This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Alan Miller, CIO and Founder, SCM Private, urges investors to re-consider emerging markets.
Warren Buffet famously urged investors to: “be fearful when others are greedy and greedy when others are fearful”. We seem to have lost sight of this wisdom when it comes to emerging markets.
While the rest of the fund management industry frets about emerging market growth and rushes headlong to put money into equities in developed economies, I believe the opposite approach has merit.
In my view the emerging markets story is a fascinating one despite almost universal agreement by fund managers and strategists that developed markets will make investors more money going forward. They cite countless issues to back this reticence up – China slowdown, Brazil and commodities, Russia and corporate governance, Turkey and demonstrations, the lists goes on.
While all these points are true, the mega-trend is being under-valued: growth in key emerging economies, such as China and India, maybe slowing but it still significantly outpaces the largest Western economies. The emerging-markets’ new middle-classes are still getting richer, they’re still buying more; retail, industry and leisure are still huge growth areas; and these countries are investing heavily in their own futures and infrastructure and tend to be on a much stronger financial footing, with significant financial firepower to stimulate their economies should they slow down markedly. For example, we have recently seen Russia announcing proposals for major rail infrastructure projects to stimulate its own economy.
However, the real critical investment reality being overlooked by the anti-emerging markets commentators is that when you buy emerging market stocks you buy companies, not countries, and you should look at the actual valuation and likely growth of the companies in which you invest.
Despite the recent tailwinds facing many of these economies, particularly those more dependent on commodities, the average earnings growth of the average emerging company stock has been downgraded by no more than the average European stock (which these same strategists now seem remarkably bullish on).
Emerging markets company valuations on almost every number (Price Earnings Ratio, Price to Cash Flow, Price to Book Value) are at their lowest for between 5 and 10 years.
Fund managers like to invest via the rear view mirror – but don’t we know all the drawbacks already, are they not already well and truly priced in? I’d argue they are in many cases.
There have been record outflows from emerging market equities and bonds in recent months and can you remember the last time a major investment manager launched a fund in this area? In my view this is herd mentality that has gone too far, leaving a window of opportunity for the rest of us.
This week, we invested in a Pacific Ex Japan Small Cap ETF - it has 472 holdings with the largest holding being just 1% of the fund and the average future earnings growth of the stocks estimated by third parties at nearly 19% per annum over the next few years which is likely to be more than twice the equivalent UK stock. Yet the average rating of these stocks is just 12x (similar to the UK); so you can pick up double the growth for the same price.
I am a great believer in growth at the right price – buying emerging markets a few years ago was buying growth at the wrong price, now I believe you can buy it at the right price.
While any investment decision has to be carefully made and weighted against your appetite for risk, experience shows that contrarian investors reap the greatest rewards.
Don’t just follow the herd, look afresh at emerging markets – there’s much to gain for the savvy investor.
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