“The macro health in major emerging market countries looks in relatively quite good shape compared with developed markets,” said Qian Zhang, emerging markets specialist at Baillie Gifford during an interview in Luxembourg on 19 October 2023. She thinks that the “monetisation of the pandemic” added “maybe 10 or 20% of GDP” to the debt pile of these countries. This is much lower than for developed markets.
Zhang commented that fiscal discipline and “preemptive rates” are “starting to bear some fruit when you look at the inflation levels.” This has created fiscal rooms and some countries such as Brazil, where “inflation has dramatically come down,” have even started to cut rates. Besides, three or four rate cuts are priced-in until the rest of the year.
Favourable technical factors
Zhang explained that the positioning in the past decades has been “pretty much a one-way direction of travel… with capital flowing out of EM to DM.” Consequently, it may explain why the “EM index trades at a price-multiple of one-third of S&P 500.”
She noted that a recent survey estimated the global funds allocation to EM is at around 7%, a decade low according to Zhang. She thinks that this level can be explained by the weak performance of EM compared to the rest of the world. She observed that the annual average return of the EM index has been 3.5% since 2010. “That is significantly lower than MSCI All Country World Index.”
Timing the market is very difficult. Time in the market is our best friend
Yet Zhang said that EM outperformed DM since 1980. Moreover, she commented that apart from the Turkish lira, “most of the EM currencies held up reasonably well” against the US dollar. Historically, a strong dollar has been detrimental for EM.
A long-term investor
Baillie Gifford is a well-known Scottish investment firm that is recognised for their long-term perspective and investment in companies like Amazon and Tesla, to name a few.
The goal of BG is to discover firms with the highest earning growth potential in the emerging markets universe as they tend to deliver the best share price return, according to Zhang.
Moreover, BG is bottom-up stock pickers which hold their positions in average for “six, seven years or even longer,” Zhang stated. “Timing the market is very difficult. Time in the market is our best friend.”
She explained that the private partnership structure of BG does “help us to do that, because our portfolio managers are solely compensated on a five-year rolling performance.”
Where to go from now
“Back in the days… investing in EM… [was directed at] quite expensive consumer staples, or… boring state-owned banks.” Zhang thinks that the macro context for the EM has “rarely been better,” with attractive valuation for “good growth companies... across different sectors and across different countries.”
“In our mind, both data and molecules are very important themes investing in emerging market in the long term.” Zhang noted that an iPhone contains 75 minerals, which is almost two-thirds of the periodic table (the table has a total of 118 elements). Fostering innovation in technologies will therefore result in the continued need to access resources and materials.
Zhang suggested that the global agenda for the green transition could trigger an inflection point that will require the extraction of larger quantities of materials such as copper, nickel, and graphite than in the past 10 years.
She thinks that there are couple of emerging countries that have the “the cheapest, the highest quality and highest efficient manufacturing sites” for these materials. Without giving company names, BG finds some of the operators behind these raw materials in Indonesia and Latin America.
Rest assured that BG is still looking at the other side of the trade barbell as it continues to focus on soft and hard technologies. On the latter, they keep their attention on the supply chain of semiconductors (TSMC) or key niche players such as high-end switch manufacturers for data centres.
[China is] actually a very small allocation most of people’s portfolios, but it does consume a lot of mental capacity.
As internet penetration trends toward 80% in emerging markets, a level close to developed markets, Zhang thinks that new business models can be built to respond to the new needs such as Mercado Libre, an e-commerce and fintech company based in Latam, and SEA Ltd an e-commerce and gaming company in Singapore.
As of 2 November 2023, some of the BG strategies own shares in companies outlined above for their clients.
China: the elephant in the room but not in the index
“The second largest economy in the world… is about 3.5% in the global equity index… [whereas the market cap] of Apple is 4% of the MSCI World Index.” She continued: “it’s actually a very small allocation most of people’s portfolios, but it does consume a lot of mental capacity.”
Questioned about the impact of various trade barriers from the western world against Chinese companies, Zhang acknowledged that they had a limited impact as 75% to 80% of the revenues are domestic for the listed companies. Similarly, the majority of Chinese equities are owned by domestic investors.
Chinese companies: Similar ESG profile as for other EM countries
Given their long-time horizon, BG asks the management “different questions” on ESG, claimed Zhang. “What is their commitment to sustainable strategy? What is their commitment to shareholder alignment?”
She believes that these questions, coupled with the ownership of a small number of stocks, enable Baillie Gifford to gain confidence. BG is attentive to the trajectory of improvement as it is aware that ESG standards of EM companies are weaker than in developed markets.
China circumventing obstacles from the western world
“Exports [from China] to the Western world has gradually declined.” On the other hand, “China’s export as share of global export hasn’t really declined… If you look at China's trade with Asean countries… It has increased quite a lot more than trade between US and Europe.”
Yet Zhang observed certain key sectors have increased their export of solar panels and electric vehicle batteries to the western world. Interestingly, she detailed an evolving trade architecture. She thinks that a lot is going on behind the scenes that does not rhyme with deglobalisation.
Indeed, Chinese companies are in the early days of evolving to better serve international clients. Zhang explained that domestic healthcare companies have clinical trials outside of China, as they build manufacturing capability in Europe, whereas some others will have “significant outposts in Singapore” while even moving their headquarters to the small republic.
As a bottom-up investor, there must be enthusiasm about a stock story. The question afterward at BG is: are we “exposed to too much risk in a certain area or in a certain sector?” The opposite question must also be answered: “do we have enough in a certain area or sector?”
Zhang thinks that without geopolitical risk, Baillie Gifford would probably be overweighting China and Taiwan. Yet, they need to think hard about missing the potential upside of a stock such as TSMC. “You need to start the bar higher; you really need very good companies with high conviction to [get a high upside] to compensate for the tail risk.”
This article was published for the Delano Finance newsletter, the weekly source for financial news in Luxembourg. Subscribe using this link.