The keys to limiting downside risk when it comes to Emerging Markets

When markets are good, it can be rather simple for investors to ride an upward wave without in-depth research and analysis. It's when markets experience a shock, and future prospects don't look as bright, that investors look around for guidance on how to proceed. This is especially true in emerging markets, where volatility and unfamiliarity can cause investors to steer clear.

For GQG Partners, the US-based asset manager specialized in global and emerging market equities, they believe a company’s underlying strength should outweigh its macro environment, and can only truly understand a company’s strength through bottom-up analysis.

Perhaps one of the most exciting success stories in our industry in the recent years, GQG Partners was created by Rajiv Jain in 2016, and has raised over $60 billion USD in less than 5 years. Led by Jain, a season fundamental stock picker and former CIO at Vontobel, GQG Partners manages 3 strategies: Emerging Markets, Global and US Equities. In Italy and Spain, Pablo Chiodi and Gabriel Poloni (from C-Alpha Management) act as marketing managers for GQG Partners.

In line with Rajiv Jain's traditional management of defending better, GQG Partners has outperformed the MSCI Emerging Markets Index by 15% by the end of September.

Below we are privy to an exclusive look at how they approach investments in emerging markets.

Continuing compounders to direct the way

2020 has been a year extraordinary in its own right, most notably driven by the rapid adoption of the “virtual everything” environment. Just six months ago, this interconnected global system of virtual meetings, events, etc. was almost entirely inconceivable, at scale. The teleconference, while not new and arguably if not for our current circumstances, would’ve remained relegated to quick meetings squeezed in between the really important ones or simply saying, “Hello” to family members abroad.

The challenge, then, as investors, is how to interpret, adapt and capitalize on our new environment. In our view, many investors have employed an overly simplistic framework, one of value or growth. Value generally is defined as purchasing securities that are “cheap” based on some metric such as low price-to-book or low price-to-earnings. The value factor has been recently maligned, but historically revered due to its somewhat intuitive formulation combined with academic citation rings on its efficacy. Contrast this with its less historically revered peer, growth, which is rooted in optimism about the future and based on metrics such as above-average revenue and earnings-per-share growth.

While not nearly as academically praised as its value foil, growth has been favored by investors for more than a decade due to a perceived “growth scarcity” as well as the prevalence of companies with strong network effects, which has seen growth strategies and indexes accrue relative gains over value-oriented products. Regardless of short- or long-term out or underperformance, the proponents of value or growth are entrenched in their beliefs and will defend their positions vigorously. Our view is not one of value nor growth, it is one of compounding and teasing out a process that works.

A 3-bucket approach to Emerging Markets

Because of our less dogmatic views on style, we believe we continue to find attractive opportunities across a variety of areas in emerging markets. While we don’t build portfolios based on “buckets”, we do think the easiest way to visualize current opportunities are to parcel companies into three buckets. Bucket 1, we will call the “continuing compounders”. These are companies that have strong moats, have resilient earnings profiles and can take market share from weaker peers. In Bucket 2, we will call these companies the “short term pain, long term gain” slot. In this area, these businesses may be of higher quality, but have some sort of sensitivity to economic shocks that make their future earnings visibility a bit hazy. Lastly, and we will call this bucket 3, is the bucket of the “disrupted”. This bucket is filled with companies that were structurally impaired prior to our current landscape and are now under severe stress due to the ongoing economic damage from the pandemic.  While certainly not every company in bucket 3 will go bankrupt, we don’t see attractive risk-adjusted opportunities in this area.

Currently, we’re finding the best risk-adjusted opportunities in the “continuing compounders” bucket. We see this bucket as the most attractive across emerging markets because we believe we’re able to capture deeper moats and highly visible earnings at valuation levels far below what we would have to pay in the developed markets. However, we fully recognize this may not always be the case, because we must always be focused on what we’re getting for the prices that we’re paying. In that sense, being adaptable is absolutely critical to finding great opportunities.

Adjusting to changing conditions

Therefore, in addition to the buckets, maybe the easiest way to think about our views are to think of them in the context of something we’re all doing a lot less of these days - driving a car. When the road is open and the sky is blue, put the pedal to metal. However, when it starts to rain, one must reduce speed for fear of a disaster. So as the conditions on the road change, the driver’s behavior must also adapt to the present conditions, not ideal ones. Similarly, with portfolio management, when the conditions change, we adjust to the market conditions we have rather than the ones we wish we had. Therefore, we will go wherever the compounding potential takes us. And in our view, unless one is willing to toggle the style spectrum, one may end up like the seasonal bug — lasting only one season.