One of the bitter ironies of the global financial crisis is that even the most risk-averse institutional investors, who tilted their portfolios primarily if not exclusively toward developed markets, sustained devastating losses and subsequently have been compelled to take on more risk — like it or not — in search of growth rates that are hard to find in Europe and the U.S.
[To view the complete list of winning firms, along with the full roster of ranked teams, go to the 2011 Emerging-Markets Equity & Fixed-Income Research Team.]
“There has been an increase in appetite for riskier assets, and emerging markets have the potential to develop superior economic growth,” observes Mark Iannotti, head of research for Emerging Europe, the Middle East and Africa for BofA Merrill Lynch Global Research in London. “Emerging markets have been a great source of interest for investors.”
Interest, yes — but also concern. Investors burned in the global meltdown may be more willing to consider emerging markets, but they are also quick to pull out at the first sign of trouble. Just last month EMEA equity-fund redemptions hit their highest level in nearly three years, according to EPFR Global, a mutual fund tracking firm headquartered in Cambridge, Massachusetts. Year-to-date through late May, those funds have seen net outflows of $8.6 billion, largely because of ongoing worries about Europe’s sovereign-debt crisis and its impact on growth across the region, EPFR reports.
Given the rising prominence of developing economies in the eyes of money managers and analysts, as well as the phenomenal growth some of these markets are enjoying in the postcrisis world, Institutional Investor opted to replace the Emerging Europe, Middle East & Africa Research Team survey with an Emerging-Markets Equity & Fixed-Income Research Team. The latter covers the same geographic area as the former — Central and Eastern Europe, the Middle East and all of Africa — but the number of industry sectors and macroeconomic disciplines it includes is significantly more expansive, so historical comparisons between the two surveys are not applicable. Thus, II is presenting this survey as a new offering.
Deutsche Bank debuts in the No. 1 spot on the 2011 Emerging-Markets Equity & Fixed-Income Research Team, capturing 20 total positions — nine of which are for teams considered the best in their sectors. In second place, with 18 positions (including six crews at No. 1), is BofA. Renaissance Capital follows in third place, with 12 positions, while three firms — Morgan Stanley, UBS and VTB Capital — tie for fourth, with ten positions each. Survey results are based on responses from nearly 500 individuals at more than 340 institutions globally managing an estimated $395.75 billion in emerging-markets equities and $108.75 billion in fixed-income assets.
Deutsche Bank has 50 analysts dedicated to these emerging markets, seven of whom were added over the past year, and they follow 325 companies, up from 319 one year ago. Local placement of team members has been key to the firm’s success, according to London-based Richard Smith, head of equity research for all of EMEA. Deutsche has analysts on the ground across the region, Smith says: 14 in South Africa, 11 in Russia, seven each in Turkey and the United Arab Emirates, four in Poland, two in Israel and one in Hungary. In addition, the firm has four analysts covering these markets out of the bank’s London office.
Pascal Moura, who directs emerging EMEA coverage from Deutsche’s offices in Dubai, says the firm plans to hire an analyst later this year to cover sub-Saharan Africa, beginning with Nigeria; that person will work out of the bank’s Johannesburg location.
BofA also has 50 analysts covering the region, three of whom the firm hired in the past 12 months, and expanded coverage by about 10 percent, to 220 stocks. Client demand drove that increase, “particularly in the macro and strategy sectors,” says Iannotti. “We have also materially increased coverage in the Middle East region, where we continue to build our Saudi Arabia coverage,” he adds. BofA also credits its success to having analysts based closed to the companies they cover; the firm has researchers in the Middle East, Russia, South Africa and Turkey, so that “we can connect clients with corporates on an ongoing basis and provide waterfront coverage of equities in the space,” Iannotti says.
Renaissance Capital, whose Russian research operations have been hard hit by analyst departures, has been among the firms expanding most aggressively, particularly in Africa. RenCap’s analyst head count has nearly doubled over the past year, from 41 to 78, and those analysts follow a whopping 540 stocks — 105 more than the firm covered last year at this time.
“The increase reflects our view of emerging markets — in particular capital flows within and between emerging markets — as having the greatest upside over the coming years,” says David Nangle, who is based in Moscow and has directed RenCap’s equity research since December, following the departure of Roland Nash for Verno Capital, an asset management firm. “We are committed to combining global sector expertise with on-the-ground analysis in the markets we cover.”
RenCap plans to continue adding analysts — just last month it hired its first researcher to cover Turkey, Yavuz Uzay — and hopes to have 93 in place by the end of the year. “We are in expansion mode, and if markets behave, we will continue our sectoral and geographic rollout at a managed pace,” Nangle explains. He adds, however, that given the volatility associated with emerging markets, “it can all come to a grinding halt very quickly in this business.”
RenCap has been pushing to increase the number of stocks under coverage in part because of emerging markets’ quick rebound in the wake of the financial crisis, he says. “We are seeing capital raising and increased interest from investors.”
In July the firm completed its $27.3 million purchase of Johannesburg-based BJM Securities, picking up a troop of 21 analysts who cover 70 local companies. RenCap also has four analysts in Nigeria and two each in Kenya, Zambia and Zimbabwe, and Nangle says plans are in place to expand across Africa: “We are now using Johannesburg as a hub for building out our Africa business.”
Rising foreign investment has been the main force behind RenCap’s expansion in Africa — “these capital flows have the potential to increase over the next decade,” Nangle says — and also explains why the firm opted to open an office in Hong Kong in July. “We are now seeing Chinese investment in Africa and Russian firms listing in Asia,” he says, citing Moscow-based aluminum maker United Co. Rusal’s January 2010 initial public offering on the Hong Kong Stock Exchange. “There are many companies looking to list in Hong Kong, as the world’s center of gravity is shifting, and a great number of Asian investors want to participate in that.”
The financial crisis challenged assumptions about the nature of markets both mature and emerging. The latter initially proved more resistant — holding out against the tide of worldwide declines and appearing to give credence to the decoupling theory, which maintains that developed markets in general are declining in influence; a downturn in Europe or the U.S. no longer necessarily will precipitate a crisis in emerging markets. It didn’t take long for old patterns to emerge, however, and when stock prices began to fall in developing markets a few months later, they fell hard — in many cases, faring far worse than the markets in which the crisis originated. The benchmark Russian Trading System index plunged nearly 80 percent from peak to trough, and Dubai’s benchmark index plummeted some 70 percent. In yet another challenge to conventional wisdom, emerging-markets economies then proved resilient, rebounding more quickly than those of developed markets, attracting the interest of investors looking for growth.
However, political instability and inconsistent reporting and disclosure still plague many emerging markets. Investors were caught off guard by the near default of Dubai World in November 2009 when the emirate announced that it was unable to meet its obligations and requested a six-month freeze on its debt payments; markets around the world tumbled anew on the revelation. (The government of neighboring emirate Abu Dhabi rode to the rescue that December with a $10 billion aid package.)
Given the image of regional instability and the frequently unprecedented levels of government intervention in markets in the wake of the crisis, macroeconomic research is understandably at a premium. Investors seek to understand the big picture as well as the small before they allocate funds, and in the emerging EMEA markets no one provides better insights, investors say, than the Troika Dialog quartet conducted by Evgeny Gavrilenkov, ranked No. 1 in Economics.
The 56-year-old economist, who works out of Moscow with two associates — the third is based in Kiev — earned a degree in applied mathematics at the Moscow Aviation Institute in 1978 and a Ph.D. in economics at Voskhod Research Institute in 1985. He joined Moscow’s Center for Economic Analysis, a government think tank, in 1992 as department head, then became deputy director and finally acting director before moving to another think tank, the Bureau of Economic Analysis Foundation, in 1997; there he worked as deputy director general and acting director general until 2002, when he joined Troika as chief economist. Gavrilenkov also served as a visiting researcher at the International Monetary Fund in 1994 and 2001, and as a visiting professor at Japan’s Hitotsubashi University from 1995 to 1997 and at the University of Paris, Panthéon-Sorbonne, in 2000.
Back in February 2009, after the National Bank of Kazakhstan devalued the country’s currency from 120 tenge to the dollar to 150, the Troika team called the move “a better policy choice as opposed to Russia’s managed gradual adjustment of the exchange rate, which destabilized the markets and encouraged speculation against the ruble.” The researchers predicted the depreciation would help Kazakhstan avoid a postcrisis contraction in gross domestic product growth in the short term and lead to account surpluses and faster growth than in Russia and Ukraine in the long term. Right on all counts. Kazakhstan’s economy expanded by 1.2 percent in 2009, while Russia’s shrank by 7.9 percent and Ukraine’s plummeted by 15 percent; last year Kazakhstan’s GDP surged 7 percent (Russia’s grew by 4 percent; Ukraine’s, 4.3 percent), and its trade surplus nearly doubled, from $14.8 billion in 2009 to $29.5 billion, the Kazakh Statistics Agency reported in February.
“The market expected appreciation to be driven by strong current accounts, rising oil prices and a weak dollar, but we said no — we do not expect appreciation of currency,” Gavrilenkov recalls. “Other countries in the region, such as Russia, cannot afford a weak currency because of mounting pressure, but a more conservative approach in Kazakhstan allowed the central bank to maintain the exchange rate at the level it wanted.” Through April 2011 the tenge strengthened only 4.3 percent, to 143.5 against the dollar, while the ruble strengthened 23.9 percent, from 36.04 to 27.41 to the dollar.
One of the challenges for investors interested in the markets included under the EMEA umbrella is understanding the political and economic diversity: The EMEA space encompasses three decidedly distinct regions, with varying degrees of correlation. The impact of unrest across North Africa and in some Persian Gulf states — the so-called Arab Spring — has been profound in the areas affected but minimal in other places such as Eastern Europe and sub-Saharan Africa. Conversely, developments in Russia — particularly with regard to that country’s all-important oil industry — have had a ripple effect across the Middle East and even central Africa.
Portfolio managers need insight into each region as well as for EMEA as a whole, and the undisputed champion of delivering the needed guidance is BofA’s Michael Harris, who leads or co-leads the winning teams in four of the survey’s five Equity Strategy sectors: Central and Eastern Europe, the Middle East & Africa; Emerging Europe (which includes Russia and the Commonwealth of Independent States); Middle East & North Africa, with co-leader Stephen Pettyfer; and Turkey, with co-leader Ecem Nalbantgil. (The top team in the fifth Equity Strategy sector, Southern/Sub-Saharan Africa, also belongs to BofA and is led by John Morris.)
London-based Harris, 41, earned a bachelor’s degree in finance and international relations at New York’s Syracuse University in 1991 and a master’s degree in Middle Eastern studies at the University of Texas at Austin in 1993; he worked as an equity strategist at ABN Amro in Istanbul before moving to Merrill Lynch in 1995 to launch the firm’s coverage of Egyptian, Greek, Israeli and Turkish equities. Harris, who is based in London, has held his current post as director of the firm’s emerging EMEA equity strategy since 2009 and oversees a team of six analysts: two each in Johannesburg and London, and one each in Dubai and Mumbai.
In May 2010, after a worldwide market rout sparked by fears that Greece would default on its debts, the BofA analysts pounded the table on Russian and South African equities. “We continue to recommend overweight positions in Russia and South Africa on the case for cyclical recovery and, coincidentally, the least exposure to [euro zone] periphery contagion risks,” the analysts wrote. They did include a caveat with regard to Russia, however, telling clients that the certainty of Russia’s real GDP recovery remains relatively high “so long as double-dip fears do not lead oil into a downward spiral.” By the end of April, the FTSE/JSE Africa all-shares index had advanced by 18.7 percent and the RTS index had catapulted 48 percent; the MSCI emerging EMEA index gained 23.8 percent. Moreover, Russia’s economy expanded by 4 percent last year, faster than many economists had predicted and far ahead of the contraction the country experienced in 2009.
Interest in emerging-markets debt has also surged in the wake of the crisis, as money managers look for ways to offset the risks associated with equities in those markets. “We’ve seen a lot of investors coming into the Russian fixed-income market. Principally, they’re buying ruble bonds to benefit from the Russian currency’s appreciation,” says Nikolay Podguzov, who moved from RenCap to VTB Capital in September as the latter firm doubled its fixed-income analyst head count, to eight, to keep pace with rising investor activity. “The central bank has hiked key interest rates twice so far this year, and that is really benefiting bond buyers,” the analyst noted in late April. Last month the bank raised rates again.
Russia’s fixed-income market has grown from $177 billion in 2006 to $350 billion today, he adds, and ruble-denominated bonds account for more than half of that market cap. The Russian Eurobond market, mainly denominated in dollars, accounts for an additional $150 billion in fixed-income instruments.
“The past year has been favorable for investors within the emerging-markets bonds, rates and currencies universe,” he observes. “Global risk appetites remain strong, with investors all over the world concentrating on how to effectively put their spare liquidity to work.”
Podguzov, 36, who leads the top-ranked team in Fixed-Income Strategy, earned a bachelor’s degree in economics at the Moscow State Institute of International Relations in 2000, then joined the Ministry of Finance’s debt-management department. In 2003 he moved to Trust Investment Bank as senior fixed-income strategist before accepting a similar position at RenCap in 2006.
The Moscow-based team launched coverage with a report in November that examined the likely impact of the U.S. Federal Reserve’s second round of quantitative easing and concluded that the policy extension would benefit emerging markets because the additional funds would help sustain the capital flows from developed economies. The strategists predicted that the ruble would strengthen against the dollar, and they were right: By the end of April, the Russian currency had appreciated 11.8 percent, from 31.09 to 27.41. It has been one of the best-performing currencies within the emerging-markets space this year, Podguzov notes.
The team also correctly anticipated the tightening of credit spreads within the Eurobond universe: From late November through April, spreads on the benchmark Gazprom 2022 bonds over ten-year U.S. Treasuries tightened from 340 basis points to 245 basis points, Podguzov says.
The rally in the price of oil, which rose above $113 a barrel last month before plunging in what Podguzov believes is a temporary downturn, “has pushed investors to pay closer attention to the commodity economies with respect to their currencies,” he says.
Commodities — agricultural products, oil and gas, precious metals and others — play a crucial role in the economic fortunes of many emerging markets, and many investors value a commodities strategy when constructing their portfolios. The VTB Capital threesome co-led by Wiktor Bielski and Colin Smith is No. 1 in this sector, according to survey participants. Bielski, 51, graduated with a bachelor’s degree in mining geology from Imperial College London (then part of the University of London) in 1980, then went to work as a geologist for Toronto-based mining and exploration company Falconbridge. He joined British brokerage W.I. Carr as a senior mining analyst in 1987 and worked at Deutsche Bank, Macquarie Bank and Morgan Stanley before moving to VTB in 2009 to serve as head of global commodities research.
Smith, also 51, earned bachelor’s degrees in law and economics at Edinburgh University in 1981 and an MBA at the Scottish Business School (now the University of Edinburgh Business School) in 1982, then worked in the oil industry for BP, Canada’s Ultramar and other exploration and production companies. He joined Hoare Govett as an Oil & Gas analyst in 1993 and held similar positions at Credit Suisse, Dresdner Kleinwort and other firms before moving to VTB Capital last fall.
Beginning in October the London-based analysts urged clients to buy companies engaged in the production of steel and coking coal — they highlighted the recommendation in December and February — on the belief that steel prices were due for a rally, thanks to strong demand from China. (Coking coal is one of the raw materials used in the manufacture of steel.) They were right on target. The price of coking coal shot up 57.9 percent, from $209 to $330 per metric ton, and the price of hot-rolled coil steel vaulted 60 percent, from $575 to $920 per metric ton through April, Bielski reports.
A bullish call on steel producers last spring helps Morgan Stanley’s three-member Metals & Mining team under the direction of Dmitry Kolomytsyn capture first-place honors in the sector. Kolomytsyn, 32, received a bachelor’s degree from the Kazakh State Academy of Management in 1999 and a master’s degree in finance from the John Molson School of Business at Montreal’s Concordia University in 2002 before joining Desjardins Securities as a paper and forest products research associate. He moved to Dundee Securities Corp. in 2005, covering the same companies, then was hired by Aton Capital the following year as a senior analyst covering Russian metals and mining. He left that firm in 2008 for Morgan Stanley.
The team, which is headquartered in Moscow, upgraded the global depositary receipts of Evraz Group from equal weight to overweight in May 2010, dubbing the GDRs a bargain at $22.82 after investors dumped them in the wake of deadly explosions at one of the Moscow-based company’s Siberian operations; the analysts also cited rising demand for steel exports. In October, after the price had shot up 36.5 percent, to $31.15, and outpaced the sector by 27.1 percentage points, the researchers downgraded the GDRs back to equal weight, on the basis of an expected seasonal slowdown in demand. They reversed course the following month and upgraded again to overweight, at $33, when a slowdown showed no signs of materializing. The GDRs rose as high as $42 in January before drifting down to close April at $33.90, for a gain of 2.7 percent that trailed the sector by 4 points, but the analysts remain bullish.
The Oil & Gas sector is also vital to many emerging-markets economies, and money managers say no one covers it better than the Troika Dialog trio captained by Moscow-based Oleg Maximov. A 1996 graduate of New Jersey’s Rutgers University with a master’s degree in public administration, the 40-year-old Maximov covered EMEA stocks for New Capital Markets, a hedge fund firm based in Washington, and for San Antonio–based USAA Investment Management Co. before joining Troika in 2003.
The team urged investors to buy shares of Gazprom in April 2010, at $6.31, making the case that the market was undervaluing the legacy pipeline assets of the state-run extractor of natural gas, the world’s largest such enterprise. Shares of the company, which is headquartered in Moscow, had risen 31.5 percent, to $8.30, by the end of April 2011. During the same period the sector gained 20.2 percent.
Commodities often receive the lion’s share of attention, owing to wild fluctuations in price and demand, but in many emerging markets consumer spending is integral to sustainable growth (as it is in developed economies). The six-strong Deutsche Bank team directed by Nick Higham, who works out of Johannesburg, and Dubai-based Zein Malas takes top honors in Consumer/Discretionary. (Malas also co-leads the No. 1 team in Consumer/Nondiscretionary, with Moscow-based Natalia Smirnova.) The team also has analysts on the ground in Istanbul, Moscow and Warsaw.
“Last year was characterized by debates over the extent of earnings recovery, with discretionary retailers posting underperformance during the prior year because of the recession. This resulted in an unusual lack of visibility on future earnings,” explains Higham, 31. “The generally lackluster outlook for developed markets resulted in strong equity market inflows into South Africa, and consumer names experienced substantial reratings, providing a challenging environment where valuations were often debated and ‘new normal’ valuations were queried.”
The analysts upgraded Abdullah Al Othaim Markets Co. from neutral to buy in March 2010, making a case for the Riyadh, Saudi Arabia–based shopping mall and supermarket operator’s improved margin outlook and cleaned-up balance sheet. In January, with the stock up a stunning 42.9 percent, from 58.25 riyal to 83.25 riyal, the analysts elevated it to top pick for 2011 for the Middle East & North Africa region. Over the life of the call, the company’s net margins expanded by 170 basis points and year-over-year net profits increased more than 100 percent each quarter, Malas reports — and the stock was up 70 percent, to 99 riyal, through April. Over the same period the sector gained 25.8 percent and Saudi Arabia’s broad market advanced 1.5 percent.
The Deutsche team initiated coverage on Sandton, South Africa–based furniture and home products manufacturer Steinhoff International Holdings in October with a buy rating, at 2,120 rand, on the belief that the shares were a bargain based on the company’s price-earnings multiples and projected discounted cash flow, which the analysts believed Steinhoff could realize by pursuing a strategy of scaling up businesses, then unbundling and separately listing them. In January the team reiterated its buy recommendation in a short note applauding Steinhoff’s proposal to acquire Conforama Holdings, France’s second-largest household goods retailer, for €1.21 billion ($1.74 billion); the deal closed in March. And by the end of April, the stock had jumped to 2,530 rand, a gain of 19.3 percent that led the sector by 11.3 points and South Africa’s broad market by 12.4 points.
Higham earned a bachelor’s degree in accounting at South Africa’s Stellenbosch University in 2000 and a postgraduate diploma in accounting at the University of Cape Town the following year. He joined Deutsche Bank in 2006 from KPMG, where he worked as an adviser in the financial services division. Malas, 28, received a bachelor’s degree from Washington’s Georgetown University in psychology and biology in 2005, then worked as an analyst covering household goods and personal care products for HSBC and Latin American retail stocks for Bear, Stearns & Co. before moving to Deutsche in 2008.
Consumer spending is dependent on available credit, and when it comes to covering the Financials sector no one can hold a candle to Deutsche’s eight-member troop guided by Daniel Harverd in Tel Aviv, with team members based in Dubai, Istanbul, Johannesburg, Moscow and Warsaw. Harverd, 41, is a 1992 graduate of the U.K.’s University of Leeds, where he earned a bachelor’s degree in economic history, and a 2000 graduate of Tel Aviv University’s Recanati Graduate School, where he received an MBA. He worked as a technology analyst at ING Barings in 2000 and 2001, then as head of Israel equity research at HSBC until 2004, when he moved to Deutsche to oversee emerging-markets financials and Israel equity research.
“I am the overlay that looks at themes across the region, and I pick our top ideas and country allocations,” he explains.
The analysts caught investors’ attention in May 2010 with a report in which they named Russia’s largest bank, Sberbank, a top pick; shares of the Moscow-based firm had already vaulted 71 percent, from $1.48 to $2.53, since the team first upgraded them from hold to buy in September 2009, on valuation. The researchers opted to elevate Sberbank to top pick — the only bank stock to earn that designation from the team last year — based on data showing a robust resumption of loan growth, which they believed would more than outweigh a margin contraction. The report also noted that falling lending rates in Russia would spur credit demand and borrowers’ ability to service debt, and that the stock was inexpensive given the team’s expectation that earnings would increase fivefold in 2010. As it turned out, Sberbank’s earnings increased more than sevenfold last year.
In January the Deutsche analysts pounded the table, with Sberbank shares at $3.41, telling clients that the appreciating ruble and Russia’s high-single-digit inflation created “an almost perfect storm” for the sector. They noted that strong loan growth, stabilizing net interest margins and falling credit costs would continue to boost the bank’s earnings. Sberbank’s shares ended April at $3.66 — an eye-popping 147.3 percent advance since the original upgrade that trounced the sector by 114.2 points and Russia’s broad market by 57.2 points.
The analysts remain bullish, and so do many others who cover the region’s emerging markets. “We find growth opportunities in many of the countries we are looking at,” says Deutsche’s Moura. “For instance, we’ve found that the private pension system in Turkey is still in the initial stages, and premium collection as a percentage of GDP in Turkey is at 2.3 percent, versus 73 percent in the U.K. — so there is huge growth potential.” In fact, he believes, most of the region will see “mid-single-digit GDP growth over the next few years,” and, given the positive economic outlook, he finds the current market valuations very attractive.
That growth will undoubtedly be accompanied by market volatility and political uncertainty, but investors that follow the guidance of the analysts on the 2011 Emerging-Markets Equity & Fixed-Income Research Team will find themselves in experienced hands regardless of market conditions.
