latamen
Emerging markets: focusing on local names in consumer space

Emerging markets: focusing on local names in consumer space

10-04-2019 | Insight
Are emerging markets a promise that never delivers? Not in our book. Robeco’s Emerging Markets Equities fund has consistently outperformed since its launch back in 1994. Returns have been strong in absolute terms as well, with the strategy delivering almost 8% annually since inception versus a benchmark return of close to 6% 1.
  • Wim-Hein  Pals
    Wim-Hein
    Pals
    Head of Emerging Markets team

Strong contributions from the two key performance drivers – country allocation and stock selection – have enabled the fund to stay successful over these twenty-five years. The head of Robeco’s EM team, Wim-Hein Pals talks about the focus on the consumer discretionary theme and emerging names.

Speed read

  • Portfolio with a high focus on China, value tilt and above average ROE
  • Improved earnings growth, attractive valuations and solid fundamentals in EM space
  • Consumer discretionary and IT are the fund’s key themes
Stay informed on emerging markets with monthly mail updates
Stay informed on emerging markets with monthly mail updates
Subscribe

Focus on country allocation and value tilt

The fund’s starting point for the investment process is country allocation. Stock selection then follows. This reflects the portfolio managers’ philosophy that fundamental differences between emerging countries remain an important source of alpha. “Our peers start with stock selection and then apply the country overlay,” says Pals.

“The beauty of the EM space is its dynamic nature,” explains Pals. “Countries come and go. Saudi Arabia, for example, has just joined while Israel has just left, having been upgraded to a DM.”

The fund’s bottom-up stock selection is based on a unique blend of fundamental, quantitative and ESG research. For the stock selection process, “the huge benefit of EM investments is the attractive valuations of emerging countries compared to developed ones,” says Pals. “The portfolio is therefore tilted towards value stocks in combination with above-average returns on equity. Our in-depth company analysis is based on fundamental, ESG and quantitative research.

Outperformance is driven by both country allocation and stock selection

Quantitative enhancement and ESG integration

Since its launch in 1994, the Emerging Markets Equities fund has reached two crucial milestones. The first was quantitative enhancement – the application of a quantitative model to the stock selection process – in 2001. “This added stability to the stock selection results, with fewer outliers and less volatility, says Pals.

The second was ESG integration. Benefitting from data provided by Zurich-based RobecoSAM, we started this in 2001 and by 2011 it was an integral part of the process. This has also helped enhance returns for our clients in various ways, adds Pals.

A bright spot: consumer discretionary

“All things EM consumer are the bright spot,” says Pals. “Within this space, the fund focuses on the consumer discretionary theme rather than consumer staples. We are fairly underweight in consumer staples, which tend to be pretty expensive. The consumer discretionary sector, on the other hand, has been a structural overweight for years, which results in much more attractive price-to-earnings and price-to-book ratios,” says Pals.

On the flipside are the producers. “The old heavy industries have never been of interest to us. Paper mills or heavy machinery producers in China – we are underweight those. China used to be the factory of the world, but the growing overcapacity means all that’s changing.”

Apart from the consumer focus, the fund also concentrates on pure emerging names and not on multinational companies. As Pals puts it, “We prefer domestic exposure in countries like India and China. In India, for example, we would rather invest in a local food company than in a multinational, because multinationals would also give you exposure to developed markets, which we generally don’t like.”

We prefer pure emerging names

Strong Asia focus

With country allocation as the starting point, the strategy is primarily oriented towards Asia, which accounts for two-thirds of the portfolio. Of the Asian countries, China dominates. Pals believes that the recent partial inclusion of Chinese A-shares in the MSCI EM Index means that the country’s relative weight will only grow. 

In February, the MSCI announced that it would increase the weight of China A-shares from 5% to 20% in three steps. As a result, China will account for roughly 40% of index in the not-so-distant future, he thinks. “We are currently overweight China, and this is not going to change. We started investing in A-shares in 2009 – a decade before the MSCI decided to include them in its benchmark. India will also continue to grow, but at a slower pace.”

Changes in sector positioning

Over the years, the key strategic change has been to increase the weight of the IT sector. “IT has become one of the most important themes in the emerging markets,” says Pals. The IT sector has also evolved, particularly in China, where the focus has shifted away from hardware and more towards software and e-commerce. The sector has also grown considerably in countries such as Taiwan and Korea. IT is now second to financials in terms of importance for EM investors, believes Pals.

Positive outlook for EMs: solid fundamentals and cost-attractive stocks

According to Pals, the current environment makes emerging markets particularly beneficial for investors due to the unique combination of earnings growth, undervalued stocks and solid fundamentals.

The EM universe currently shows superior GDP growth compared to that of developed markets – but that’s not the only factor. It also shows better earnings growth, which Pals believes offers very positive prospects. In many emerging countries, earnings growth increasingly correlates with GDP growth. “Take China, where companies now have a much better understanding of how to generate shareholder returns.”

The third driver of EM attractiveness is the valuation angle. “EMs now offer a 30% discount to DMs,” says Pals, adding that the current situation is truly unique. “This difference is unsustainably high, as historically the average discount has been around 10%. But this will come down to the levels we have seen in the past.”

And as far as macro fundamentals are concerned, many countries in the EM universe are currently on a strong footing – whether in terms of high foreign reserves, large budget surpluses, high bank reserve build-ups or high savings ratios. “Overall, fundamentals in EMs are stronger than in DMs,” says Pals, “which will dawn on more investors at some point!”

1 Source: Robeco. D-share, gross of fees. In reality, management fees and other costs are charged. These have a negative effect on the returns shown. The value of your investments may fluctuate. Results obtained in the past are no guarantee for the future.
Subjects related to this article are:

Important information

The Robeco Capital Growth Funds have not been registered under the United States Investment Company Act of 1940, as amended, nor or the United States Securities Act of 1933, as amended. None of the shares may be offered or sold, directly or indirectly in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act of 1933, as amended (the “Securities Act”)). Furthermore, Robeco Institutional Asset Management B.V. (Robeco) does not provide investment advisory services, or hold itself out as providing investment advisory services, in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act).

This website is intended for use only by non-U.S. Persons outside of the United States (within the meaning of Regulation S promulgated under the Securities Act who are professional investors, or professional fiduciaries representing such non-U.S. Person investors. By clicking “I Agree” on our website disclaimer and accessing the information on this website, including any subdomain thereof, you are certifying and agreeing to the following: (i) you have read, understood and agree to this disclaimer, (ii) you have informed yourself of any applicable legal restrictions and represent that by accessing the information contained on this website, you are not in violation of, and will not be causing Robeco or any of its affiliated entities or issuers to violate, any applicable laws and, as a result, you are legally authorized to access such information on behalf of yourself and any underlying investment advisory client, (iii) you understand and acknowledge that certain information presented herein relates to securities that have not been registered under the Securities Act, and may be offered or sold only outside the United States and only to, or for the account or benefit of, non-U.S. Persons (within the meaning of Regulation S under the Securities Act), (iv) you are, or are a discretionary investment adviser representing, a non-U.S. Person (within the meaning of Regulation S under the Securities Act) located outside of the United States and (v) you are, or are a discretionary investment adviser representing, a professional non-retail investor. Access to this website has been limited so that it shall not constitute directed selling efforts (as defined in Regulation S under the Securities Act) in the United States and so that it shall not be deemed to constitute Robeco holding itself out generally to the public in the U.S. as an investment adviser. Nothing contained herein constitutes an offer to sell securities or solicitation of an offer to purchase any securities in any jurisdiction. We reserve the right to deny access to any visitor, including, but not limited to, those visitors with IP addresses residing in the United States.

This website has been carefully prepared by Robeco. The information contained in this publication is based upon sources of information believed to be reliable. Robeco is not answerable for the accuracy or completeness of the facts, opinions, expectations and results referred to therein. Whilst every care has been taken in the preparation of this website, we do not accept any responsibility for damage of any kind resulting from incorrect or incomplete information. This website is subject to change without notice. The value of the investments may fluctuate. Past performance is no guarantee of future results. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. For investment professional use only. Not for use by the general public.

I Disagree