- Geopolitical Strategist
Switzerland, Intermediary
ChangeThe views expressed are those of the speaker(s) and are subject to change. Other teams may hold different views and make different investment decisions. For professional/institutional investors only. Your capital may be at risk.
Episode notes
In this episode of WellSaid, two veteran emerging markets investors, Bo Meunier and Niraj Bhagwat, join host Thomas Mucha to share their insights on the potential for a rebound in the asset class, with particular focus on opportunities in China, India, and across the Asia-Pacific region.
Key topics:
2:00 – Investment outlook for emerging Asian equities
4:30 – Effect of China’s reopening
8:45 – Indian stock market valuations and business cycle
10:45 – Emerging markets geopolitical risks
16:00 – On-the-ground research
18:45 – Importance of EM ESG
21:00 – Capital allocation across EMs
23:45 – Personal observations
Transcript
Investing in China, India, and across emerging markets
COLD OPEN (BHAGWAT): Asia, which is half of humanity, and I’ll repeat it, it’s half of humanity, and it boasts some of the largest amount of young populations in the world, in my 30 years, have never traded such low valuations. Now, you have an asset class which is not only trading at low valuations, but also trading at low profitability, which is improving, and has materially lower debt than the US. So to me, looking here for the next decade, Asia has all the ingredients to take over leadership within the global equity asset class.
MUCHA: 2023 is a fascinating time to be investing in emerging markets, given the shifting macro, geopolitical, and policy backdrops around the world. Now are these markets poised for a rebound? To help make sense of the opportunities and risks across EMs, we have two deeply experienced portfolio managers at Wellington, who both specialize in emerging markets, which have seen an increase in investor interest in recent months. I’m joined here in Boston by Hong Kong-based Bo Meunier, who currently manages emerging markets and China-focused regional portfolios, and Niraj Bhagwat, who joins us from Singapore and is a longtime investor in emerging markets. Welcome, both of you, to WellSaid.
MEUNIER: Thank you for having us here.
BHAGWAT: Thank you Thomas, for having me.
MUCHA: Well Niraj, let’s start with you. EM equity returns have been, let’s say, disappointing since the global financial crisis. 2022 was another challenging year. So what’s your outlook for the asset class this year? And thinking longer term here, how might the next decade be different for EM equities?
BHAGWAT: Thank you, Thomas. So in the last decade, the US was the clear market leader in global equities. Now sitting here, US is sitting at peak profitability, it’s accumulated a high amount of debt, valuations, even though they are lower than last year, are still not what you would call low. And that’s not what makes a recipe for great outperformance. Now when you compare that to EM, and I’m going to talk about Asia here, because remember, Asia now accounts for 80 percent of EM, so that’s what really matters, within EM. If you look at Asia at the time of the last, last big cycle, Asia profitability and ROEs were sitting at peak. Since then, they have come back to historical lows, driven by global crises, as well as, of course, by local crises. Also the strong US dollar has played a key part in that. Now as the US dollar doesn’t keep strengthening, and so the headwind is gone for Asia. But also more importantly, lot of things are changing here. So first of all, China is waking up, and opening up, finally. India is off to a great new cycle. But even smaller countries like Indonesia, Malaysia are going to be helped by sustained high commodity prices. So where Asia didn’t grow earnings pretty much materially at all in the last 10 years, compared to say, the US, now it’s going to have sustained EPS growth in the next 10 years. And then, when you take a step back, Asia, which is half of humanity, and I’ll repeat it, it’s half of humanity, and it boasts some of the largest amount of young populations in the world, in my 30 years, have never traded such low valuations. Now you have an asset class which is not only trading at low valuations, but also trading at low profitability, which is improving, and has materially lower debt than the US. So to me, looking here for the next decade, Asia has all the ingredients to take over leadership within the global equity asset class.
MUCHA: So the structural factors are lining up positively for EM equities. What about the risks this year? Is it the dollar, is that the key risk that you’re looking at?
BHAGWAT: So obviously this is EM, Thomas, so there are always risks, right? So a new variant which comes out, which is more toxic. But apart from that, I think what the Fed does, what the Japanese Central Bank do, all these are key variables which one most look at. And above all, one must see what happens in Russia/Ukraine War. That is obviously a key determinant of what happens globally.
MUCHA: So Bo, as Niraj has just stated, China’s important. All eyes are on China. From your perspective, what effect will China’s reopening from COVID have on other emerging markets? And then, specifically with regard to Chinese equities, is there still upside potential after the rally we’ve seen here?
MEUNIER: Yeah, definitely. The first answer, China’s effective reopening will have a meaningful impact on the emerging markets. Just before COVID happened, give people a perspective, the number of Chinese tourists leaving the country each year, was equivalent to the size of Germany’s population. So it’s a very large number of Chinese who leave the country to go out shopping and using services. One this reopening happens, we see a number of countries benefiting from the outbound travel again. Starting with Asia, where Niraj highlighted, just a lot of travel within Asia, for ease of convenience, flights, also culture, food, many reasons. So in specific countries, using Thailand as example, they benefit tremendously from the global tourism. But Chinese tourism in particular drives a large part of that. So you can own companies like shopping malls, airports, which see increase in volume, but also more importantly in sales and profitability. So that’s definitely one area. In Korea, again, people would go there for services and consumption. So just the sheer number of people going there would benefit. There’s also another side of it, that would be the commodities. Because while it’s China reopening, it’s not just about Chinese leaving the country, but also the economic activities in China would start to resume again. We’re assuming that will change now that people are out about, and anecdotally, being on the ground, my team visiting different parts of China, they are seeing resumption of those economic activities and capital expenditure. So as a result of that, I think commodity demand would increase, and that benefit a lot of emerging market countries. So South Africa being one, Brazil is another one, plus Indonesia and Malaysia that Niraj highlighted. So I think emerging markets benefit from all three different aspects.
MUCHA: So a big change across EMs. What about the Chinese equity market from here?
MEUNIER: Yeah. So China equity market definitely was in a rollercoaster mode last year. I’m happy to get into the details for reasons, but just highlighting the valuation, as you touched on. So by October, it was basically looking at more than 10-year, multiple-year low. So the bounce back in fourth quarter was dramatic. But if you look at where it is now, it’s many companies still below the 10-year average. So we’re not definitely at the high end, it’s below average, but it’s not at the extreme low level. So that’s the starting with multiples. Then if you look at earnings prospects, we do expect economic activities to recover. Santiago Millán, our China economist, is expecting more than 5 percent GDP growth this year. With that, many companies we’re talking to are expecting acceleration in earnings. Some of that is the top-line recovery. Some of that is focusing on margin improvement. And that is something I think we can talk more about, is China had to be in a place where people were growing business purely from the top line. But with the slowdown economically, global, and in China, we’re seeing a lot more companies focusing on cost structure, focusing on efficiency. As a result of that, we are seeing improvement in margin. That can be from large companies in the internet space, to smaller companies like industrial companies, logistic companies. So margin improvement is also driving some of the earnings growth. So that’s why I remain constructive on China. We’re starting from a below-average level, but also earnings growth should accelerate.
MUCHA: So you remain constructive on China?
MEUNIER: Exactly.
MUCHA: Niraj, what’s your view on China?
BHAGWAT: You asked the question to Bo, which she answered well on the impact on emerging markets, and she mentioned about commodities, which I agree with. I think that one must also think about the impact on developed markets. so as China reopens up, it’s a sleeping giant, it wakes up, impact on commodities, what that means for inflation, what that means for the Fed, and I don’t think many people are discussing that impact, as well.
MUCHA: Right, it’s clearly a factor that the entire world will have to grapple with. So Niraj, you mentioned India earlier. Investors struggle with the valuations of a lot of Indian equities. So how are you framing the investment opportunities there? And with corporate valuations in particular?
BHAGWAT: So yes, Indian valuations have always been a question, and in fact, Thomas, if you look at it, Indian valuations have always been at a premium to other emerging markets. And yet, India has delivered better performance than every emerging market, and in fact, I would say on par or sometimes bigger than the US across 10, 20, 30 years. So one must really ask, why is that? So if you take a step back and I would say investors look at parts of EM and especially we look at a big country like China, people often get seduced by the size of the country, the GDP growth, the ease of doing business, the fantastic physical infrastructure, which is completely not there in India. But when I look at investing, I think when you look at China, for example, a lot of corporate profitability and drivers are because of the government. But India, I think everything is despite the government. So when you find companies in India which face a lot of high operational costs, and you find good quality companies which can beat those high costs, then you can have a set of companies which can deliver high returns for a sustained period of time. Now, I would say in the near term or today, there might be another reason to consider why Indian markets are at a higher valuation. And that is the TINA factor, which is, “there is no alternative.” I can’t name a single market for investors which is a large market, great demographics, great growth potential, but also a very vibrant, functioning democracy. Now, having said all that, I must admit that there are many parts of the Indian market which are expensive. I will say the technology sector is a great, great example of that. But I think even today, we are finding attractive opportunities where you can find quality businesses at good valuations. And I think Indian market remains a good example of, a good place for active management.
MUCHA: You just have to know where to look.
BHAGWAT: Exactly.
MUCHA: So geopolitical issues are, are never far from investors’ minds when it comes to EM, nor are they far from my mind, of course, as the firm’s geopolitical strategist. The last several years, in particular, have seen pretty significant national-security developments in Ukraine, of course. But also across the Indo-Pacific. So which geopolitical dynamics, are you most focused on, right now? And this is a long list, obviously: war, deglobalization, liquidity, inflation, energy and commodities demand, as we’ve discussed.
MEUNIER: Yeah, so geopolitical risk is a very important part of analysis when we look at investing in emerging markets. Definitely my quick answer is all of the above. And actually being sitting here in Wellington, we have colleagues like you who spend a lot of time looking at this from both sides. And go deeper in Washington D.C., getting the mindset of policymakers, really helps me to think about what are the risks? And I have to say, using China as example, as an investor, we definitely have a lot of confidence from the fundamental side. But that itself is not sufficient, because the geopolitical risk, if anything, is only going to intensify. It's definitely not going away. Among the factors that you talked about, I do see deglobalization is something that’s structural and that’s going to be ongoing. So when we think about deglobalization, there’s the key part of that is supply chain reshuffling. The globalization benefited many countries, many companies, and the reversal of that is going to start. So people should think about this, not just one year, US but much more implications from the cost, from efficiency, from inventory management. There are definitely active implications for some of the Chinese companies that have a large share of the export. But also silver lining out of that, as well, some of the localization of supply chain may move more to Asia. So regionalization, Mexico benefit from this, some Southeast Asian countries are seeing increasing FDI from China, as the reshuffling of the supply chain. So there are definitely a lot of moving parts there. And it’s not all risk; there are definitely opportunities among that. So that part would be the first one. The second one, is, the global liquidity and inflation. As Niraj highlighted, when US dollar is strong, it doesn’t speak well for the emerging markets in general, it just historically has never happened. So with our outlook that the US inflation may be peaking, the US dollar strength may be at the peak level, this is fairly positive for emerging markets in general. So I think the inflation impact will be there, but may not be as bad as the last cycle, where China had such a huge property boom. We’re not anticipating that type of policy, or level of buildout inside China. The last part I’m thinking about is really the global energy transition, I think this is the most important topic for the next 10 years. And who are going to be the winners of this? Companies and countries with more of the leading technology on solar panel filming, on EV battery supply chains, are going to be beneficiary of that. And again, the emerging markets, because they were suffering a lot from the commodity price, have been much more willing to develop and adopt these type of technologies. If you look at the battery manufacturers, Korea and China occupies a large part of global share. So I think that’s another area, it’s a risk, but then opportunity is also alive within some of the emerging market countries.
MUCHA: Yeah, I do think there’s a lot of opportunity resulting from these structural changes. You mentioned supply chains, you mentioned renewable energy and the energy transition. Those are top of mind for policymakers that I speak with every day, those two issues. Niraj, same question to you. Now you’ve been doing this for a long time. How do you approach a big structural change like this in the world from an investment perspective? Particularly through the geopolitical lens?
BHAGWAT: I would put that answer into two categories, broadly. So in some ways, and I always tell, jokingly to my clients, I’m a product of the bear markets in Asia, I started my career in ’96, and you know, Asia has not been short of wars. I think what’s new is really deglobalization, that’s something that we, as current investors, haven’t seen. And also one more thing which we haven’t seen is climate change. And so climate change is going to exaggerate everything that we’re looking at from a macro perspective. So what we do as investors is obviously we would get experts like yourself or other people in Wellington, but what we try to do is ask every company that we work with, and try and see how the managements are thinking about it, and how they can mitigate to the best of their ability. Because remember, our job is to compound client capital. We have to be invested here to compound the capital, and so the best way to I think mitigate all these issues is to invest in companies where managements are good custodians of the capital, and where they understand these issues, and can really safeguard the capital. So that’s how we’re approaching it.
MUCHA: Great. Both of you have, have mentioned proprietary research already as being central to your investment processes, of course. And Bo, I want to ask you about this on-the-ground research in emerging markets, in particular. So obviously, that’s important, but how does that play out on a day-to-day basis? What does that look like?
MEUNIER: Emerging markets in general has a reason to be emerging, and not developed. So you start with the country’s political framework, with the, industry dynamic, as well as the company’s corporate governance. There’s a lot of reason that people want to spend more time doing research. And I’ll start with the reason why I think we need to spend more time on the ground, versus DM. I started my career in Wellington 22 years ago, covering US equity. You get a lot more information, reliable information. But when I switched over to cover China equity markets, you don’t have the same level of information, either for company, or industry, or kind of where the country is heading, or like sometimes the policy is heading. So you need to just get more information locally to really build conviction, but also to identify risks. So how is that done? I’ll give you an example, before COVID, when travel was easy, I would spend roughly one out of three days on the ground in China. And connection between Hong Kong and mainland China was easy. People may not realize, they built a high-speed train, so from downtown Hong Kong to downtown Shenzhen, you could get there in less than 30 minutes. So it was definitely easy travel logistics, but also more importantly, the need to be there. What we do on the ground many times, we definitely meet with the companies, but more importantly, you need to check around the companies, meet with suppliers, their competitors, multinationals versus locals. And again, that’s where Wellington platform is helpful, we get much broader exposure to players in that industry, to have a fuller sense of what is going on, where the risks are, and who is really doing well.
MUCHA: So China’s opening is going to have an impact on your day to day, I assume?
MEUNIER: Yeah, definitely. We’ll be back there continuously. But I do want to highlight, we take our fiduciary duty very seriously. Even when China required three weeks of quarantine just to enter the country, my team, every single one of them, went back to China to do research, the due diligence, and that three weeks is not sufficient for some companies. When you get to their city, you need to additional quarantine of three to five days in order to visit the management. They really want to make sure you’re absolutely clean of the virus. And we did that in order to identify investment opportunities. So just shows you how important local research is, despite all the hurdles, we did it.
MUCHA: So I’d like to move the conversation a bit to ESG issues. Niraj, from your perspective, you obviously use ESG in your process. So what are some of the most important issues, ESG issues, as seen through the EM lens here? And how much does improving performance in these areas matter to the company fundamentals?
BHAGWAT: Yeah, so I’ve always thought that ESG matters. And, our philosophy of focusing on companies to believe in taking along all stakeholders. I think that philosophy has not changed, and who, who would have a problem with that? So I think when companies take along all stakeholders, first of all, that reduces the biggest risk in money management, the risk of permanent capital loss. But not only it does that, but it also improves the goodwill among its current employees, its future employees. It improves the goodwill among its dealers, its suppliers, the ecosystem, the society, and the government. And obviously as they do that, and as investors, if you can find such like-minded companies, we can get along the journey of them getting better, that works out good results for our clients as well. So for a long period of time, issues in EM used to be the usual governance issues, which were people-focused, investors focused. But now, more hot-button issues like climate mitigation, modern slavery, women empowerment, are coming to the fore. And my team, we have a belief, our process, that we try and engage with companies in almost every company interaction we do, rather than wait for just one annual interaction on ESG. And we try and ask one question at least on ESG focus. And I’ll give you an example how that works. So we had a portfolio company in real estate in India. And during the COVID crisis, you know how bad the situation was, and we were talking to them, what they were doing about the labor, and remember, modern slavery is a real topic in real estate in India, among other places. And what we found was that this company voluntarily was not only vaccinating its employees, but the employees’ families, its entire supply chain, but also contracted labor and their families. Nobody had asked them to do it, and in fact I don’t think most people know out there, so nobody has given them a high valuation for that. But how I think that was helpful is first of all, that created a massive goodwill among its own employees and future employees. But for me as an investor and custodian of client capital, it tells me a lot about how management thinks. And if the management can take along stakeholders, then it tells me a lot of what they think about my clients’ capital. I think ESG matters, and eventually I think following and joining hands with the good quality companies with like-minded thoughts, I think, results in the better alpha, as well.
MUCHA: All right, I want to pull the lens back a little bit here for both of you, and we’ve been discussing, and investors often discuss emerging markets collectively. But in reality, this asset class is diverse, it’s a dynamic set of different countries. So I’m going to ask you both, and I’ll start with you, Bo, how do you approach allocating capital across this rapidly evolving universe? I mean, what’s your framework here?
MEUNIER: The emerging market research on our team has a framework we call country, sector, and company. For every single country, we run periodical reviews to look at what changed monetary policy, fiscal policy, industry dynamic, to really identify those inflection points. We also work with our global industry analysts again, looking for inflection points of our industry developing on the positive, for an active side. Those are framework we use regularly, whether we invest in the stock, or in the country, or not. And that’s one starting point of the capital allocation. Then we compare them across, we think the EM universe, using more of a conviction level, a targeted price, to identify the attractiveness. Also want to highlight the resources we have here, working with the debt team. They cover even broader set of countries than we do, so working with them, seeing what they identify as the change, I think as an investor, it’s important, but inflection points tend to be a very rewarding points to identify. So we do use a lot of resources looking for that. That could be country, industry, or company level.
MUCHA: Niraj, how do you approach that daunting task?
BHAGWAT: So Thomas, when people talk about emerging markets as one asset class, I’m quite amused. Because if you think about the difference between South Korea and Indonesia, it’s the same difference between US and China. And I’m not even talking about the cultural differences between every country. So I think that clients want their capital compounded. They don’t care whether the capital is compounded in Korea, China, or Indonesia, or Egypt. And so we take a bottom-up approach. We try to understand the management, the cultures much better, and I think the answer to that is, one, obviously try an experienced team and understand the managements better. But also and maybe because of my past background as an auditor, I believe that to get differentiated outcomes, you need differentiated processes. So we try and be on the ground, we don’t attend conferences, we see the ecosystem, do annual road trips. So I think that’s the approach we take.
MUCHA: So I want to end here, this fascinating discussion with a more personal question. You were both born and educated in probably the two most important emerging markets, in China and India, respectively. So what are your favorite things to do when you return to that first place you call home? And Niraj, let’s start with you.
BHAGWAT: Yeah so I grew up in Mumbai, but I was born in a very small coastal town called Ratnagiri, and while I studied in Mumbai, I used to spend a chunk of my time every year at my grandfather’s farm. And so every time I go back to India, obviously on the menu, no pun intended, is meeting friends and family, but what I really cherish is going back to my grandfather’s farm and spending time among mango trees and cows.
MUCHA: Wow, that sounds fun. What’s your favorite mango dish?
BHAGWAT: Well, Alphonso mango, that’s kind of the type of mango where I come from, but my favorite is mango milkshake.
MUCHA: All right Bo, same question to you.
MEUNIER: I was born and raised in northeast part of China, it’s cold weather, but more importantly, at the time I grew up in China, I experienced dramatic economic development. Almost 30 years, equivalent to three generations of change here in the US. As a result of that, I couldn’t go back to my grandmother’s house anymore, because even the house I grew up is totally gone, 10-plus years ago. But what’s left is memory and friendships. So when I go back, definitely same thing, visiting my friends from elementary school, high school, college. The modern world is connecting people in amazing ways, no matter where you are, how far apart. So when I’m back there, we definitely touch base to see the dramatic change, and the range of their life is so wide, it is very fascinating. Since I couldn’t find the home, but the food is always there, and Chinese culture, I spend a lot of time and value on food. So dumplings is what the town that I grew up in is very, very well known for. So if any one of you go to northeast part of China, I highly recommend dumplings. Some stores you can get 100 type of fillings, and there’s nothing like that. I call that home.
MUCHA: You had me at dumplings. All right, Bo, Niraj. Thanks again for this fascinating conversation. It’s been a real joy to dig into your process, and how you’re thinking about this dynamic asset class. So thanks and come back soon, please.
MEUNIER: Thank you for having us.
BHAGWAT: Thomas, thank you very much for having me. It was a pleasure.
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Views expressed are those of the speaker(s) and are subject to change. Other teams may hold different views and make different investment decisions. For professional/institutional investors only. Your capital may be at risk. Podcast produced February 2023.
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