Are Emerging Europe Equities a wise investment option with the current situation of the markets? What portfolio allocations could be more interesting? The Emerging Europe area includes countries such as Belarus, Bulgaria, Croatia, the Czech Republic, Hungary, Poland, Romania, Russia, Slovakia, Slovenia, Turkey and Ukraine. Emerging Europe has been the standout region within the Emerging Markets complex, returning 17.3% year-to-date as of Aug-end 2021, outperforming EM by +16.0%. Recent performance has been supported a run up in commodity prices and pent-up demand from Covid, however our medium term outlook remains positive.
We wanted to have a look at some of the funds with better returns 5 years annualised, based on the data available in Morningstar, for that reason we have asked the portfolio Managers from the Schroders, BlackRock, SEB, and Franklin Templeton funds to take us through their strategies so we can understand if it is a good moment to invest in Emerging Europe Equities.
Source: Morningstar 20/10/2021
Schroder International Selection Fund Emerging Europe
Rollo Roscow, Emerging Markets Fund Manager, Schroders
There are signs that global Covid-19 cases have peaked, which is good news for the global economy, as restrictions are also starting to ease. In this context, in emerging markets there has been a notable acceleration in the distribution of vaccines, a trend that should continue to improve. Indeed, in emerging Europe, progress in vaccine delivery, with the exception of Russia, was already remarkable. In Russia, there are concerns about distribution, but the openness of the economy is being maintained and appears to be on the road to recovery. It has also clearly benefited from the rebound in commodity prices.
Another variable with a clear influence on markets is monetary policy, which remains accommodative and whose normalisation should have beneficial effects in 2022 as, while economic growth may decelerate from high levels, it is expected to remain solid. Moreover, the CE3 markets (Czech Republic, Hungary, Poland) and Greece should be the main beneficiaries of the EU recovery fund.
It should be noted that this fund is potentially the first step towards greater mutualisation of debt in the European Union and significantly reduces the short-term macroeconomic risks surrounding many emerging market member countries. As a result, these countries have seen their borrowing costs fall.
The combination of stimulus measures and a return to more normal routines should bring about a recovery in economic activity and lift demand. A reflation of economies tends to favour old economy stocks such as energy and materials, which, together with banks, account for approximately 70% of the MSCI Emerging Markets Europe Index and are the dominant sectors in emerging Europe.
Against this backdrop, the objective of the Schroder ISF Emerging Europe fund is to provide capital growth in excess of the index, net of fees, over three to five years by investing in equities of Central and Eastern European companies. We are positive on these markets and are confident that expectations of a sustained global economic recovery and exit from the pandemic will drive a recovery in emerging European equities, both in absolute terms and relative to other markets.
BlackRock Global Funds – Emerging Europe Fund
Sam Vecht and Christopher Colunga, Portfolio Managers BGF Emerging Europe Fund
Emerging Europe has been the standout region within the Emerging Markets complex, returning 17.3% year-to-date as of Aug-end 2021, outperforming EM by +16.0%. Recent performance has been supported a run up in commodity prices and pent-up demand from Covid, however our medium term outlook remains positive.
Generally, given a high concentration in the energy, materials, and financial sectors, the region tends to do quite well in a late cycle environment where tight commodity and labor markets can lead to rising inflation and monetary tightening. While oil may pull back from recent highs, we expect energy prices to remain elevated over the next couple quarters as demand rises into what could be a particularly cold winter across the continent.
On a longer-term horizon, we’ve observed a number of IPOs come to market in the past 12 months, diversifying the opportunity set and increasing potential for consumption-led growth exposure going forward. More immediately, we expect the €750bn EU Recovery Fund to directly impact Emerging European markets due to a combination of strong exports, improving growth outlook, and direct access to funds. With a majority of the recovery funds being directed towards ESG projects, we also believe industries tied to decarbonization efforts look increasingly attractive, across region.
SEB Eastern Europe Small Mid Cap
Pavel Lupandin, Portfolio Manager SEB Eastern Small Mid Cap
Central and Eastern Europe as well as Russia presents an interesting investment universe to our clients who value fundamental investment approach to markets still poorly covered, especially in global context. Combined share of Eastern Europe, Russia and Turkey is around 5% of MSCI Global Emerging Markets index – this makes it a great playground for capable stock pickers with dedicated knowledge of the region.
Strategically positioned between Western Europe and Asian countries, the Central European region has kept its manufacturing base and educated workforce and over last 30 years has managed to grow consistently, while avoiding devaluation, and benefiting from EU structural funds. Russia and Turkey has been less lucky in regards to internal devaluation as dollar based GDP growth for them over last 10 years has been less good – however recently Russia has been closing the gap buoyed by much more competitive export economy aided by devaluations and recently strong commodity markets. At the same time Turkey remains below radars as Central Bank politics keep investors away.
Labour costs have also been half of that of Western Europe, which helps with concept of near-shoring for European companies looking to augment their supply chains tested by the Covid19 pandemic. An educated workforce also plays well into this. On the other end of the spectrum, there have been more and more success stories in tech sector in Eastern Europe, with increasing interest from VCs and PE firms.
The equity market – despite what may appear tricky politics in the region from outside at times – tends to reward those governments that keep focus on fiscal stability above all else (and punished profligacy). It is, in a way, very meritocratic and this observation helps us navigate what at times may seem rather tricky patchwork of economies and governments with different needs and goals. These days some goals appear to be overlapping, such as ESG focus across all sectors and economies, certainly making a laggard in that regard more attractive going forward.
The region has always been a value play next to some of its larger emerging market brethren and has provided attractive investment opportunities for dedicated fundamental specialists. Demographics and rising labour costs will be challenges which will face the region in coming decades, however. Having said that, there is plenty of investment opportunities and growing liquidity after what seems like a decade of stagnation is likely to put the region back on the map for global funds and give the region a wider audience it deserves.
Templeton Eastern Europe Fund
Krzysztof Musialik, SVP, Senior Executive Director and Portfolio Manager for Franklin Templeton Emerging Markets Equity
Eastern Europe is very frequently associated with strong vodka and harsh winters. Is there anything else? Of course there is. It is a land of plentiful investment opportunities. Firstly, it is a resources rich region. Russia is abundant in many critical commodities enabling the global economy to keep going. Although the world is shifting away from fossil fuels they are going to stay with us for many years to come. And Russia produces them at a very low price meaning Russian producers will still generate plenty of cash even if prices drop.
On top of that, there is an upside risk of the oil price going up, as the oil majors do not invest in new oil field hence limiting future supply which may be too low to meet a still oil-hungry world. The fund has also an exposure to producers of copper and aluminium which are critical in the “green shift” happening in the world. Secondly, the region is home to many innovative companies. A Hungarian pharmaceutical company has developed a drug from scratch whose sales are counted in billions of dollars. It treats many mental health illnesses like schizophrenia or depression.
A Russian IT company is among leading companies globally developing self-driving cars. A large pool of graduates skilled in STEM (science, technology, engineering, mathematics) especially in Russia bodes well for the future as the world is in the midst of the fourth industrial revolution. Thirdly, companies have global ambitions. Lots of them have been expanding in the region but also beyond it. Some Polish apparel and footwear companies have expanded in adjacent countries. A Polish company runs a business in sunny Spain – it is a quick service restaurant operator running La Tagliatella restaurants.
In terms of the portfolio, it is aligned with Templeton philosophy focusing on companies with strong management teams whose interests are aligned with shareholders. The portfolio management team uses a bottom-up approach while selecting stocks. However, a bottom-up approach does not exclude the analysis of long-term structural changes taking place in the global economy and societies (eg ecommerce, cloud, etc). On the contrary, the portfolio manager is aware of those trends and selects companies which will benefit the most as a result of such trends.