martes, 19 de marzo de 2013

martes, marzo 19, 2013

Barron's Cover

SATURDAY, MARCH 16, 2013

The Next Wave

By RESHMA KAPADIA

Forget indexing. In the emerging markets, a more complicated global economy calls for a more sophisticated strategy. Here it is.
 Thomas Reis for Barron's



For nearly a decade, the key to successful investing in emerging markets could be summed up in a single word: emerging. Economies like Brazil, Russia, India, and China were creating an emerging middle class, which in turn would create emerging demand for consumer goods, commodities and everything in between. It was a virtuous cycle -- or so it seemed. In the five-year period from 2003 through 2007, the MSCI Emerging Markets Index compounded at a 36% annual clip, and all it took to make money was to buy the index or a fund that hewed pretty closely to it.



Then came the global financial crisis, complete with a near-worldwide recession, housing and stock market crashes, and endless political strife -- all rooted in the developed markets but nonetheless affecting the emerging markets. The so-called BRIC countries, which make up 43% of the index, initially made a strong comeback in 2009, but have faltered since, dragging down the whole group.


The broad indexes that track emerging markets are skewed toward the largest companies, which are often state-run and sometimes managed for political gain rather than economic gain. They're also typically export-oriented, dependent more on Americans buying gadgets or on commodity prices than local demand.


Today the operative term for emerging-markets investors is markets. While the MSCI Emerging Markets Index is down 2% over the past year, other markets have fared far better. The MSCI Frontier Markets Index, which includes Pakistan, Kenya, and Vietnam, is up 9%. The JPMorgan Emerging Markets Bond Index Global Diversified index of dollar-denominated sovereign debt in these markets is up 17%.


Carve up the emerging markets even finer, focusing on where local consumer markets are thriving, and the results are even better: The MSCI Philippines index, for example, is up 39% in the past year; Nigeria is up 70%; and Mexico is up 17%.


Meanwhile, the widely held BRICs have faced serious growing pains. Brazil's economy grew a scant 0.9% last year. India is projected to grow at just 5% this year, the slowest rate in a decade, and while China averted a much-feared "hard landing," its new leaders are targeting economic growth of 7.5%, down from its 10% rate of recent years. Uncertainty about how the leadership of both nations will handle the current economic conditions is keeping pressure on their broad stock markets -- and hiding some gems.


All this slicing and dicing requires a fair amount of expertise -- finding the right stocks in the right markets at the right time requires savvy management. That's why institutional investors, including endowments and pension funds, are increasingly assembling teams of specialists to parse their allocation to emerging markets. Individuals can achieve the same results by adding a larger variety of holdings, including stocks, bonds, and funds that align with the biggest themes.


The Consumer

Undoubtedly, the most tempting part of the emerging markets story is the consumer. Since 2008, consumer-oriented sectors, such as health care, staples (such as food and household items) and consumer discretionary (retailers and media companies) have outperformed. Markets such as Thailand, Colombia, and Turkey, which are skewed toward consumption, have racked up double-digit gains in the past three years, notes Tony Welch, an emerging-markets analyst with Ned Davis Research. Funds that hew close to the broad index, however, likely missed the bulk of those gains, since the three sectors make up just 18% of the index and those three countries comprise only 6% of the index's assets.


No matter how finely sliced an index fund is, investors often don't understand what it holds. Take the iShares FTSE China 25 Index Fund (ticker: FXI), one of the most popular ways to get access to China. The $7 billion ETF accounts for 80% of the category's assets. "Why? Because it's the easy button," says Matt Hougan, president of ETF analytics for IndexUniverse. "There are much better options." Indeed: Most investors would say they want Chinese consumer and technology stocks, yet the biggest ETF has no exposure to technology, health care, or the consumer. The $204 million Global X China Consumer ETF (CHIQ) can offer direct exposure, while the broader $1.3 billion iShares MSCI China ETF (MCHI) offers more diversified exposure, with about 17% invested in consumer, health care, and technology stocks.


There are several ways to gain access to the sought-after emerging-markets consumer, including U.S. or European companies like Nike (NKE), which gets a quarter of its sales from emerging markets, and LVMH Moet Hennessy Louis Vuitton (MC.France), which gets about a third of its sales from emerging markets.


For direct access to the emerging markets, it's better to choose a fund manager who can navigate the variation in valuations and growth to focus on the consumer. For example, Lewis Kaufman, the manager of the three-year-old Thornburg Developing World Fund (THDAX) often veers from the index to seek out companies generating plenty of free cash and catering to domestic demand. The strategy has the fund beating 98% of its peers in Morningstar's emerging- markets category for three-year returns. The $1.6 billion Virtus Foreign Opportunities Fund (JVIAX), run by veteran manager Rajiv Jain, invests in multinationals that offer an indirect play on emerging markets and is heavily tilted toward consumer companies. For those set on an ETF and willing to take on more risk, the $886 million EGShares Emerging Markets Consumer (ECON) is an option. The ETF invests in 30 large consumer-driven companies; almost half its assets are in Latin America.


Small and Frontier Markets


While much of the developed world has been starved for economic growth, a handful of smaller markets -- including countries as far-flung as the Philippines, Indonesia, Mexico, and Turkey -- have expanded enviably, largely on the heels of economic reform and newfound political stability. That's led to gains as high as 39% for the Philippines in the past year, and 17% for Mexico, and strong inflows into both markets. Both markets now seem a bit pricey at first glance: The Philippines trades at 17 times and Mexico 14 times next year's earnings, compared with the multiple of nine for emerging markets as a whole.

 
Experienced managers, however, still say they can dig up some deals in what appear to be pricey markets. Investors sometimes balk at valuations too quickly, underestimating the longevity of some consumer trends, says Laura Geritz, co-manager of the Wasatch Emerging Markets Small Cap Fund (WAEMX). Geritz points to one of her holdings, Nestle Nigeria (NESTLE.Nigeria), which trades at 21 times 2014 earnings. Geritz says that's not an unreasonable level, based on the country's per capita gross-domestic-product figure. Consumers now have more income, and are willing to pay a premium for branded food and beverages. A similar situation played out in India with Nestle India (Nest.India), she says. Nestle India now trades at 31 times forward earnings, but was far pricier in 2000. Its earnings have grown 800%, or ninefold, since then, and the stock has grown 1,451% -- in other words, a $1,000 investment in 2000 would be worth $14,510. "You don't get a lot of shots to buy these great growers," she says, adding that valuations look more approachable as earnings growth materializes.


Other small markets are attractive because the returns haven't been as outsize. Indonesia's 6% return in 2012, for instance, paled in comparison with its neighbors. Though blessed with resources and a large and young population, investors have been wary of Indonesia because of its high current-account deficit and weak currency. But some money managers say the softness in the Indonesian market allows them to scoop up companies with good long-term potential.


Increasingly, advisors are also adding a little exposure to frontier markets like Sri Lanka, Vietnam, and sub-Saharan Africa. They're in an earlier phase of consumption and offer longer-term growth potential. Frontier markets -- typically defined by fast economic growth but nascent stock and bond markets -- also offer greater diversification. With a 0.61 correlation to the MSCI All Country World Index and a 0.60 correlation with emerging markets, frontier markets have offered some of the highest diversification in the world of stocks over the past decade.


Given the harder-to-parse valuations, lack of stocks traded on a U.S. exchange, and the illiquidity of many of these markets, it makes sense to use mutual funds. Investors looking for a purer play on this theme can look at the Wasatch Emerging Markets Small Cap fund, which has beaten 99% of its peers in the past three- and five-year periods, or the new Wasatch Frontier Emerging Small Countries Fund (WAFMX), which ranks in the top percentile over the past year. The Matthews Asia Small Companies Fund (MSMLX) has about 60% of assets in emerging markets and ranks in the top 20% among peers over the last three years.


The New Way to Play Emerging Markets

 
 
Investing in the developing world has become a lot more complicated, and sophisticated investors are taking a much more nuanced approach. These funds capitalize on the big themes in emerging markets today.


Assets Returns
Fund Name/Ticker (bil) YTD 3 Yr* Comment
SMALLER COMPANIES, FRONTIER MARKETS
Wasatch EM Small Cap / WAEMX $1.80 5.00% 15.80% Top fund over the past three-year period; long history in small-caps.
Matthews Asia Small Companies / MSMLX 0.4 4.4 11 Invests in all of Asia, but two-thirds of its assets are in developing countries.
Templeton Frontier Markets / TFMAX 1 6.4 6.5 A pricey fund, but run by veteran emerging-markets manager Mark Mobius.
Harding Loevner Frontier Emerging Markets / HLMOX 0.1 7.6 5.4** One of the few managers with lengthy institutional record in frontier markets; retail share class is newer.
BONDS
TCW Emerging Markets Income/ TGEIX $7.60 1.30% 12.80% Invests in all types of debt; currently favors local corporate bonds.
Wisdom Tree Emerging Markets Local Debt Fund / ELD 1.9 -0.2 N/A Popular way to get local-currency exposure for cheap.
Payden Emerging Markets Bond / PYEMX 1.1 -0.2 10.8 Top holdings include bonds from Colombia, Serbia, and Brazil.
Fidelity New Markets Income / FNMIX 7.4 -1.3 11 About a quarter of fund is in corporate bonds; rest in sovereign debt of countries including Venezuela.
DIVERSIFIED
Thornburg Developing World / THDAX $0.30 9.70% 13.00% Not afraid to look different from the benchmark, notable exposure to smaller markets like Philippines, Peru.
Virtus Foreign Opportunities / JVIAX 1.6 4.5 11.5 Bulk of emerging-market exposure comes indirectly through large global stocks. Veteran manager favors consumer plays.
EGShares Emerging Markets Consumer / ECON 0.9 -0.2 N/A Not diversified, but a better way to get exposure to domestic demand than sticking with the broad index.
DIVIDENDS
Matthews Asia Dividend / MAPIX $4.70 6.70% 10.40% Ranks in the top percentile over the last five years; run by veteran Asian manager keen on dividend growth.
WisdomTree Emerging Markets Equity Income Fund / DEM 5.6 -2.1 6.9 Popular way to play dividends, but heavy on Chinese banks lately.
Forward Select EM Dividend Investor / FSLRX 0.05 6.6 N/A Fund launched in 2011 with strong performance to date, but is still very small.
Note: Data are latest available.
*Annualized.
**Performance reflects institutional share class.
N/A=Not Applicable.
Source:Morningstar


Cheap Markets


Looking for the cheapest markets brings investors back to the BRICs, specifically, Brazil, Russia, and China. BRIC funds have seen outflows in 50 of the past 51 weeks, according to EPFR Global. While these countries struggle to navigate slower economic growth, they are bound to recover from their recent slumps, says Garry Evans, HSBC's global head of equity strategy. Earnings expectations are steady, he adds, whereas they are being cut in Europe and the U.S. Meanwhile, BRIC valuations have dropped to levels that are piquing managers' interest.


Few money managers, for instance, expect to see much change in the transparency and governance issues that have kept Russia on the cheaper end of the spectrum. And state-run companies in any country pose a risk. But with the market trading at just five times earnings and energy giant Gazprom (GAZP.Russia) trading at three times, it's cheap enough to warrant a look, even though it's 50% government-owned, says Arjun Divecha, head of GMO's emerging-markets equity team. Divecha is looking at energy companies as well as some banks in Russia.


There are also catalysts to watch for. Brazilian stocks will get a reprieve if the government backs away from recent interventionist measures, such as trying to keep a lid on energy prices and pushing banks to lend. Just one example: Shares of the state-run Brazilian energy giant Petrobras (PBR) rallied 15% earlier this month after the company raised diesel prices -- a move it was able to make as government pressure to keep energy prices low eased. Some managers are looking at banks and real-estate investment trusts in Brazil as indirect consumer plays that are cheaper than retailers and other more obvious consumer stocks.


China, as ever, is a more complicated story. Wages are rising, which means consumer stocks are appealing, as are some more subtle plays, like automation companies that can replace pricey workers. "You have to pivot to capture the opportunities that are going to be beneficiaries of that transition," says Kathryn Koch, senior portfolio strategist at Goldman Sachs Asset Management.

 
The most obvious consumer plays, even in these battered markets, are not bargains, but there are plenty of indirect ways to tap the consumer that are still reasonable. Michael Reynal, manager of the $802 million RS Emerging Markets Fund (GBEMX), likes Chinese PC maker Lenovo Group (992.Hong Kong) as a way to tap demand for computers and smartphones in emerging Asia, especially smaller markets other global players may not be able to easily tap. Lenovo derives two-thirds of its sales from emerging markets. Reynal is also looking at natural-gas companies as China struggles to combat its record levels of smog.


As the Chinese focus on cultivating domestic demand, smaller local players will be among the beneficiaries. The trouble for U.S. investors is that the universe of companies to invest in is far more limited for those investing in China through the more-accessible Hong Kong market. The Chinese A-share market -- mainland China's two stock markets, Shenzhen and Shanghai -- is denominated in the local currency and restricts foreign investment. But many of those stocks, Koch says, are more geared toward the "new China" story, with companies targeting the smaller cities that are in the earlier part of the consumption cycle. But the greater volatility and restrictions make it difficult for even professionals to invest. Just a handful of U.S. managers invest in A-Shares, including the tiny $43 million Aberdeen China Opportunities (GOPAX), which has the highest exposure at 5% of assets, according to Morningstar.

Dividend Payers


If dipping into these riskier areas makes you queasy, dividend stocks can offer some relief. Over the past decade, dividend-paying emerging-market funds have generated better returns and less volatility than the MSCI Emerging Markets Index, according to Morningstar. The average dividend yield of 2.7% in emerging markets and 3.9% in frontier markets is undoubtedly attractive as well. "If you have more than half of the total return you expect coming from yield, you don't have to reach," says Jesper Madsen, manager of the Matthews Asia Dividend Fund (MAPIX), whose top-performing fund yields 3.7%.


But there's another reason to own dividend payers. As investors move into smaller markets where information is harder to find, dividends may be one of the best road maps available, since they telegraph a management's confidence in the future, says Bruce Brewington, co-manager of the $48 million Forward Select EM Dividend Forward Select EM Dividend Fund (FSLRX).


Here, too, there are some ETF options, but look carefully at their holdings before investing. The $114 million iShares Emerging Markets Dividend ETF (DVYE) yields 3.5%, though 29% of its portfolio is in developed markets. The WisdomTree Emerging Market Income Fund (DEM) yields 3.4%, but one thing to note: After its latest rebalancing, it's more heavily skewed toward Chinese financials -- an area some managers are wary about given the country's shadow banking and nonperforming loans.

Bonds

Yield-seekers have recently discovered emerging-market bonds, and have poured in $144 billion since the beginning of 2010, according to EPFR Global. The appeal is clear: Dollar-denominated government bonds from Russia, Brazil, and Turkey yield more than a full percentage point than Treasuries and are arguably in stronger fiscal health.


But yield isn't the only reason to include bonds in your emerging-markets portfolio. Emerging-market debt offers greater geographic diversification, even when sticking to the index: The JPMorgan Emerging Markets Bond Index Global Diversified index has almost 70% in Latin America and Eastern Europe, for instance, while its equity counterpart, the MSCI Emerging Markets Index generally has about 25% there. What's more, bonds can provide access to economies in the earliest stage of development -- like Senegal or Angola -- through their government bonds, often before there is a sufficiently liquid and vibrant stock market.


Bonds denominated in dollars have garnered the most attention and vast sums of new money. That doesn't bode well for the short term, but in the long run there's still room for big gains. Emerging-market debt makes up just 5% of fixed-income investors' assets, but these economies are on track to account for half of global economic activity, says Jan Dehn, co-head of research at Ashmore Investment Management, which oversees $71 billion in emerging-market assets.

 
In the shorter term, managers see more upside in sovereign bonds denominated in the local currencies and dollar-denominated corporate bonds -- many of which have yields into the low teens.
Investing in local-currency debt also helps investors diversify away from the dollar. Many noted investors, including Pimco's Bill Gross, have warned that the United States' burgeoning debt levels can cause inflation and a weaker dollar.

 
Developing countries have more robust reserves and a fraction of the debt -- China, for instance, has $3.6 trillion in reserves -- setting the stage for stronger currencies in the long term. "Policy makers cannot prevent [currency appreciation] over time," even though they'll try in the short term, says David Robbins, co-manager of the TCW Emerging Markets Income Fund (TGEIX).


Corporate bonds are also attractive, with improvements in credit quality and a greater variety of companies looking for financing. Bond investors can tap industries like railways in Georgia and telecoms in Panama that don't have many liquid publicly traded stocks. Neither country is represented in the $159 million Guggenheim Frontier Markets ETF (FRN). Bonds can also be more resilient than stocks, especially in times of government intervention. When the Chinese government announced stricter lending standards earlier this month, Chinese property stocks tumbled 8% in the week following the announcement, but the bonds fell only 0.2%.


TCW Emerging Markets Income fund and Fidelity New Markets Income (FNMIX) are run by veteran managers who can invest in any of the categories of emerging-market debt. "While emerging-market bonds had extraordinary performance in 2012, we are nowhere near bubble levels," says Robbins, who expects total returns on his portfolio to be as high as the low double digits.

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