Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Ewan Thompson, manager of the Neptune Emerging Markets Fund.
Hello, Ewan.
Ewan Thompson: Hi.
Wall: So, firstly, congratulations on stellar performance, five-star fund. What has driven this performance not only in the fund but in emerging markets in general, because it's been a pretty good run?
Thompson: Yeah. Well, I think, if you look back over the last three or four years, even five years, it's been a massive inflection point we've seen. So, going back to the start of 2016, markets in emerging markets bottomed. So, the reason for that would be really the arrival of the synchronised global recovery.
So, emerging market is quite well leveraged into that. So, as that continued, EMs have done well. But actually, the performance of the fund and the performance of the markets have been very different in the couple of years prior to that and a couple of years after that. So, I'd probably say the drivers were very different during or depending on which timeframe you are talking about.
Wall: And more recently then, what's been so great about your fund's performance?
Thompson: Really, I think, it's been the willingness to embrace more value opportunities, more cyclical opportunities. So, again, if you go back to 2010 to 2015, the QE era, real growth was very slow. So, the kind of stocks people were looking for were, as everywhere, bond proxy type stocks, quality stable cash flows, got very expensive. And as really the inflection point in global economic momentum came in 2016, suddenly then all these stocks which were geared into that which were incredibly cheap.
So, from 2016 through 2017 and indeed into 2018, you have really seen renaissance in those kinds of stocks. So, I'd say, over the last couple of years really the performance of the fund has been driven by countries such as Brazil, Russia; or on the sector level, the materials or industrials, or even financials and really underweight positions in things like consumer staples which very well-owned during that previous period and have got expensive and generally seen sort of selling in those relative to the opportunities elsewhere.
Wall: But the thing is about cheap stocks is once they rally, they are no longer cheap. So, looking forward, can we expect both emerging markets to continue to outperform developed markets? But also, are you finding it bit more difficult to find those in value opportunities?
Thompson: Well, I think, equities are quite a headscratcher from because they – they have done so well over recent years. But I think what's frustrating in emerging markets is, we are only just a year or two into this. And if you look at the S&P, it's been sort of a nine-year bull market. So, in emerging markets, we've just got started.
If you look historically, you tend to get – it's rare that you get one or two years of emerging market outperformance then underperformance. It tends to be in these longer, sort of, more half-decade or longer cycles, six, seven years, which makes sense really that it would mirror really the global capital cycles. So, we've had a period of low investment after the financial crisis and that's really turned around in the last couple of years. They tend to last longer than we've seen. So, that would be the first point.
The other thing is, despite emerging markets doing really well for the last couple of years, relative valuations are still very attractive. So, EM versus DM, still about a 30% discount on P/E or price-to-book basis.
So, if you are looking at x reasons and thinking where do I put my money, we think that given the economic momentum still remains very strong, earnings have inflected dramatically in emerging markets and you're still getting that 30% discount overall, then that's great. And within emerging markets, there are still these pockets of value.
So, Russia still trades at a 50% discount to emerging markets more generally. So, it has a huge sort of value opportunity there as well. So, I think, there certainly is – there are opportunities within emerging markets for sure.
Wall: And that's a good point to make, because of course, emerging markets are a heterogeneous group even though they are all lumped all in together when it comes to things like asset class. Apart from Russia where are the opportunities? India has done very well, for example. I know those stocks are beginning to look a little bit expensive. Where are the best value opportunities?
Thompson: Yeah, obviously, if you look at our fund by a country allocation basis, then our biggest overweight is Russia, as you said. But beyond that, the next would be Brazil. So, I think, what those two markets share in common is a dramatic inflection point.
Whereas maybe a country like India has been pretty stable, so an outstanding performer within emerging markets during the tough times, very sort of insulated economy. The likes of Brazil have been sort of hit very hard by the cyclical downturn and also political woes. But actually, if you go back to late 2015, Brazilian economy was contracting at nearly 8% annualized and it's now accelerating at 3%. So, going from minus 8 to plus 3 and you know, similar but maybe less extreme in Russia. These are really the cyclical turning points where we've been able to sort of find the most value.
If you look at India, still an overweight for the fund, but that was a market we had a lot of money in, maybe in 2014 to 2015. But as opportunities were risen elsewhere and as the market, as you say, has got a little bit more expensive, we've incrementally had less money in India and more money elsewhere just because just the valuation opportunities are so much more obvious elsewhere.
Wall: Ewan, thank you very much.
Thompson: Not at all. Thank you very much.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
