash flows do not capture attention the way big promises of future profitability do. This is further underscored by the fact that AI narratives have been driving the market frenzy. Semiconductors, cloud, and data centre infrastructure businesses—among the most cyclical industries in the world—have become irresistible magnets for capital, as we have discussed at length in our Dotcom on Steroids series.^[2] Investors seem to be willfully ignoring their inherent cyclicality, chasing businesses trading at sky-high valuations on peak margins tied to AI trends with little regard for near-term profitability. Many names in these industries are now ‘priced for perfection,’ in our opinion, leaving no margin for error and setting the stage for significant disappointment when the inevitable CapEx spending slowdown arrives. We feel the disregard for these businesses’ historical boom-and-bust cycles is nothing short of reckless. But, as history shows, narrative-driven momentum can keep markets disconnected from fundamentals far longer than logic suggests, as seen in past bubbles including the dotcom era of the 1990s.

The dotcom bubble reached its height in early 2000, a time when US tech stock valuations were soaring, relying heavily on the promise of profitability rather than hard earnings. These valuations were fueled by a belief in the transformative power of the internet and favourable monetary conditions but overlooked traditional, yet frankly quite basic, fundamentals.

Then came the dotcom crash and bear market aftermath (March 2000 to October 2002), and that is when defensive stocks in the S&P 500 outperformed significantly, with some even gaining in absolute terms despite broader market declines.

While the S&P 500 index took around seven years to recover its peak value (until mid-2007, before another crash) and the tech-heavy Nasdaq took 15 years, defensive stocks experienced minimal losses and, as such, did not have a significant recovery period. For example, during the dotcom crash the S&P 500 plummeted 49% from peak-to-trough, but the consumer staples sector delivered 11.2% annualised returns, “a stunning outperformance of approximately 33 percentage points annually versus the broad market.”^[3]

Companies like Procter & Gamble, Coca-Cola, and Altria Group held their stock prices while businesses tied to the internet craze imploded, with Altria surging over 100% by December 2000 from the March 2000 market peak. Utilities as a basket generated nearly 50% total returns over that same period.

History does not repeat itself, but it rhymes, and so we feel excited about the opportunity to capture outsized absolute returns within defensives given their potential of generating an asymmetric payoff if the AI bubble unwinds.

Names that bring this opportunity to life

While we are not valuation-driven investors, we do believe valuations matter, particularly over the three- to five-year investment horizon we target, especially when they trade at extremes as they do today.

As we touched on earlier, defensive sectors like US utilities have been showing faster, more consistent, and more predictable earnings growth than they have in years. Yet, surprisingly, utilities are still trading at a meaningful discount to the S&P 500. This is despite delivering earnings growth that is historically in line with the broader index, in addition to boasting a solid ~3% dividend yield. We think this means that utilities should continue to meet our objective of compounding capital at a high-single-digit to low-double-digit rate, driven by earnings and dividends alone, without meaningful valuation compression risks.

In the same vein, consumer staples also look more attractive than they have in quite some time. Here is why: during COVID, these companies gained favour as consumer behaviour shifted toward spending on essentials like food-at-home and other goods to a level that came to dominate consumers’ wallet share for several years—while discretionary spending, largely tied to services, took a back seat. But when that trend started to unwind, it created years of relative underperformance for staples compared to the index.

Seeing this underperformance, many investors may have soured on staples, perhaps assuming there is something fundamentally wrong with the sector. The loudest critics point to structural challenges like shifting demographics, the rise of private-label brands, or even GLP-1s. All valid trends at the margin, but we think the real story is much simpler: it is about cyclical normalisation. In our view, select high-quality staples businesses have returned to high-single digit EPS growth and are now leaner, more focused, and positioned to thrive. Take Kroger, now trading at an approximate 12x EPS for fiscal year 2027, where we see a long-term earnings growth opportunity of 6% to 7% paired with a consistent dividend yield of 2.5%.

Kroger, in our view, is priced well below its fair value. It is benefiting from a low multiple, accelerating store openings in fast-growing markets, and new leadership which we believe is poised to guide the company successfully into the future.

We think insurance names also offer an attractive risk-reward profile, including stocks like traditionally ‘boring’ property and casualty insurers such as Allstate. Over the past five years, Allstate delivered an annualised total return of around 17%, beating the S&P 500’s 14% return over the same period. What is even more striking is that Allstate pulled off this outperformance while its valuation multiples declined from nearly a 17x peak back in 2023 to about 8x by early 2026—even in the middle of an AI-driven bull market.

To put it in pragmatic terms: ask a group of people to compare the perceived value of ChatGPT to auto insurance. While most people pay for and would pay more for auto insurance—even if rates increase or they lose their job—very few pay for ChatGPT, and far fewer would pay more if its price went up.^[4] That willingness to pay, especially in tougher conditions, is the quiet edge we feel that ‘boring’ insurers offer in markets as topsy-turvy as this.

Defensives at multi-decade lows even in Europe

Sectors like staples, healthcare, and utilities in Europe are, in our view, also offering an analogous “coiled spring” setup, with valuations at or near 20-year troughs relative to the MSCI Europe Index. The opportunity is not simply that Europe is cheap; it is that defensives have been de-rated for years, leaving a starting point that already discounts a lot of bad news, in our opinion.

As with the US, we feel European staples are beginning to get their mojo back in that they are benefiting from growth both on and off the continent. Companies like Unilever, British American Tobacco, and Danone, with significant emerging markets exposure, are particularly well positioned, in our view. Even though consumption growth in emerging markets has slowed from past levels, it is still expected to outpace developed markets, giving these companies a more reliable growth tailwind compared to most developed market cyclicals.

This resilience and adaptability are why we remain confident in staples, even amid concerns about the potential impact of GLP-1s. One may argue that these concerns are already priced in, given valuations are at a substantial discount compared to the broader market and their historical levels. While the claim that GLP-1s could impact consumer staples may hold some truth, in our view the market is being overly punitive and is ignoring these companies’ proven resilience and adaptability. Staples giants like Unilever and Danone have faced shifting trends before—from the backlash against sugary drinks to the rise of health-conscious eating—and emerged stronger by innovating. We think their massive advertising and innovation budgets, retailer partnerships, and control over prime shelf space give them a competitive edge over would-be new entrants. If GLP-1s shift consumption toward high-protein or functional foods, we believe companies like Danone, with expertise in dairy and nutrition, are well positioned to capitalize. And when indulgent categories like soda faced scrutiny, staples leaders reinvented with zero-sugar options and creative packaging, reigniting growth.

To be clear, we have also made the opposite call on staples when the risk-reward was unfavourable. In the summer of 2016, we wrote a paper titled “Do Multiples Matter?” on the sector’s valuation risks as we felt investors were overpaying for perceived safety near the start of what became a decade-long period of underperformance. This matters because it underscores that we are not dogmatic: today’s setup looks the opposite to us, with defensives de-rated to levels that make the asymmetry more compelling.

European bank valuations, by contrast, tell a very different story. While there are some solid franchises we like, the broader sector remains constrained by limited loan growth, especially since valuations in parts of the complex have inflated to their highest levels post the Global Financial Crisis.

The continent’s macro backdrop matters. Economic data is not getting better across European markets in a way that supports a broad, cyclical re-acceleration: unemployment rates in the UK, Germany, France, and Australia have moved higher versus three years ago, and housing in many markets looks worse, not better. Without clear economic tailwinds, it is hard to identify what will drive sustained improvement in credit demand, balance-sheet growth, and most importantly, earnings growth going forward.

Germany is a useful reality check on the European growth debate. As recent reporting has highlighted, the German economy has been stagnant for roughly three years and corporate stress appears increasingly broad-based, with rising insolvencies and notable closures across sectors.^[5] An environment like that is not the backdrop you want to rely on for a continent-wide bank re-rating that requires stronger loan growth; it is a backdrop we feel where stable cash flows purchased at washed-out valuations can become relatively more attractive.

We would also be more cautious on parts of European industrials. With a structural slowdown in China and the possibility that the data centre buildout eventually normalises, a number of industrial business models face meaningful downside if that incremental demand impulse hits a wall—especially where there is not a second driver to take the baton. In our view, the risk is that valuations are discounting high-single digit to low-double digit secular growth that may not be sustainable once the data centre cycle cools. This is why the longer-term valuation gap between defensives and cyclicals, such as utilities versus industrials, matters here.

Valuations speak for themselves

Due to faster growth in parts of the MSCI Europe Index, defensive sectors like utilities, staples, and healthcare trade at steep discounts relative to the broader market. That said, utilities, in particular, offer stable cash flows and play key roles in Europe’s energy transition. While there is more widespread optimism around them now, the relative valuation disconnect still helps frame why we think defensives can hold up well if macro uncertainty persists. Healthcare adds a different kind of durability, with ageing demographics and structurally rising healthcare spending supporting long-run demand.

Conclusion

While the market’s centre of gravity has shifted towards one story (AI), valuations and index concentration have moved with it, widening the gap between what is “exciting” and what is simply essential. That is precisely when we prefer to own businesses whose returns are driven by durable cash flows rather than perfect expectations.

Defensives today offer that setup in both the US and Europe: reasonable relative and absolute valuations, visible earnings growth, and meaningful capital return, without requiring heroic assumptions. In our view, this is a compelling paid-to-wait profile that can compound on fundamentals alone, with embedded optionality if market leadership broadens, the data center cycle normalizes, or the crowded trade unwinds. We do not buy on mean reversion, but when gaps get this wide, any normalization can become additive to already attractive expected returns.

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Notes:
[1] Duke Energy Third Quarter 2025 Earnings Report. 7 November 2025.
[2] GQG Research. Dotcom on Steroids Part III. 18 December 2025. Dotcom on Steroids: Part II. 21 November 2025. Dotcom on Steroids. 11 September 2025.
[3] ”Sectors and Stocks That Gained During the Dot-Com Bust.” Red Lotus Capital. 2 November 2025.
[4] Claburn, Thomas. ”OpenAI’s ChatGPT is so popular that almost no one will pay for it.” The Register. 15 October 2025.
[5] “Germany’s Economy is so Bad Even Sausage Factories are Closing.” The Economist. 15 January 2026.

Definitions: Earnings Per Share (EPS) is a measure of a company’s profitability, calculated by dividing quarterly or annual income (minus dividends) by the number of outstanding stock shares. The P/E (Price-to-Earnings) ratio is a valuation metric that measures a company’s current share price relative to its earnings per share (EPS), indicating how much investors are willing to pay for $1 of earnings. A high P/E ratio can indicate a company is overvalued, or that investors have high hopes for future growth. Conversely, a low P/E might suggest the company is undervalued or that it is expected to underperform.

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The United Arab Emirates and Saudi Arabia are poised to become influential economic centres

Key takeaways

• Emerging markets in the Gulf region and Turkey are attracting investors seeking new opportunities beyond the traditional Western economies
• The United Arab Emirates and Saudi Arabia are poised to become influential economic centres while Turkey also presents potential due to its strategic location and growing sectors
• While these markets are young and still carry risks, particularly from oil price dependency, their growth offers investors the chance for early-mover advantages in broadening their investment portfolios

New York, London, and Hong Kong have been the global financial, trade, and cultural hubs of the last century. That paradigm is widening to now include Abu Dhabi, and Riyadh, as well as Ankara as spheres of influence evolve.

We believe capital markets investors are increasingly looking at once unlikely new territories for the next generation of global investing opportunities since catalysts for growth in most western economies appear to be more limited.

The Gulf countries, once solely reliant on their oil exports for income, are now participating in sectors that were typically dominated by the Global North.

The United Arab Emirates is leading economic diversification by expanding into tourism, trade, real estate, banking, and finance. This process has been hyper-accelerated by a dual-track strategy based on strong property rights, safety and security of assets, and robust human capital due to its multiculturalism.  

The new spheres of influence

Turkey and the GCC countries

Saudi Arabia, which has been perceived by the West as one of the most socially conservative countries in the world, is undergoing a social change the pace of which is remarkable. With a young population of 37 million operating in a digitally connected world, the Arab kingdom is increasingly opening its society, fostering entrepreneurship, and diversifying its economy.

These Arab countries, as well as Turkey, possess massive growth potential and have increasingly important roles to play in the geopolitical sphere, in our opinion. Indeed, we believe they have been setting the stage to become the world’s new influential centers of economic and geopolitical gravity. Investors with the foresight and openness towards participating in these countries’ growth potentially have an early-mover advantage.

To be sure, the Gulf region has broadly dollar-pegged economies where fluctuations in oil prices can make or break national coffers. Growth is nascent and markets are young.

In our view, these emerging economies aren’t likely to replace traditional financial hubs but rather broaden the scope of investment opportunities.

Multilateralism prevails 

Given current geopolitical challenges—the US and Europe have frozen some national assets, most notably Russia’s—the race is on to explore new areas of relative safety, stability, and potential growth stories outside of traditionally western avenues. In this context, the UAE has been an obvious beneficiary of the global shift towards multilateralism, especially due to its solid financial sector, evidenced by banking assets.^[1]

It’s not surprising that by the end of 2023 a total of 102 asset management firms were operating in Abu Dhabi’s financial centre and another 125 firms including hedge funds and asset managers are expected to open their doors this year.^[2]

Saudi Arabia and the UAE are leveraging their location and wealth of resources not only to raise capital, but also to bolster their roles as important partners to global investors and governments alike.

India’s relationship with the Gulf states has evolved from one focused on trade and migration into a more ambitious, strategic, and deeper political, economic, and defense partnership. In fact, UAE and Saudi Arabia are India’s third and fourth largest trading partners behind the US and China.

Turkey is also playing a role as a NATO member, an intermediary in regional conflicts, and gate keeper of the critical Black Sea. 

Most recently, amid the unintended economic consequences of Russia’s invasion of Ukraine, Saudi Arabia and UAE have stepped in to ease shortages of energy in Europe and food in Africa. Meanwhile, Turkey plays a balancing act of maintaining relations with both Russia and the West.

On the one hand, Ankara supplies military support to Ukraine and secures Kiev seaborne exports while adeptly blocking Russia from beefing up its Black Sea fleet from outside, or from moving warships in the Black Sea back into the Mediterranean.

 On the other hand, Turkey never went along with the West in imposing sanctions on Russia. On the contrary, it’s now the third largest buyer of Russian crude, behind China and India, and has thrown Russia an economic lifeline by being a hub for their oil and gas exports to Europe and beyond.

What’s more, a USD $1 trillion economy, Turkey has been growing at a faster pace than the Euro Zone. It’s GDP (on an inflation adjusted basis) will have risen by over 150% through the end of 2028 based off IMF estimates versus where GDP levels stood at the end of the 2000s decade. That compares to the Euro Area which will have grown by a fifth of that amount, or roughly 30%, over the same time period.

In this environment, as the world’s geopolitical and economic order expands from West to East, we believe it’s more important than ever to own equities where the interests of strong corporates and stable public policymakers are aligned. 

Investments rise

Both the UAE and Saudi have seen a rise in foreign flows into the financial services sector on the back of heavy investments in technology, tourism, renewable energy, real estate, and infrastructure. The region has also increased investments in private equity and venture capital to help existing local businesses expand in a move towards diversification.

Qatar, one of the world’s three largest liquified natural gas exporters along with the US and Australia, has also been playing a strategic role by offering a lifeline to European and Asian countries that were cut-off from Russia’s gas.

Saudi Arabia’s influence has evolved and strengthened. Once an oil-dependent closed economy, the kingdom embarked on a decades-long reform program starting during the reign of the late King Abdullah.  The pace of reform accelerated significantly with the ascent of King Salman to the throne in 2015, the year the country ran a record budget deficit  due to a global oil supply glut. Soon after, the nation launched a vigorous and highly ambitious social and economic reform program with a vision not only to wean its dependency from oil exports, but also to transform the Kingdom and to propel it into the future with a renewed sense of self-confidence. 

The UAE, with only 1.1 million Emiratis, has benefited from hosting the other 9 million or 88 per cent of its population, the majority from South Asia and having participated in much of the country’s growth. Most recently around half a million Russians have landed in Dubai and Abu Dhabi—especially after that country’s conscription—filling shops, hotels, restaurants and becoming foreign buyers of real estate.

And yet, so far 40 per cent of global emerging market funds don’t have exposure to UAE equities, and half don’t have exposure to Saudi Arabia or to Turkey. These countries have what we consider to be quality businesses at reasonable valuations.

Global emerging market funds positioning

Conclusion

As spheres of influence evolve and the face of global investment shifts at a more rapid pace, we need to keep our eyes wide open to the positive potential and new dynamics in an increasingly relevant part of the investment world.

As investors seeking growth opportunities outside of developed markets, we believe non-traditional emerging economies, such as the UAE, Saudi Arabia, and Turkey, are fertile areas of exploration.

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Notes:
[1] Jimenea, Adrian and Taqi Mohammad. “Middle East and Africa’s 30 largest banks by assets, 2023”, S&P Global Market Intelligence, April 26, 2023.
[2] “Abu Dhabi: The Capital of Capital Ends 2023 with ADGM as the Region’s Fastest-Growing IFC”, ADGM, March 6, 2024.

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• Europe is experiencing challenges typical of emerging markets, including energy insecurity and increased government intervention, which threaten its long-term industrial and technological competitiveness
• European nationalisations, windfall taxes, and fiscal deficits resemble emerging market conditions and may deter investment, exacerbating energy supply issues and economic instability
• In contrast to Europe’s regressive policies, countries like India and Brazil are adopting reforms that promote economic growth and create a more favourable business climate

A place plagued by energy insecurity, nationalisation of power infrastructure, windfall taxes, price controls, and large fiscal deficits. No, we are not referring to a small, politically unstable country in Latin America, but rather these events describe what has transpired in most of Europe over the last few years.

We have written much about the reforms in many emerging markets like India and Brazil, which have led to resilient economic growth after a decade of stagnation. In contrast, we have witnessed the opposite in Europe, where politicians are trading structural growth for quick political wins. This behaviour will likely undermine European competitiveness in industry and technology over the longer run. We find it challenging for even the best management teams to succeed against global competition if they are hamstrung by energy insecurity, windfall taxes, and regulatory interventions.

Energy insecurity

Europe’s overdependence on imported natural gas and renewable energy sources that are only intermittently reliable has led to significant spikes in power prices over the last few years and associated demand destruction. Natural gas is a critical feedstock into many industrial processes as well as electricity generation. Prior to the invasion of Ukraine, Europe imported ~40% of its natural gas requirements from Russia. Ironically, if Germany had not decided to shut down most of its nuclear capacity a decade ago, they would likely not be in the current scenario where their manufacturing base is so dependent on imported natural gas.

Power prices began to spike in early 2022 due to the supply shock, driven largely by the reduced imports of Russia natural gas (~10% of European gas supply). Although prices have significantly declined in 2023, this is not necessarily good news as lower power prices have largely been caused by demand destruction. In the first half of 2023, European (EU) electricity demand fell roughly 3% to 1,261 Terawatt hour (TWh), the lowest since at least 2008 for current EU member states (S&P and IEA).^[1,2]

A variety of heavy industry businesses have been most impacted by the higher energy costs. Depending on the subsegment, most industrial supply chains have seen a 10-20% decrease in industrial gas demand including industries like chemicals, refining, food and beverage, as well as pulp and paper which are at the heart of most industrial economies. We believe that signs of such significant basic industrial demand destruction are a major cause for concern. In our view, it is not an exaggeration to say that Europe is de-industrialising.

Nationalisation of energy infrastructure

The issues around energy security have led to heavy-handed government interventions. The rapid rise of natural gas prices led to the German gas utility Uniper becoming insolvent, requiring a 15 billion EUR bailout by the German government. Despite the nationalization, the core issue around the lack of natural gas availability has not been solved. In a similar scenario, France also decided to nationalise its nuclear utility EDF, trampling on minority shareholders in what was effectively a “takeunder.” While these countries have been prioritizing a green agenda, we believe these policies need to be based on rational thinking and not utopian visions. Many of these European countries have neglected baseload power, which cannot be solved easily by green technology, and have put their longer term industrial base at risk, leaving an overdependence on imports from Russia.

Broadly, these nationalisations remind us of the re-nationalisation of YPF in Argentina in 2012, which was then the largest energy company in the country. To this day, Argentina remains in an energy trade deficit which has caused major current account issues over the last decade. The Vaca Muerta shale basin was once talked of in the same vein as the Permian basin in the US. However, politics have relegated the latent energy resource potential to just that, failed potential. Nationalisation has not solved the fundamental issue of energy security in cases like Argentina, and we doubt that nationalisations in Europe this time around will solve the crux of the issue: energy supply.

In contrast, Brazil recently privatised their biggest utility (Eletrobras) and India is looking to open up its electricity distribution to private players for the first time.

Windfall taxes and price controls

Coupled with energy insecurity, politicians have felt a need to enact the classic playbook of both arbitrary taxation as well as price controls. We know that both tools, while popular politically, tend to reduce supply. We think these actions will produce short-term political gain but may result in longer term pain. The table below shows a few examples of the windfall taxes we have seen over the last few years. Of note, this is not a comprehensive list and excludes many of the smaller European countries. While there are certain instances of tax-friendly policies (France recently reducing corporate income tax from 33% to 25% as an example), we are struck by the breadth of unfriendly windfall taxes over the last two years.

We find it ironic that many of the power and utilities taxes will directly apply to renewable energy generation. While Norway has been the most explicit in directly taxing wind farms an incremental 35%, the UK is effectively placing an incremental 45% tax on any future renewables development. In this context, we are not surprised by the complete failure of a UK offshore wind auction in September 2023, given the heavy-handed treatment, coupled with rising construction costs in the renewables space. In other countries such as Germany, auctions are still proceeding, but the most recent August 2023 auction saw capacity awards decrease sequentially even though Germany needs to triple its renewable capacity by 2030 to meet their internal targets. Already, we are seeing the negative impacts of heavy-handed government policy.

This behavior is, again, in contrast to what we see in India and Brazil. Over the past decade, Brazil and India have moved towards opening up their respective energy and utility sectors. Brazil’s government now compensates its state-owned oil company (Petrobras) for taking non-economic decisions. For example, in 2018, the government responded to a trucker’s strike by cutting diesel prices but paying Petrobras the difference. Similarly, India has been slowly linking domestic energy prices to global prices. Earlier this year, the government approved a new natural gas pricing policy allowing domestic prices to be reset on a monthly basis rather than every six months. These two countries have some of the best energy and power supply growth globally. We are not surprised.

Fiscal deficits amidst an inflationary environment

Amidst the chaos of COVID and the Russia-Ukraine war, the EU has adopted aggressive fiscal measures. Since 2020, the fiscal deficit across the EU has ranged from 3% to 7% depending on the quarter. Unfortunately, these levels of fiscal deficits look uncomfortably close to many oft-criticized emerging market economies. We don’t see any natural ‘brakes’ on such reckless spending.

Fiscal Deficit

While we are not explicitly predicting a crisis (although some macro investors would remark that this appears to be a setup for a balance of payment crisis), we believe the risk of an external shock increases in these circumstances with high fiscal deficits, energy imbalances in the current account, and a weakening of the industrial economy. With large fiscal deficits today, there is also less future capacity to weather potential future shocks.

Already, currency markets have sniffed out the relative differences in fiscal discipline, as the EUR has performed much worse versus the USD than currencies like the Brazilian Real and Mexican Peso since the start of 2021.

Why does this matter

It will likely take many years for the full impacts of recent policy to show up. We do not expect that politicians will be punished for their behavior in the near-term, and in fact, they may end up winning more votes. Unfortunately, as we have seen in so many markets, these sort of policies that revolve around arbitrary taxation and price controls end up reducing investments in critical industries which end up exacerbating structural issues over the longer run.

We are reminded of the heavy-handed digital and internet regulation from the EU since the mid 2010’s, and how such bureaucracy essentially killed any hope for creating technology giants that could rival the US. There really have not been many new large-cap technology companies worth investing in within Europe that have come up in the last 10-20 years. In our opinion, much of this could be traced to the bureaucracy smothering any risk taking.

In contrast, our current excitement around India, Brazil, and Indonesia has been because of changes in government policy leading to more favourable corporate earnings potential.

Companies in these emerging markets seem to face a more favourable regulatory regime coupled with healthy country-level growth. Meanwhile European companies increasingly have to navigate a tough operating environment in the face of slowing economic growth and difficult regulatory regimes. While we still invest in certain businesses with European headquarters, these tend to be global businesses that service global markets rather than those servicing domestic markets.

In many ways, the lines between emerging economies and developed economies have begun to blur. Developed markets have increasingly adopted classic emerging market playbooks – price controls, windfall taxes, and nationalisations. In contrast, so many emerging markets seem to have adopted developed market playbooks – price liberalisation, tax incentives, and privatisations. While we are apt to change our minds especially in the face of new data, it really does seem like certain emerging markets are trending in the right direction and European countries in the wrong direction.

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Notes:
[1] Electricity Market Report Update: Outlook for 2023 and 2024”, IEA, 2023.
[2] Gupte, Eklavya. “Weak industrial demand drags down EU fossil power generation: Ember”, S&P Global Commodity Insights, August 30, 2023.

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Laird Abernethy

The GQG Partners Global Equity AUD Hedged strategy is now available on the Colonial First State (CFS) FirstChoice platform. This strategy is a supplementary offering to the unhedged version of the same product, the GQG Partners Global Equity strategy, which has been available on the FirstChoice platform since November 2022.

The GQG Partners Global Equity strategy invests in high-quality companies with attractively priced future growth prospects in both developed and emerging markets. It seeks to limit downside risk while providing attractive returns to long-term investors over a full market cycle.

Laird Abernethy, GQG Partners’ managing director of Australia and New Zealand, says: “Our Global Equity strategy gives advisers access to a portfolio of high-quality companies with a focus on managing downside risk that has historically exhibited a lower volatility profile than its index and peers. Access to the hedged version of this strategy allows advisers to help minimise the impact of the rising Australian dollar on their clients’ international investments while accessing high-quality companies in a truly global equity portfolio.

“Since establishing our business in Australia in 2019 we’ve seen a series of challenging markets, including the outbreak of the COVID-19 pandemic and more recently a sustained inflationary and rising rate environment. We believe that our focus on assessing a company’s future quality attributes as well as our adaptable investment style has allowed us to successfully navigate the market volatility from these events and helped us deliver strong relative returns for our clients since inception.”

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Laird Abernethy

GQG Partners, one of the world’s leading global equity boutique investment management firms, has been awarded the International Equities – Emerging Markets and Regional accolade for its GQG Partners Emerging Markets Equity Fund at the 2023 Zenith Fund Awards, held in Sydney on Friday, 13 October.

This marks the second consecutive year that a GQG Partners fund has been acknowledged, with the GQG Partners Global Equity Fund taking out the International Equities – Global category in 2022.

The Zenith Fund Awards acknowledge and encourage excellence in funds management across all asset classes and disciplines and aim to raise the standard of funds management in the industry for the ultimate benefit of investors. Each award is based on long-term factors derived from Zenith’s extensive research and due diligence of fund managers.

The GQG Partners Emerging Markets Equity Fund seeks to invest in quality companies with attractively priced future growth prospects in emerging markets. The fundamental investment process evaluates each business based on financial strength, sustainability of earnings growth, and quality of management. It aims to limit downside risk while providing attractive returns to long-term investors over a full market cycle.

Laird Abernethy, managing director, Australia, and New Zealand, GQG Partners, said that winning the International Equities – Emerging Markets and Regional award is an outstanding accolade for the business and is testament to the adaptability, durability, and strength of GQG’s investment team and process.

“Our investment process at GQG is centred around identifying those companies that exhibit strong ‘forward looking’ quality attributes. We believe that focussing on the future quality of a company, as opposed to its current or historic quality, enables the team to think outside the traditional prism of value and growth investing and instead focus on identifying those future quality compounders, regardless of which sector they may reside.

“We believe this forward-looking approach provides our portfolio managers a higher degree of adaptability, particularly as market regimes shift.”

Whilst headquartered in Fort Lauderdale, Florida, GQG Partners has a strong affinity with Australia, opening its first registered office outside of the USA in Sydney 2019. Additionally, GQG Partners’ parent company, GQG Inc., was listed on the ASX in October 2021.

The GQG Partners Emerging Markets Equity Fund holds a ‘Highly Recommended’ rating from both Zenith and Lonsec as well as a Morningstar Medalist Rating^TM of ‘Gold’ (assigned 04/05/23).

As at 30 September 2023, the GQG Partners Emerging Markets Equity Fund is the sole emerging markets fund in Australia to receive the highest rating from all three of the country’s prominent investment research and portfolio construction institutions.

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Daniel Pante

GQG Partners, one of the world’s leading global equity boutique investment management firms, has appointed Daniel Pantè as Associate Director of Business Development – VIC. Mr Pantè is the second distribution hire for GQG Partners in Melbourne, where he will join current Director of Business Development, Muneeza Killen, as GQG Partners continues to expand their Australian wholesale footprint.

Mr Pantè has more than 15 years of experience in the finance industry, including 13 years as a financial adviser, during which time he owned and operated his own Geelong based financial advice practice for four years. Most recently, Mr Pantè was a Business Development Manager for Macquarie Group, covering both cash and wealth platform solutions.

In his new role at GQG Partners, Mr Pantè will report to Director of Wholesale Markets, Daniel Bullock who commented that Mr Pantè’s appointment is central to further expanding the company’s national distribution strategy.

“Dan is a welcome addition to the GQG Partners wholesale team and brings with him yet another differentiated background. His firsthand experience as a financial adviser, as well as his alignment in values with GQG Partners, will improve the current wholesale distribution teams’ capabilities and makes him a natural fit for taking our products to the Victorian market. We look forward to working with Dan as he delivers best-in-class outcomes for GQG Partners and our clients.”

Mr Pantè holds a Bachelor of Business with Distinction from RMIT University.

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Kevin Osten

“Over the last decade, under the leadership and political stability established by Prime Minister Narendra Modi, India has passed several reforms that will help attract private investment and foreign capital and make it easier to do business. We put these reforms into three broad categories: increased infrastructure spending, a strong credit cycle, and a burgeoning property cycle.

“Looking at infrastructure, India has passed a US$1.4 trillion National Infrastructure Pipeline plan aimed at improving the country’s competitiveness and includes over 9,000 already-announced projects such as railways, roads, power and gas infrastructure and pipelines. Just a few months ago, India announced a 32 per cent increase in its budget for the 2024 fiscal year. By comparison, the US infrastructure plan that was announced in 2021 was about $1.2 trillion, but that’s for an economy that’s seven times larger than India’s.

“In terms of demographics, India’s population is still growing and is young relative to other countries. This has led to a significant level of loan demand on both the consumer and commercial side, with loan growth projected to be in the mid-teens for the next several years. This contrasts to a lot of other countries, especially when there is no deterioration in credit quality.

“India’s private debt to GDP ratio is also lower than it was 10 years ago, which can’t be said about the other BRICS countries of Brazil, Russia, China and South Africa. With asset quality remaining very high and a declining ratio of bad loans, these are all positive signals for India moving forward.

“India is coming out of a significant economic downturn, which has led to a lot of pent-up demand as the labour market has remained robust. India’s population demographics are also helping underpin this trend, with around 100 million Indian households will move from the lower income to middle and higher-income levels. That will require more housing in an industry that’s chronically been undersupplied.

“Finally, India has also passed the Real Estate Regulation and Development Act, which will not only help consumers but also help take out some of the weaker, less-capitalised players that have destroyed the market in the past. This is going to lead to much better performance and operating metrics for this sector and this cycle, relative to previous ones.”

By Kevin Osten, client portfolio manager

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There have been three time periods that had a significant economic impact on investment in India.

In an era where government intervention is becoming the norm globally, it is refreshing to see one major country going the opposite direction. We believe India’s Prime Minister, Narendra Modi, is following the playbook that has proven successful in many other countries. Prior examples include the United Kingdom under Margaret Thatcher, the United States under Ronald Reagan, and probably most closely, Singapore under Lee Kuan Yew (although Singapore is a city-state with a population comparable to that of a mid-tier city in India).

In looking back at over three-plus decades, there have been three time periods that had a significant economic impact when it comes to investing in India.

Period one: the partial liberalisation of the Indian economy in the early 1990s

The decades of socialism since Independence had led to a dormant economy, with a vast majority of the population in poverty. Many still remember monopolies being handed to a few cronies, resulting in long waiting lines for almost everything, from buying a two-wheeler to securing a telephone connection.

During this period, entire sectors were nationalised (such as the banking system in the early 1970s), tax rates exceeded 90 per cent for the highest earners, and corruption ran rampant. The corporate tax rate was close to 57 per cent and customs duties of 200-300 per cent were common. These economic policies stifled the country’s growth for decades; critics cruelly dubbed it the “Hindu rate of growth”. It is hard to believe now, but GDP per capita only grew at 1.3 per cent per annum over those four decades.

Eventually, India faced a major economic crisis in 1991, where the government nearly defaulted and ran out of foreign exchange reserves. This forced the hand of then Prime Minister Narasimha Rao to institute much-needed reforms. Rao’s Congress administration does not get enough credit, but he was ironically the best Prime Minister the Congress party produced in its long history. The rest of them, while being adept politicians have turned out to be rather mediocre economic stewards of India.

While painful at the time, the 1991 crisis proved to be a blessing in disguise as it forced the country to adopt pro-market measures and end the License Raj. State-owned companies were privatised, the currency peg was eventually removed, private-sector investment was encouraged, and the fiscal situation was stabilised. In other words, India was finally beginning to cut back on socialistic policies, resulting in an economic boom. In 2001, Goldman Sachs even named India as part of the BRIC countries expected to dominate the global economy. However, the good times did not last.

Period two: the stagnation post-GFC (Global Financial Crisis)

Politicians seemingly forgot what had triggered the boom years – a combination of reforms and the global boom led by China. The reform agenda stalled, and in certain cases, even reversed. The incumbent party was embroiled in countless corruption scandals, including the infamous telecom scandal, where the government was accused of giving away cheap spectrum licenses in exchange for bribes. As a result, in 2013, Morgan Stanley labeled India as one of the Fragile Five emerging market economies.

Period three: the ongoing reforms (2014-present)

Frustrated with the lack of progress, Indian voters decisively removed the incumbent party from power in the 2014 elections. Narendra Modi, the then-chief minister of Gujarat state, won the election with the promise of economic reforms. Under his leadership, Gujarat had heavily invested in infrastructure, cut red tape, and emerged as one of the most pro-business and prosperous states in India. As prime minister, he promised to replicate the “Gujarat model of development” across the country. However, he was dealt a bad hand and spent the first few years stabilising the economy. By the time he came into office, the rupee had collapsed from 45 USD/INR in 2010 to 65 USD/INR in 2014, and the banking system was on the verge of a major crisis. A decade later, Modi has the highest approval ratings in the world by far, largely due to his economic policies.

Before we proceed, we want to make it clear that this is not a political statement or endorsement. Rather, this is an attempt to objectively analyse and highlight key structural and economic policy improvements taking place in India, putting aside the political noise or controversies one may point to regarding Modi and his party. As global investors who have followed India closely, our focus at GQG Partners is to shed light on what we consider to be a major transformation that has been occurring in India and getting lost in the headlines.

Potential impact of economic reform not yet fully recognised

While Indian voters have already recognised it, we believe that the financial markets and mainstream media have not fully grasped the long-term implications of Modi’s economic reform agenda. Given India’s sheer size (with one in every six people globally residing in India), reforms in the country will have implications for the world economy, akin to the early-2000s China boom. Despite being the fifth-largest stock market in the world at $3.5 trillion (for comparison, Germany is $2 trillion and Japan is $5 trillion), India represents less than 2 per cent of the MSCI ACWI Index and less than 15 per cent of the MSCI Emerging Markets Index, partly due to quirks in the index construction that we believe are not always logical.

We have also been surprised to witness such negative media coverage on India despite the remarkable progress. Jefferies’ strategist Chris Wood attributed this lopsided coverage to the fact that most “Indian correspondents talk only to the traditionally champagne-socialist intelligentsia so visible on English language Indian TV channels…[who] have found themselves removed from all forms of influence in Delhi since Modi took power in 2014…[and] are willing to air their frustrations to anybody prepared to listen.”^[1] This lack of financial and media interest in India creates an attractive entry point for long-term investors in our opinion.

So why are we so bullish on India?

As global investors, we monitor economic policies in every major country and deploy our capital accordingly. We have been increasingly disappointed with the recent policies implemented in the developed world, such as endless stimulus in both the US and Europe, regulatory crackdowns in China, and even nationalisation in France. In contrast, we believe India stands out with its move to become more pro-business.

Modi’s economic framework can be boiled down to these key pillars:

Reducing corruption and crony capitalism

A landmark reform was the 2016 Insolvency and Bankruptcy Code, which created a framework to deal with insolvent companies. A joke among veteran Indian bankers was that corporate borrowers would travel in coach while initially securing loans, and then travel in private jets while arrogantly renegotiating loans. Those days are over; managements that renege on loans now end up forfeiting their assets and getting arrested. Similarly, the 2016 Real Estate (Regulation and Development) Act has transformed the real estate sector and ensured that fraudulent real estate developers are punished and weeded out.

Reducing government’s role in the economy

To quote Modi himself, “the government has no business to be in business.”^[2] We couldn’t agree more. Based on our experience investing in other emerging markets, a bloated government tends to crowd out the more efficient private sector and hurts productivity growth. For example, the Indian government recently announced the National Monetisation Pipeline where it will monetise its key state-owned assets and use the proceeds to fund infrastructure development.

A good case study is Air India’s privatisation.^[3] Air India (the second-largest Indian airline operator) was a chronically loss-making state-owned company. It cost the taxpayer approximately $1 billion annually just to keep it afloat until the government sold it to the Tata Group in 2022. Just a year later, the Tata Group placed the biggest aircraft order in India’s aviation history. This demonstrates the power of privatisation: the government receives cash to deploy elsewhere, and consumers benefit from increased investment in the sector. In contrast, China is going in the opposite direction.

Fostering private sector investment

Every Indian corporate we speak to mentions how much the current administration has streamlined day-to-day business, whether it is acquiring land, obtaining business permits, or bidding for projects. For example, this administration simplified India’s complicated tax policy with its landmark GST Tax Reform in 2017. This bill reduced the tax burden for businesses while still increasing government tax collections. The bill also allowed the government to eventually reduce the corporate tax rate from 30 per cent to 22 per cent in 2019.

Additionally, the government has made impressive progress on the digital front. For example, its Unified Payments Interface was launched in 2016 to facilitate digital transactions, bringing millions of Indians and small businesses into the formal economy. By some standards, India has leapfrogged many developed countries with its payments infrastructure. Similarly, India’s private sector has innovatively increased broadband access increasing 12 times in the past ten years to nearly 900 million connections. Indian consumers now enjoy first world broadband at developing world prices.

Investing heavily in infrastructure

Infrastructure investments have a powerful multiplier effect on the economy as they facilitate trade, improve mobility, create employment opportunities, and boost overall economic productivity. The Modi administration has made infrastructure a key component of its economic agenda. For example, the government recently increased its capital investment outlay by almost 30 per cent year over year in its latest budget. Railways alone have been allocated approximately nine times as much money as compared to just a decade ago.

While this is not perfect, we believe the country’s infrastructure is heading in the right direction.

In many ways, India’s infrastructure push under Modi reminds us of China’s boom in the early-2000s. Historically, India’s manufacturing sector faced a significant disadvantage versus global peers due to sub-par domestic logistics. But that is now finally changing. For example, the two freight corridors connecting New Delhi to Mumbai and Punjab to West Bengal will increase the average speed from 25kph to 70kph and allow double stacking.

Similarly, under Modi’s administration, the country has doubled both its rural road network and number of airports. Approvals, as well as project execution, have improved by an order of magnitude. As an example, India’s new parliament building went from initial design phase to final completion phase in just over three years despite facing COVID challenges in between. Similarly, Mumbai’s Trans Harbor Link is a 14-mile sea bridge connecting the island to the mainland and is nearing completion just 5 years after beginning construction. Few countries could deliver these projects so efficiently, outside of China. This is very unlike the India of 15 years ago!

India’s economic prospects are promising

Clearly, the political arena, whether in the US or in an emerging market like India, is complex and outside our area of expertise. No government or politician is perfect, and mistakes will inevitably be made.

In India’s case, it is also important to be realistic with the timing and magnitude of these reforms. As a thriving democracy with robust checks and balances, there is a limit to how much change can be implemented in short order. However, we remain quite excited about India’s future economic prospects and continue to increase our investment in the country. We believe that the pro-business Modi administration is following a well-trodden path that has historically led to significant economic success in many other countries.

———-

End Notes:
[1] Wood, Christopher. “Modi and the champagne socialists”. Jeffries Group, Greed and Fear. May 25, 2023.
[2] Government Has “No Business To Be In Business”: PM Narendra Modi”. NDTV News Desk. February 24, 2021. https://www.ndtv.com/india-news/government-has-no-business-to-be-in-business-pm-narendra-modi-2377787
[3] Agarwal, Anil. “Privatized Air India’s takeoff can lead other PSUs to thrive as well.” Mint. March 22, 2023. https://www.livemint.com/opinion/columns/privatized-air-india-s-takeoff-can-lead-other-psus-to-thrive-as-well-11679507831150.html

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Victoria Flygare

GQG Partners has appointed Victoria Flygare as Director for Business Development, across South Australia and Western Australia.

Mrs Flygare has more than 12 years of experience in funds management and brings a diverse skillset to GQG, having worked across business development, institutional trading, equity research, and investment operations.

She will be based in Adelaide and will report to Director of Wholesale Markets, Daniel Bullock.

Mrs Flygare joins GQG Partners after spending 10 years at Magellan Asset Management, where she was most recently responsible for building a local presence in South Australia. Prior to this, she was an institutional trader at Magellan and helped develop Magellan’s first active ETF. She also served as an institutional dealer at Ankura Capital and BNY Mellon and previously worked at Eight Investment Partners.

Mr Bullock says Mrs Flygare’s appointment is central to further expanding the company’s national distribution strategy.

“Victoria has a trusted reputation in the industry due to her personable nature, authenticity, and client-centric approach. Her strong track record in business development, coupled with her technical expertise, will be instrumental in executing GQG Partners’ growth strategy across both states

“Her experience in identifying opportunities and building client relationships, as well as her alignment in values with GQG, makes her extremely well-suited to be our representative in South Australia and Western Australia. We look forward to working with her as she delivers best-in-class outcomes for GQG and our clients. “

Mrs Flygare holds a Bachelor of Commerce and Bachelor of Business Law from Bond University where she was a Vice-Chancellor Scholar.

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The Fund invests in high quality companies, located anywhere in the world, that GQG Partners believes can sustain long term earnings growth and are available at a reasonable price. It has a particular focus on long term capital appreciation and dividend income and is suited to investors with a five year plus time horizon. The objective of the Fund is to provide a rate of return (after fees and expenses and before taxes) which exceeds the return of the MSCI ACWI High Dividend Yield ex Tobacco AUD.

Rajiv Jain, chairman and CIO of GQG Partners, says, “We look for companies with a strong financial position, capable management, and promising growth opportunities, as we believe these businesses are most likely to enjoy sustained earnings growth over time.  Our approach involves an in-depth analysis of company’s financial statements, economic health, competitors, and the markets that it serves.

“We believe our focus on quality companies positions us to manage downside risk during periods of market volatility.”

Laird Abernethy, GQG Partners managing director Australia and New Zealand, says the strategy has been designed to complement existing Australian income focused portfolios.

“We believe a global income strategy that’s derived from GQG Partners’ strong focus on quality will be an attractive option for Australian investors. Our aim with this strategy is to bring better downside protection and potential total return to existing income focused portfolios.”

In its report, Zenith said: “Zenith believes the team’s collective experience and unique structure is a key point of difference relative to peers. Overall, we view Jain as an impressive and insightful investor whose oversight is critical to the overall success of the Fund and the broader business.”

It also stated: “Although the strategy has a relatively limited track record, Zenith’s conviction in the Fund is underpinned by our high opinion of GQG’s key investment personnel, particularly Rajiv Jain, who has an impressive long-term investment track record within global equities. Zenith holds GQG’s investment capabilities in high regard and believes the Fund is well positioned to achieve its investment objectives over the long term.”

The minimum initial investment amount for the Fund is $25,000, and minimum additional investment are $5,000.

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