The evolution of GEMs

A discussion on the state of frontier markets today
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‘The beauty of China is that it is an incredibly deep market’

John Malloy, Manager, RWC Global Emerging Markets Fund Tweet

At the end of July, it was announced that the Chinese authorities were to crack down on online after-school companies and stop these educational services from making profits or raising capital.

Despite regulation being nothing new in China, a wave of headlines in the media proclaimed a Chinese ‘crackdown’ on technology was subsequently taking place which prompted a sharp, multi-day sell off, in which the country’s largest educational and internet companies lost billions of dollars.

With China representing some 34% of the MSCI Emerging Markets Index, it’s little wonder this sell off sparked concerns for many  managers in the region. However, despite the fact the MSCI China Index has fallen over 15% year-to-date, the MSCI Emerging Markets Index is marginally positive proving there is more to the region than just China.

John Malloy, Manager of the RWC Global Emerging Markets Fund, notes that going back to the 1990s all emerging markets were essentially frontier markets, with China barely existing as a major stock market.

“The evolution in the region over the past three decades has been phenomenal,” Malloy says. “When I started as manager in the 90’s the index was basically made up of oil and gas, mixed in with some banks, cigarette and beer companies.”

Today he says the make-up is completely different, with a much heavier representation towards technology, technology services and internet-based companies. To take advantage of this shift, and not to be beholden to the index, Malloy says the RWC Global Emerging Markets team take a very active approach, with an active share of 80-90%.

“This allows us to flourish as stock pickers, finding good companies with strong macroeconomic backdrops and take advantage of these opportunities,” he says.

So where are the best opportunities right now? Is Malloy concerned about regulation in China?

“Waves of regulation are nothing new in China,” he says. “We saw them in 2014, 2015 and 2018, but what has happened this year has been deeper and more pronounced. This is partly because we are coming out of a bull market which meant there was huge amount of froth and resulted in the large correction we saw in July.”

Indeed Malloy believes this wave of regulation is coming to an end, with the headlines and news flow being much quieter in recent months. Subsequently, having been very underweight in China a year ago, over the past two quarters the portfolio has increased its weighting back to a neutral position.

Owning no energy companies or banks and having little state-owned enterprise exposure, he says the portfolio still looks very different to the benchmark. “The beauty of China is that it is an incredibly deep market,” he says. “We have companies in certain consumer and healthcare sectors that are doing very well.”

Away from China, and despite being all the rage a number of years ago, Malloy argues that frontier markets have almost been forgotten about by investors. In an environment of rising commodity prices and rising global interest rates, he says the backdrop for frontier markets is favourable, with the added bonus of valuations also being cheap.

“In this fund our focus has to be on the more liquid frontier markets, such as Vietnam,” he says. “Vietnam is taking advantage of the diversification away from China, with Samsung Electronics investing over $10bn a year into the country.

“We also have exposure to Africa in the Democratic Republic of Congo and Zambia, which as large producers of copper are large beneficiaries of the renewable energy story.”

Malloy also believes there are good opportunities within Russia and Latin America, which he argues have equally been forgotten about.

“As the price of oil, has recovered Russia has done well this year, economic growth is good and valuations are cheap,” he says. “Brazil meanwhile has had a difficult year because of the election cycle, the interest rate hiking cycle and because the currency has been weak.”

However, Malloy believes this presents an opportunity and as a result the fund has been building up some exposure to Brazil.

“Latin America overall is set to perform well as the commodity complex is set to do well over the next decade,” he adds.

A further proof of the evolution of emerging markets is the shift the region is seeing towards ESG considerations. Malloy notes every conversation he has with a company today involves ESG, which he says is a truly positive shift.

“The drivers of governance, social and looking at issues like climate change are front and centre for many emerging markets,” he says. “While of course there are risks, the opportunity set is pretty positive right now.”

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