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Holly Cook: At the Morningstar Investment Conference I've sat down with Kim Catechis. He is head of global emerging markets at Martin Currie. I asked him to explain the recent performance of emerging markets and his outlook for the sector. Here's what he had to say.
Kim Catechis: Well, I think if we cast our minds back five years, credit crunch was a bit shock to investors and the developed world particularly. There was, I guess, an irrational exuberance, in the sense that there was an irrational expectation that the emerging markets economies were going to suddenly pick up where the US and European consumer left off, and develop their new role as drivers of the world economy. The fact is that, a lot of the – whilst lot of that growth did materialize, economic growth that is, it didn't materialise in terms of stock market returns, and there are many different reasons for that.
First of all, because it's a major adjustment, and I think it's being quite impressive how many Chinese export manufacturers have redesigned their plants and turned that capacity from export to the inward domestic market. Another reason that returns have disappointed is because the profitability has actually fallen away very sharply. If you think about it, China is the biggest consumer market in the world, and every man and his dog are there, and do not underestimate – you mustn’t underestimate – the strength and the ferocity of competition in that market, where everyone thinks they have to be a winner. So they all sacrifice short-term returns for the greater market share gain. As a result, profitability can fall pretty sharply in that particular market.
In terms of overall stepping back a little bit, I think also there was, I guess, an almost a kneejerk reaction to go into cash and bonds, away from equities generally, and that really can't be put at the door of the emerging markets.
Cook: So is it enough to invest in emerging markets as a whole, if you are an investor and you believe that this is where some of the best returns are, or should you be looking for individual countries, fashion sort of tends to refocuses on Turkey, South Korea, Vietnam and sort of moved away from BRICs a bit, or is it better to be looking at the whole area?
Catechis: It's our view that you don't look at countries or sectors. My first boss in this business told me do not fall in love with a sector or a country or a name, and I think that's sound advice. We are bottom-up stock pickers. We're driven by fundamental research, the kind of thing that used be called old-fashioned before Bernie Madoff. Now my answer to that is that you almost disregard countries; you look at the companies and you look for companies that have an ability to fight the natural fate of returns over time and keep good returns coming against the cost of their own capital. Now, within that, you clearly have to be aware of politics, of macroeconomics as sources of risk in our view to a good bottom-up driven piece of research.
Cook: So in terms of the theme then, if we disregard countries, the consumer theme is one that people really are focusing on an awful lot at the moment and you mentioned South Africa, China, for example. Is that still the big story for you?
Catechis: I think in terms of the size of the opportunity, it is still valid and I think it's a theme that's got many decades to run, simply because so many people in emerging markets are only just starting to enter middle class. However, as a stock market investor, you cannot afford to just take that simplistic view and say, oh, well, that's what I'm going to buy. There is one very, very crowded trade in the emerging market space at the moment, and it’s exactly this one. A lot of my well-resourced and highly intelligent and very experienced competitors are staying with this particular sector in the market; we’re not. The reason we’re not is not because we know something they don't.
We know a lot of these companies, we agree with them that they are very good companies and have an excellent history of good returns over time, and they are all very defensive. However, our mindset is slightly different in the sense that we believe that over time as a company continues to deliver, it essentially does two things. It increases the premium that it gets over its competitors, which is fair. But at the same time, surreptitiously, it builds in a nasty habit of being able to disappoint more for a lower degree of miss. So, if I can explain myself a little bit better, what I mean by that is you don’t need a good company to have an implosion to lose that premium. All you need to do is puncture that bubble of aura of invincibility. So our way around it is to find other ways in other companies that again play to that middle class growth story, but in less loved sectors, like technology or financials.
Holly Cook: Well, Kim Catechis, thank you very much for your warning today.
Kim Catechis: Thank you.
