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AAA-rated EM equity stars share secrets on staying ahead

AAA-rated EM equity stars share secrets on staying ahead

Emerging market equities are back in vogue, but while yield hungry investors are queuing up for the ride, leading fund managers are taking a more nuanced view, Rob Griffin finds out.

Rising living standards in several developing countries over recent years have provided a boost for Citywire AA-rated Gonzalo Pangaro, manager of the T Rowe Price Emerging Markets Stock fund.

‘The ongoing improvement in living standards across several emerging markets is a favourable long-term trend for consumer-related companies. We are finding a good range of opportunities in both the consumer discretionary and staples sectors,’ says Pangaro, who is ranked seventh and 19th over three and five years respectively.

A prime example was the decision to take profits from his holding in drinks company SABMiller and reinvest this money into Brazilian brewer AmBev, whose brand names include Skol, Quilmes and Brahma.

‘The stock is trading at attractive valuations owing to the downturn in Brazil but there are signs that the domestic economic situation is improving and the company has the support of a 5% dividend yield,’ he says.

Improving living standards also promote the growth of the middle class within many emerging markets, and the consequent increase in consumer spending is another long-term theme for Pangaro’s portfolio.

‘An example is Brazilian apparel retailer Lojas Renner, which outperformed last quarter,’ he says. ‘Our large overweight here was the dominant factor behind positive stock selection in this area of the market.’

He has also identified a range of good investment opportunities among financial stocks, which account for some of the portfolio’s largest positions. One of the key holdings in this area is Sberbank, a prominent Russian banking group.

‘The shares outperformed as investors reacted positively to its first-quarter results, which showed an increase in profits and return on equity,’ Pangaro says. ‘In our view it’s one of the best-managed companies in Russia.’

IT boosters

Information technology is another area of the market that Pangaro expects to benefit from the growing prosperity of the regions’ consumers. One of the largest positions the fund holds in this area is Chinese internet service portal Tencent.

‘The company has a solid market position due to the popularity of its WeChat application,’ he says. ‘The shares rallied on a positively received quarterly earnings report that showed stronger-than-expected revenues.’

While the lion’s share of Tencent’s revenue currently comes from the gaming area, Pangaro believes that advertising is set to become more of a growth driver over the next three to five years.

Elsewhere, he remains underweight materials, as a number of commodity-related markets are oversupplied and losing demand. ‘Concerns over the sustainability of the oil price at current levels and a relative lack of growth opportunities mean we also remain underweight the energy sector,’ he says.

Tencent is also a favourite of AAA-rated Thomas Schaffner, who runs the Vontobel Fund – MTX Sustainable Emerging Markets Leaders fund with Roger Merz.

‘Tencent has a large user base that is currently under-monetised compared with global peers.

‘We believe this increasing monetisation will drive the return-on-invested-capital for the company and also the stock price,’ says Schaffner, who is ranked second over three years.

The inclusion of this firm goes some way in illustrating the fund’s approach, particularly the fact that it focuses on four principal pillars: profitability; industry positioning; valuation; and environmental, social and corporate governance factors.

Schaffner expands: ‘A company needs to be in the first quartile in terms of profitability and industry positioning, trade at a discount to intrinsic value and fulfil our minimum standards in terms of ESG to be included in our portfolios.’

Stock selection soars

Both the fund’s country and industry allocations are the result of stock selection. Over the last five years, for example, the strategy has been strongly overweight information technology and slightly overweight consumer discretionary and real estate.

‘Geographically we are overweight China, which might surprise some people,’ he says. ‘However, China has quite a broad market and the profitability of selected companies is quite good if you leave out traditional industrials and commodity-related sectors.’

Schaffner is keen to stress there are some well-run private companies in China, while valuations are quite cheap. His high China exposure is also partially driven by holdings in selected Chinese A-Shares, which are not yet included in the MSCI.

‘The local A-Share market offers a larger number of companies from mainland China than Hong Kong-listed H-Shares,’ he says. ‘Access to this market widens the range of Chinese companies people can invest in.’

However, he remains highly selective in this space. ‘We try to focus on leading firms which generate high return-on-invested-capital and which trade at a fair valuation,’ he says. ‘Zhengzhou Yutong Bus, a manufacturing conglomerate, is one such example.’

Looking ahead, Schaffner says it will be important to stick to his investment philosophy and invest with conviction, while ignoring the noise. With investors being very underweight emerging markets at the start of 2016, he expects to see more inflows.

‘The overall macro situation in emerging markets has stabilised this year and we are seeing improvements in earnings revisions,’ he says. ‘Overall, these regions offer a better growth picture, while valuations are at a discount to developed markets.’

These comments originally appeared as part of a supplement which was published alongside the October edition of Citywire Selector magazine.

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