Alastair Reynolds

Back in the 80s, an American fast food chain made the memorable slogan, “Where’s the beef?” to imply that its competitors were not providing enough substance – in this case – beef!

In this update on the Emerging Markets (EM) Martin Currie, an active equity manager and part of Franklin Templeton, lays out why EM is a compelling asset class story.

“The question we get most often is “what’s the catalyst that’s going to drive EM forward?” In this case, we’d like to use this easy to remember analogy and highlight “the beef” for the asset class-earnings growth,” says Alastair Reynolds, Portfolio Manager Martin Currie.

“What’s also interesting about EM earnings is how critical it is for driving asset class performance throughout longer-term cycles.

“When we look at EM’s performance versus Developed Markets (DM) over the long term, we see that relative earnings growth is a major driver of EM’s outperformance. For example, the 35-year earnings per share (EPS) compound annual growth rate (CAGR) for the US has been 6.4%.

“What we’ve observed historically is that during strong outperformance periods for EM equities, the earnings growth is double-digit (strong on both an absolute and relative basis). Fortunately, we are right at a key turning point and the case for EM earnings outpacing DM is strong, in our view. It’s driven by higher growth rates (GDP) and less margin pressure as inflationary forces abate.

“Furthermore, for technology companies in EM, it’s also supported by strong market positioning and structural growth drivers such as artificial intelligence (AI). As shown In Figure 1, emerging markets are expected to deliver higher earnings growth (relative to DM) over the next 12 and 24 months. In particular, the major EM constituents – China, India, South Korea, and Taiwan are set to deliver explosive earnings growth over the next 2 years.

Divergence between earnings and share prices in China

Reynolds adds “Recently we have observed strong earnings delivery from two key areas in the Chinese stock market: 1) Chinese digital economy stocks and 2) Chinese financials – namely insurance companies. There is a positive divergence between fundamental earnings delivery (relative to MSCI EM) and the stock performance (relative to MSCI EM) using the two largest Chinese benchmark holdings in the MSCI EM (Tencent and Alibaba).

“When we see such a divergence between share prices and stock earnings, we view this as an opportunity for fundamental, bottom-up investors. We have increasing confidence in the profitability of these quality growth companies in EM.”

Where’s the growth?

“While acknowledging the difficulty of predicting growth in 2023, the International Monetary Fund (IMF) has just published its forecasts for DM and EM. The IMF expects that EM will outgrow the advanced economies, forecasting 4.0% GDP growth for EM and 1.2% for DM. Global growth is estimated at just under 3.0% for 2023. Within that, China and India are expected to be key drivers of this, contributing to approximately 50% of that growth projection.”

Where’s the valuation?

“Given this combination of GDP/macro growth and earnings growth, EM offers a once in a generation opportunity in terms of a reasonable absolute and relative valuation. The asset class is trading at a 35% discount to MSCI World. Using a medium-term outlook, MSCI EM Index is trading at 10x P/E versus the MSCI World Index at 15x.

“The beef may have been in DM over the past decade, but that does not mean it will continue and the current backdrop in EM looks exciting. With superior GDP growth expectations, trading at discounted valuations, and the expectations for stronger earnings growth going forward, it’s clear to us the beef is now in EM,” notesReynolds.

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Alastair Reynolds

Despite negative stock market reaction to the results from the 20th National Congress and Xi Jinping’s re-election, the investment case for China remains intact, notes Martin Currie, an active investment manager (part of the Franklin Templeton Group).

Alastair Reynolds, portfolio manager at Martin Currie notes: “Although the outcomes had been widely predicted, Western investors still hoped that the National Congress of the Chinese Communist Party might provide an opportunity for the Chinese Government to change course following a year of slowing economic growth, public frustration over zero-Covid policy, and displays of industrial and geo-political intransigence.

“The results of the week-long Congress dashed any hopes of an imminent change of course on any of China’s policy objectives.

“Over the course of the 7 days, Xi Jinping gave no indication that China would relax any of its recent contentious policies. He reiterated the importance of internal and external security and said Beijing would work faster to modernise and enhance its military capability. He also promised to build China’s self-reliance and strength in science and technology.

“All things considered, the likely consequence of this is that China will be even more determined to forge a path based on the ideology of its party leader, Xi Jinping. This conclusion is supported by changes introduced to the Party’s constitution, which cement Xi as leader of the Party and his ideas as the guiding principles for China’s future direction. The unveiling of the membership of the Standing Committee and the Politburo brought further confirmation, with China’s key decision-making bodies now dominated by Xi loyalists, along with the removal of several free-market reformist party officials. These changes display resounding support for the belief that Party controlled economic and ideological direction represents a distinct advantage over freer markets.

“Reports following the Party Congress have focussed on Xi’s defiance of his critics and his moves to concentrate power at the top of the Communist Party. This narrative gained unexpected fuel when former President, Hu Jintao, was escorted off stage during the closing ceremony. The portrayal of this incident as a deliberate power play by Xi appears provocative given the range of other plausible explanations. In addition, there has been little emphasis in the reporting of the economic and business friendly credentials of the new generation of officials appointed to both the Standing Committee and the Politburo.

“Given the points above, it is worth emphasising some of the less reported messaging from the Congress. Although Xi made clear that China will focus on “security,” this was discussed in very broad terms and reliant on economic growth. Specifically including the pursuit of high-quality development, highlighting prosperity in China is positive for the world, as well as importantly acknowledging that China cannot develop in isolation from the world.”

It is also worth reiterating the broader case for continued investment in China, notes Reynolds.

“One of its obvious attractions is the range of opportunity resulting from its size. It is the world’s most populous nation and boasts the world’s second largest economy. It is also the world’s largest exporting nation. Its stock markets are home to over 4000 companies. The scale of China’s domestic and export markets, combined with its desire to develop national industrial champions, has resulted in the creation of many truly world leading Chinese companies in a broad range of industries.

“Despite its zero-Covid policy and ongoing efforts to unwind its debt-dependent property sector, China is still achieving economic growth of 3%^[1] year-to-date in 2022. There are several routes China could take to relax its Covid policy which could trigger a rebound in domestic consumption. The government has the ambition to grow the economy over the longer term, with a stated aim to achieve per capita GDP comparable to a mid-level developed country by 2035.

“Despite the slowing economy, broadly speaking, Chinese listed companies remain in sound financial condition and continue to allocate capital effectively to the benefit of minority investors. For example, we have begun to see a broadening out of share buybacks as highly cash generative firms take advantage of lowly valued stock prices.

“Whether we consider the overall market or look at individual companies, China’s equities are trading at attractive valuations, at a discount to comparable businesses in other countries.^[2] Critics may suggest low valuations reflect a path to becoming uninvestable.

“Whilst we acknowledge Chinese ideology is very different to Western norms, we continue to see Chinese corporates and broader economic policy as rational,” says Reynolds.

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Alastair Reynolds

The Legg Mason Martin Currie Emerging Markets Fund has been added to the Macquarie Wrap investment platform, giving a larger group of investors access to a high-performing global emerging markets investment portfolio.

Featuring a distinctive investment approach, the Fund is an actively managed, high-conviction strategy that aims to hold a well-diversified portfolio of 40-60 stocks across about 20 countries and 20 industries. With country exposure generally close to benchmark, alpha is driven by stock selection.

The Fund’s largest holdings are in China, South Korea, Taiwan and India, across companies in the information technology, consumer discretionary, financial and communications industries.

Alastair Reynolds, Portfolio Manager of the Legg Mason Martin Currie Emerging Markets Fund, says the Martin Currie investment team focuses on companies that have long-term growth prospects that are not yet reflected in their stock prices.

“The team has an investment horizon of at least five years, typically owning their investments for multi-year periods in order to fully exploit market inefficiencies and let companies reach their long-term intrinsic value,” he says.

“Martin Currie also believes environmental, social and governance (ESG) factors are important drivers of long-term performance,” he adds. “The team considers a lack of ESG credentials as value destructive to a company’s prospects.”

Legg Mason Martin Currie Emerging Markets Fund has gained ‘Recommended’ Ratings from Lonsec and Zenith and received a Morningstar Analyst Rating^TM of ‘Bronze’ as of 6 May 2021. It is available across most leading investment platforms.

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Alastair Reynolds

As the global economy returns to growth, investors looking to catch the growth wave should be looking to emerging markets, says Martin Currie, the active equity specialist investment manager of Franklin Templeton.

“Take one example. In 2021, the global semiconductor market will approach US$500 billion in sales and there are concerns about a shortage of supply globally,” says Alastair Reynolds, Portfolio Manager of the Legg Mason Martin Currie Emerging Markets Fund.

“The list of leading global semiconductor businesses is now dominated by emerging markets companies. They include Taiwan’s TSMC, which grew revenue 25% in 2020; South Korea’s Samsung Electronics and SK Hynix; and Taiwan’s Globalwafers.”

Reynolds says another sector that highlights the strong prospects of companies in emerging markets is the electric vehicle (EV) market. The demand for EV batteries is expected to grow ten-fold over the next 10 years, and the majority of that growing demand is currently being met by Asian producers, including South Korea’s LG Chem and China’s CATL.

“Emerging markets provide access to young and growing populations and tap into some really important consumption themes, as well as themes that are driven by urbanisation and digitisation. Our Fund provides access to highly profitable companies that are capable of delivering higher levels of growth.”

Launched in 2011, the Legg Mason Martin Currie Emerging Markets Fund has consistently beaten its benchmark, the MSCI Emerging Markets Index (AUD). Since inception it has produced an average return of 10.2% a year (net of fees), compared with average 9.0% annual growth of the benchmark over that period.

Over the five years to the end of April, the Fund returned 17.0% a year (net of fees), compared with the benchmark return of 12.2% a year – top quartile performance for the Morningstar Equity Emerging Markets peer group. And over the 12 months to the end of April, the Fund returned 32.0% (net of fees), compared with the benchmark return of 26.0%.

Reynolds puts this outperformance down to the Fund’s distinctive investment approach. It is an actively managed, high-conviction fund that aims to hold a well-diversified portfolio of 40-60 stocks across about 20 countries and 20 industries. With country exposure generally close to benchmark, alpha is driven by stock selection.

A distinctive feature of the Fund is its industry leading approach to environmental, social and governance (ESG) analysis to help inform investment decisions. A pillar of its investment process for over 20 years, ESG integration is in Martin Currie’s DNA.

“The team considers a lack of ESG credentials as value destructive to a company’s prospects, and stocks without proper ESG credentials can be deemed uninvestable,” Reynolds says.

“The team’s awareness of ESG issues was a key reason for its early position in the EV space. Now the team is finding opportunities further down the EV supply chain, including companies making the equipment used to produce the batteries.”

Another of the Fund’s distinctive features is its collaborative whole-team approach. The portfolio managers conduct proprietary research within their own sectors, such as financial, technology and natural resources. The team then comes together to make collective decisions on the portfolio, an approach designed to lead to fewer biases and better outcomes.

The team takes a long-term investment horizon of at least five years, typically owning their investments for multi-year periods in order to fully exploit market inefficiencies and let companies reach their long-term intrinsic value. Long-term macro conditions are considered as risks in the investment process, rather than a source of alpha generation.

Apart from the managed fund, Australian investors can access the opportunities presented by emerging markets via another vehicle: the BetaShares Legg Mason Emerging Markets Fund ETF (ASX: EMMG), which was launched in 2019.

Both Legg Mason Martin Currie Emerging Markets Fund and the BetaShares Legg Mason Emerging Markets Fund ETF have gained ‘Recommended’ Ratings from Lonsec and Zenith and are available across most leading investment platforms. In addition, Legg Mason Martin Currie Emerging Markets Fund recently received a Morningstar Analyst RatingTM of ‘Bronze’ as of 6 May 2021.

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