Emerging markets are often touted as a great place to invest for fast growth, but the potential rewards come with greater risk.
A number of managers are positive on the prospects for these developing economies though. Here are three reasons to consider putting them in your portfolio.
Dividend Payers
Dividends may not be the first thing that comes into mind when thinking of emerging markets, but many businesses in these countries offer a decent income for investors willing to do their research.
Ross Teverson, co-manager of the Jupiter Emerging & Frontier Income fund (JEFI), says there are plenty of companies that pay good dividend at the moment and, crucially, many that have the potential to grow their dividend, or to start paying one in the future.
Dubai real estate firm Emaar Malls (EMAAR) and Brazilian shipping company Wilson Sons (WSON33) are just two examples of stocks yielding more than 5%. Meanwhile, fast-growing companies such as Chinese gaming company NetEase (NTES) and Korean semiconductor SK Hynix (000660) are likely to introduce dividends in the not-too-distant future.
Mario Solari, manager of four-star rated Genesis Emerging Markets (GSS), particularly likes NetEase, the second largest games company in China, because it’s cheap, has a strong culture and is hard to replicate: "Its growth is more sustainable than the market realises,” he says.
Attractive Valuations
At a time when investor sentiment has been preoccupied by Covid-19 and trade tensions between the US and China, investors who are able to look through the noise can often find operationally resilient companies trading at attractive valuations.
Indeed many stocks are trading at or near the low end of their historic range after the recent market falls. Teverson is using the situation to pick out companies “where an element of change has not yet been reflected in the share price". When you compare emerging markets to the developed world, he says, there are more companies with few or no other investors monitoring them, making it easier to find hidden gems.
He says: "current valuations could prove an attractive entry point. Many companies have continued to deliver solid operational performance and also have exposure to long-term structural changes, which we think will continue regardless of short-term macro headwinds.”
Solari likes Gruma (GRUMA B), the largest producer of corn flour and tortillas globally, and Bangkok Dusit Medical Services (BDMS), the dominant hospital operator in Thailand with 48 hospitals and 8,300 beds.
But Andrew Ness, manager of the four-star rated Templeton Emerging Markets Investment Trust (TEMIT), warns that while valuations relative to developed markets look more appealing than they have for some time, there will be significant volatility in earnings over the coming months.
He looks for businesses with more cash on their balance sheets than their developed market counterparts, an indication the firm is being managed prudently. “Looking at the top 100 corporates, the number with net cash on the balance sheets in Korea, Taiwan, Japan and China is at least double that of US companies," he says.
Industry-leading Companies
While emerging economies may still be developing, many companies in the region are already leaders in their field. Asia's tech sector, for example, is home to many of the world’s leaders in semiconductor chips and face little to no competition from elsewhere in the world. Just think of names such as Samsung (SMSN) and Taiwan Semiconductor Manufacturing Company (2300).
Teverson says a number of lesser-known smaller companies are also doing particularly well. Bizlink is one of these, unnoticed by many global investors,e it manufactures wire harnesses for top electric vehicle companies like Tesla.
The data-driven technology space has undoubtedly benefitted from the coronavirus pandemic and, while there has been less demand for electrical products and mobile phones, companies like Samsung (005930), TSMC and Mediatek (2454) have offset this with demand from 5G and servers, with greater pressure on networks to deliver fast, reliable connections.
Teverson says: "The shift to remote working is a trend that could be here to stay, which would make demand from the server sector more sustainable. This transition is a structural change we had previously identified, but the measures put in place to contain Covid-19 are will only accelerate the trend."
Ness points to online entertainment, gaming and messaging platforms as other areas to benefit from a demand boom in recent weeks. "We are searching for companies that could benefit from any permanent behavioural changes in society, and we think that technology is now more likely to be strongly embraced. One of the major questions we'll be asking ourselves is whether social distancing will become more normalised and what this means for how we interact."
Ness likes Chinese internet giant Tencent (00700) and lesser-known Naver (035420), "the Google of Korea", with 70% of the country's internet search market share.
This article was originally published on Morningstar.co.uk in May 2020 and has been repurposed for our Special Report Week on Emerging Markets in July 2022
