Malcolm Dorson is the portfolio manager of the Mirae Asset Emerging Markets Great Consumer Equity Strategy. We wanted to chat to him to learn more about the strategy of the fund, its allocations, the sectors the fund is invested in, and which future investment opportunities he sees in the Emerging Markets.
As an Emerging Market Equity Specialist – How would you describe your approach to analyse the market and decide the asset allocations of the investment fund?
For over eleven years, we have generated alpha by allocating assets through a bottom up approach. IE: Our country and sector weights will be driven by where we’re finding the best bottom up ideas. Overall, we’re searching for quality companies that boast returns above their cost of capital, allowing them to compound earnings growth over a long term time horizon.
How many people are part of the investment team? And what role would you say each of the members of the team plays in the investment process?
There are 12 people on our investment team. The strategy boasts a unique team structure in that we are split between Asia and ex-Asia regions. EM has grown into a 27 country asset-class with different economies, currencies, political systems, and business models within them. Our large dedicated EM team, supported by various other regional and product specialists across the world give us a strong competitive advantage in covering the asset class.
Given the current ~75% market cap concentration to Asia, most investors tend to focus their teams to that region. This creates inefficiencies, which leads to overlooked opportunities, which our team – with hyper focused regional specialists – is structured to benefit from. Each analyst is responsible for his own sector based recommendation list within his/her region. The team speaks 11 unique languages and, for the most part, has grown up and/or currently lives in Emerging Markets.
This is a concentrated strategy, so deep local knowledge of each holding and its surround thesis is paramount. Team members carry personal, academic, and professional experience within Emerging Markets, which complements our deep fundamental research with local understanding and reasoning.
“We see EM in the midst of a powerful transformation as countries shift away from asset heavy/low-return industries (like commodities, manufacturing, and construction) towards innovative, asset light, profitable business models classified as “New EM”.
Could you describe the investment philosophy of the fund? and the investment process you follow?
We see Emerging Market economies rapidly moving away from asset heavy, low return business models towards innovative, well-run, profitable sectors. This structural dynamic creates higher paying jobs as employees move up the value chain, which inherently grows the middle class across Emerging Market countries. These entrants spend their newfound discretionary income on education, healthcare, technology, goods, and services – all of which fall into the latter category of business models. This creates a self-fulfilling cycle of domestic consumer driven growth. The Mirae Asset GEM Great Consumer Equity Fund aims to capture this structural shift. The strategy seeks investment opportunities across all sectors, but will aims to remain underweight energy and materials.Key pillars of our investment philosophy include:
- Identifying internal and structural tailwinds, while avoiding macroeconomic headwinds
- Investing in companies that benefit from sustainable competitive advantages
- Partnering with management teams aligned with minority shareholders
- Finding visible growth opportunities that will lead to near and long term positive earnings revisions
- Analyzing intrinsic values based on “GAARP” (Growth At A Reasonable Price) with multiples balances by both growth and return profiles
- Maintaining a key focus on consumption
We seek to add value through active management by taking advantage of transient mispricing effects to invest in companies at attractive relative valuations when we perceive a disconnect between current prices and intrinsic values.
Our investment philosophy works as a result of our disciplined and long-term approach to investing. This approach allows us to capitalize on the numerous inefficiencies found in emerging markets by identifying companies best poised to benefit from the secular growth themes arising from a growing and dynamic consumer base. These companies often are those with sustainable competitive advantages that are able to cultivate their strong franchise value.
We also believe that our underweight positioning in materials and energy reduces an unknown and allows us to focus on our strengths, which should diminish volatility, and improve risk-adjusted returns.
From a valuation perspective, we firmly believe that finding companies with sustainable ROE or ROIC profiles above their cost of capital creates a strong prospect for compounding accretive growth.
The strategy makes investment decisions as a result of its strict and repeatable investment process. Once the screen determines a quality based investment universe, analysts focus on the pillars of our investment philosophy (internal growth, structural growth, competitive advantages, aligned management teams, visible growth, attractive valuations, and consumption) to identify attractive business models trading below their intrinsic values. Step two of the process incentivizes analysts to focus on quality of ideas over quantity. In addition, analysts rank their ideas based on conviction. This creates a clear and transparent environment where the portfolio manager can make decisions knowing
1. Due diligence is complete and up-to-date and
2. Analyst conviction levels are clear and transparent. From there, the portfolio manager can construct the portfolio based on a combination of best ideas and risk guidelines. The strategy aims to generate alpha from stock selection, and not from country or sector allocation. Country and sector allocations are generally an outcome from where the team is finding the best bottom up ideas.
The portfolio managers and analysts all generate ideas. Idea generation comes from initial IU screening, traveling/field trips, attending conferences, industry-specific days, capital market events, sell-side research, and communication with Mirae Asset colleagues from different teams and offices.
Our investment process consists of the following:
Step 1: Proprietary quantitative screening of emerging market universe to arrive at an Investable Universe (IU)
Step 2: Recommendation List (RL) of stocks done by each sector analyst for his/her respective region
Step 3: Model portfolio (MP) determined by the investment team
Step 4: Actual portfolio (AP) construction done by the portfolio manager
The process requires each analyst to identify and validate his highest conviction ideas, based on fundamental company analysis, and weight them in his RL. The investment team utilizes the RLs to determine a model portfolio (MP), which reflects stock weightings to indicate relative conviction level of ideas. The portfolio manager utilizes the MP to construct an efficient actual portfolio.
Where appropriate, analysts will assess whether top-down factors may affect the fundamentals of their bottom-up analysis.
What EM countries do you believe are more interesting at the moment?
On a regional basis, we continue to favor a domestic secular driven growth story in China and companies that have benefited from the structural reforms in India. Current macroeconomic conditions lead us to remain optimistic on South Korea and Vietnam as we look ahead. We see Latin America and Eastern Europe, Middle East and Africa (EEMEA) as under-owned regions. The average global equity investor has approximately a 4% weighting to EM and Asia represents roughly 80% of the asset class, which means the average investor has only less than 1% allocated to Latin America and EEMEA combined. This underweight creates a significant moment for stock pickers assessing overlooked and inefficient regions. We see particularly attractive opportunities in Greece, Mexico, Brazil, and Russia.
China: As we move into 2022, we believe the initial challenges from “common prosperity” policies will turn into tailwinds as the government focuses on stabilizing the economy and promoting greater social equality and welfare. China has delivered significant economic achievements over the past 30 years, so we see recent efforts to iron out excesses and stabilize its financial system as positive steps to establishing a foundation for longer-term sustainable growth. Consumption has come under some pressure from COVID19-related restrictions; however, we anticipate a rebound post-February, when China hosts the 2022 Winter Olympics and the government is expected to relax mobility restrictions relating to domestic travel. We see green shoots for significant opportunities in select areas of China’s market. The Chinese government understands that it must move its economy up the value chain, create higher-paying jobs, grow its middle class, and improve growth via consumption. This process starts with transitioning capital allocations away from real estate and low-level manufacturing to higher value-add production. China is now the second-largest spender on research & development (R&D) in the world, behind only the US, and accounts for over 20% of global R&D spending.8 China plans to increase its R&D spending by more than 7% per year between 2021 and 2025. The country has topped the rankings in global patent filings since 2019 and now ranks 15th in the global innovation index. The share of the population with a university degree exceeded 15% in 2020, almost double the amount ten years ago, with most of those graduates in science, technology, engineering, and math (STEM) fields. Investment is not stagnant but is shifting towards innovation in higher-end manufacturing and green projects. Combine this with the rapidly expanding middle class, and we expect China to sustain 5-6% GDP growth in the coming years.
India: Daily new COVID-19 cases have continued to trend down from peaks of around 400,000 in May to less than 9,000 by the end of November. The improvement was supported by the country’s impressive vaccine rollout, which at one point saw up to 10 million vaccines administered per day. The government demonstrated a measured response concerning fiscal stimulus last year and instead focused on extending its Production Linked Incentive (PLI) scheme to promote domestic manufacturing. This prudence has proved to be the right move, and its success is now manifesting in the form of substantial foreign direct investment (FDI) flows and job creation. By early 2022, we expect vaccination rates in India to reach critical mass and recovery to gather further strength. One area where we see long-term opportunity is in India’s internet sector. We believe the industry is now at an inflection point and about to witness hyper-growth in the coming years as tech companies continue to disrupt traditional services. The COVID-19 disruptions throughout 2020-21 have provided significant tailwinds for internet companies. As many of these digital businesses come of age, we see exciting opportunities in the robust pipeline of Indian technology IPOs, especially within key internet verticals such as fintech, food delivery, and e-commerce. While other leading economies face the issue of managing an aging population, India has one of the youngest populations globally. We expect this large working population to provide a tailwind for strong economic growth over the coming decades. As urbanization rates continue to rise along with strong wage growth, we believe India’s rising aspirational consumer class will likely lead to sustained growth in discretionary consumption. We already observed the start of this trend in 2021 when new housing registrations in Mumbai reached a 10-year high in October, indicating positive signs for a recovering market and likely demand for other consumer durable goods.
South Korea: Though Korean online companies came under regulatory scrutiny in 2021, we believe the worst is now past and maintain a positive outlook for internet and e-commerce companies going forward. Unlike China, the South Korean internet landscape appears much more fragmented, with no clear leaders claiming the majority market share. Regulatory talks regarding South Korea’s internet sector are much less structural in nature and pose less risk when compared to that of China. We are, however, cautious about the volatility of the South Korean market, where there may be impacts from global macro conditions given the country’s strong correlation with the global market. As valuations in South Korea have come down close to their 10-year historical averages, we expect the market to gain attractiveness once participants sense comfort around the global policy stance
Brazil: Brazilian equities now trade at roughly 7.4x earnings, which is over two standard deviations below its historical average of 11x P/E. This correction makes Brazil the third cheapest country in EM behind Russia and Turkey. At the same time, the expected ROEs for Brazilian equities have hit 5-year highs, above 21% as of November 30, 2021. Current President Bolsonaro and former President Lula appear most likely to reach the second round of the election, and having locked in their respective voter bases, they should begin to appeal to the center. We have already seen Lula look incrementally pragmatic, showing concern around inflation and distancing himself from the economic proposals of the Worker’s Party, which is a positive catalyst. An outside candidate progressing to the second round would also help sentiment, but this is a low probability scenario. The economic landscape could present another positive catalyst as well. Brazil’s Central Bank has been a first mover, tightening interest rates since March. This timeline means the inflection of interest rate flattening could happen in Brazil first as well. Once inflation subsides, the conversation could turn to lower rates and falling risk premiums. All of which we believe would be positive for equities. From a COVID-19 perspective, Brazil has turned the bad numbers around and has joined the leaders across EM with close to 80% of Brazilians having received at least one dose of vaccine and 63% fully vaccinated as of November 30th, 2021. Brazil is ahead of the US in the share of fully vaccinated people and has surpassed Germany, the United Kingdom, and Israel in terms of partially immunized citizens.
Russia: Russia boasts, arguably, the best fundamentals in EM. High oil prices have allowed the country to maintain its fiscal and current account surplus while the Finance Ministry’s “Budget Rule” provides a stable currency regardless of external factors. Unemployment and inflation rates remain in the mid-single digits and the Central Bank was one of the first to begin hiking interest rates this cycle, putting Russia ahead of the curve in controlling higher prices. Despite geopolitical and Covid-19 related risks, Russian equities should have the capacity to withstand market volatility. Russian equities trade at roughly 6x earnings and 1x book value, with a 9.2% dividend yield and average debt-to-equity levels below 25%.
Mexico: Mexico’s robust fiscal performance versus other EM countries and its strong ties to the US economy have driven outperformance. We anticipate this trend to extend into 2022 as Mexico continues to see positive tailwinds from a robust US economy and more expected near-shoring from China. As global supply chains move towards normalization, we should see a boost to auto and electronic manufacturing sectors, followed by a combination of wage growth and foreign direct investment. Politically, we saw Mexico’s legislative elections in 2021 as a positive sign for President Lopez Obrador going into the second half of his mandate. This political solidarity should reduce the risk of market-unfriendly policies. However, potential electricity and infrastructure reform and institutional erosion remain concerns moving into 2022.
Greece: We remain optimistic on Greece moving into 2022 as the government continues with its growth-oriented reform agenda. This agenda includes measures such as lowering the corporate tax rate from 24% to 22% in 2022 and lowering the sales tax on many goods and services until June to help households offset the expected rise in food and power costs. Even after several positive revisions to its 2021 GDP growth estimates, Greek GDP for 2022 is estimated to grow at a 4% growth rate in 2022, as Greece’s largest industry, tourism, continues to recover. After several years, the country’s financial sector has also seen notable improvement with banks nearing single-digit nonperforming exposure (NPE) ratios. The sector’s focus is now turning towards driving sustainable growth and returns. Lastly, Greece has navigated EU politics well and should continue to see Recovery Fund disbursements throughout the year.
Vietnam: Moving into 2022, we are optimistic about the rebound of ASEAN countries as 1) reopenings should promote a recovery in domestic demand, and 2) reopenings will allow workers to return to work, lifting production levels and, subsequently, help alleviate supply-side constraints. Increased production will allow these economies to participate more meaningfully in the global export boom, especially in the lead-up to the Regional Comprehensive Economic Partnership (RCEP), which comes into force in January 2022. The RCEP is set to be the world’s largest trade bloc (covering China, South Korea, Japan, Australia, New Zealand, and the 10 ASEAN countries), accounting for 30% of the world’s population and output and more than a quarter of global trade. This trade agreement is a positive catalyst for ASEAN equities, particularly in Vietnam, Malaysia, and Indonesia. We believe these countries are well-positioned to potentially benefit from the increasing supply chain shift to the region. An increase in manufacturing jobs should drive income growth and urbanization, creating further opportunities for consumer sectors
Do you believe inflation will have a big impact on the allocations of the investment fund during 2022? Are you taking any measures to avoid a negative impact?
We have seen inflation rise on a global basis throughout 2021. From an emerging markets perspective, I’m encouraged to see various EM central banks prudently hike interest rates well ahead of the US and Europe. This is exciting for two reasons. One it creates an interest rate differential between EM and DM, which means that more assets should flow to higher yielding Emerging Markets, which should support EM currencies. Second, it means that EM is well ahead of the US in its monetary cycle and we could see the tapering of hikes or even conversation of cuts roughly around the same time that the Fed begins to take off.
Which are the main sectors the investment fund is invested in?
Our strategy invests across all sectors, but focuses on companies that benefit from domestic consumption growth. With that said, we tend to carry heavier weights within Consumer, Financials, Technology, and Healthcare
What investment opportunities do you see coming in EM in the following years?
We believe we have a unique view on the direction for sustainable growth and returns across Emerging Markets (EM). We see EM in the midst of a powerful transformation as countries shift away from asset heavy/low-return industries (like commodities, manufacturing, and construction) towards innovative, asset light, profitable business models classified as “New EM”. That means that companies are generating higher returns and can pay higher salaries, which creates more discretionary income, and essentially, a middle class. That new high earning group is spending their money in this “New EM” category – discretionary goods & experiences, healthcare, education, travel, luxury, and services – all of which creates a domestic consumer-driven, self-fulfilling driver of growth. End of the day, it means EMs return profiles are increasing, their earnings drivers are growing more predictable, and dependence on outside forces (like commodity prices, trade rhetoric, and foreign exchange) is diminishing.
The importance of consumption driven-growth shows through an economic lens as well. A country’s economic success depends on Gross Domestic Product (GDP) expansion, and EM countries understand they need new drivers to maintain growth.