As part of Morningstar.co.uk's Global Emerging Markets Week, I spoke to Lazard's Kevin O'Hare, Portfolio Manager of the newly-launched Developing Markets Fund, about investing in the region and the recent talk of 'overheating', while also asking O'Hare to highlight particular areas and companies where he sees exciting opportunities.
Holly Cook: Global emerging markets have been a ‘hot topic’ for much of the last two years and growth in the region has fuelled the global economic recovery, but this has inevitably led to talk of overheating. What’s your outlook for the region as a whole?
Kevin O'Hare: The emerging markets continue to lead the world in this cycle and are, increasingly, becoming dominant players in the global picture. The contrast in the prospects between the developed and emerging worlds could not be starker. While the United States, Western Europe and Japan seem trapped in a cycle of low growth, many emerging markets are expanding rapidly.
We don’t see “overheating” as an issue at present, as macro issues, such as the Greek sovereign debt crisis, have left stocks heavily discounted in regions as diverse as Africa, Emerging Europe and the Middle East. However, the market is now beginning to focus more on the relatively buoyant conditions in countries such as Turkey and Egypt, where loan growth continues to advance strongly and the local economy is booming.
Cook: There’s an ongoing debate regarding diverging opportunities within GEM, for example China vs India, which countries do you think provide the most exciting opportunities and are there any that you are willing to avoid?
O'Hare: Although we would consider ourselves stock-pickers and do not base investment decisions on country allocation, Russia currently offers a number of compelling opportunities for growth investors. Although the generally high level of political uncertainty makes Russia a challenging market for investors, we believe the current environment presents a very attractive opportunity on a risk/reward basis. Russian banks are exhibiting strong growth profiles and are priced very attractively.
In contrast, while South Korean shares are some of the least expensive in valuation terms, and would be attractive to value investors, we find the earnings growth in that market to be highly cyclical and unattractive over a market cycle. In addition, equity valuations are already fully reflecting the growth opportunity. The South Korean economy is not growing as quickly as other emerging markets and we are avoiding the domestic consumer and local industries.
Cook: You recently launched a new fund investing in this region, the Lazard Developing Markets fund, which is available to both institutional and retail investors. Why ‘developing’ rather than ‘emerging’ markets—is there a valid difference?
O'Hare: There is no significant difference between the terms ‘emerging’ and ‘developing’. However, the principal characteristic of the Developing Markets Fund is that our focus is on growth stocks, i.e. companies which can demonstrate their ability to grow profits faster than the market average. Our research suggests that emerging market growth stocks are cheaper than they have been on average over the past 10 years. In spite of their much improved prospects, growth stocks are not much more expensive than low growth value stocks. In short, ‘growth’ is now great value in emerging markets.
The Lazard Developing Markets Fund focuses on the clear long-term investment opportunity in these undervalued emerging market growth stocks – companies whose exposure to the region’s dynamic economies and exciting profits potential is not reflected in their share price.
Cook: Alongside the rush for emerging market exposure, investors have also been snapping up fixed income and, inevitably, turning to emerging market debt for diversification. Where is the Developing Markets Fund investing? Could you provide some examples of some top holdings and why?
O'Hare: The Developing Markets Fund is focused on investing in companies where valuations are at a discount to prospective growth rates. The fund is invested across all regions, with the largest percentage of the fund invested in Asia. In the majority of emerging markets, we also have a high weighting in financials companies, which we believe to be attractively priced. At a stock level, we consider Pacific Rubiales, a Colombia oil exploration company, to be undervalued compared to its production growth profile. Additionally, the valuations of Exxaro Resources, a South African coal miner remain attractive when we look at its growth potential.
Cook: Investors typically buy emerging market exposure for long-term growth, especially given the region’s relatively high volatility. What sort of volatility do you expect the Developing Markets fund to face and how does this impact the potential role of the fund in an investor’s diversified portfolio?
O'Hare: We believe the volatility of the Developing Markets Fund to be in-line with that of the MSCI Emerging Market Index. The portfolio construction is based upon fundamental analysis, accessing the trade off between valuation and multi-year earnings growth opportunity. As a result, the portfolio is appropriate for core emerging markets equity exposure or in conjunction with another investment manager employing a different investment philosophy.
Cook: You’ve launched this fund as an OEIC but closed-end funds have enjoyed something of a resurgence recently as investors seek cheaper investment products. Why did Lazard opt for an open-ended vehicle rather than closed-end?
O'Hare: In the UK, Lazard does not have closed-end funds. The Lazard Developing Markets Fund is part of our Lazard Investment Funds range.
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