By David Gould
Before they were emerging markets (EM) they were LDCs – less developed countries, a designation that hinted at a top-down mercantilist perception, i.e. simple economies that depended on low-cost labor or commodities, boomed for a bit, and then flamed out. Modern-day investors, however, are learning to flip the lens and appreciate the quality and potential that comes into focus via a bottom-up view of emerging markets.
“In emerging markets, a certain sector might be in or out of favor, a particular country may be getting a lot of buzz – we pay very little attention to that,” says Patricia Ribeiro, senior vice president and senior portfolio manager, emerging markets team at American Century Investments. “We want to know, where the best ideas are coming from, which company has something happening on a fundamental level that stands out, including which management teams are strategically aligned with the consumer – that’s where we find opportunity.”
Professional investing is often a matter of which information you pursue and pay attention to. “We are a fundamental, bottom-up manager,” says Ribeiro, a Brazil native educated in the U.S. “It starts with a recognition by our group of an inflection point in company performance data—evidence that it may be poised for sustainable earnings acceleration.”
Early recognition is about focusing on the direction of a company’s growth rate rather than the absolute level of growth, since the latter indicator often reflects performance that is already baked into the company’s stock price. Based on that initial glimmer, the in-depth investigating begins. Is the inflection in a company’s earnings growth sustainable? An affirmative answer to that pivotal question indicates potential for superior risk-adjusted investment performance over the long term.
The team takes a long-term approach with the goal of identifying businesses that are delivering improving and sustainable fundamentals. Thinking seriously about where a company will end up in two or three years’ time is not what most sell-side analysts do. For American Century’s EM group, it is standard procedure. The team is content to let its peers focus on backward-looking metrics like historical growth rates, choosing instead to identify potential improvement at an early stage and then build an investment thesis around it. Ribeiro’s team looks for breakout-type activity at the company level – cases of economic needs and wants identified, or solutions to significant problems potentially hit upon.
One point of pride for the EM team at American Century is its proven ability to identify inflection points early – before the market recognizes a company’s improving fundamentals. “We make it our business to be ahead of the market,” says Ribeiro. She judges the prevalent EM fund pattern of allocating by country and allocating by sector as a big advantage for her portfolio. “That benefits us, because when investors focus on macro factors it often translates to a good business being overlooked,” she says. “When a country comes back in favor, valuations get pushed up, and we realize that additional gain because we still have our positions.” While the team believes it is important to understand macro risks, they do so by incorporating the macro into their bottom-up analysis.
Quality leadership begets growth
Even when the conventional EM wisdom gets behind a management team and supports its stock based on fundamentals, there is a tendency to realize gains and deploy them wherever the next supposed hot spot might be. By contrast, American Century sees the emerging world as a place where inspired leadership can lead to tier upon tier of growth. Tencent Holdings Limited attracted Ribeiro and her group way back when it tracked toward success in desktop gaming, its original line of business. “The company’s strength wasn’t necessarily in desktop gaming,” Ribeiro notes. “Over time it showed a sense of where consumer demand was going, and it continually reinvented itself.” Now a top-10 Internet company worldwide, with a huge presence in social media, Tencent has remained a fixture in the American Century EM portfolio through nearly its entire growth trajectory.
That portfolio is underweight India, a position driven by its bottom-up stock selection process. But by no means is a broad brush applied. Instead, Ribeiro views the portfolio as properly weighted in India.
“Last year the second-best performing country in our portfolio was India,” she reports. “We have trouble finding names there that fit our process, but the names we do own are excellent quality and have been outperforming by any standard.” Ribeiro notes that “everyone gets excited about India.” There are many reasons this is true, but none more so than infrastructure. India jumped 19 places in the World Bank’s Logistics Performance Index in 2016, to rank 35th amongst 160 countries. Infrastructure is a favored beneficiary of government policy, with US$92.22 billion earmarked in the 2018-’19 budget for a massive push that aims to expand railways and bring universal household electrification to the country, among other targets.
A widely published expert on economic modernization, Bernard Arogyaswamy, wrote recently about a persistent expectation that “emerging economies would always be emerging but never emerge, to challenge the early industrializers.” Whatever the cultural implications of such an outlook, EM analysts and managers at American Century have long leaned the other way. Discussing so-called Chinese premiumization, Ribeiro speaks as someone who was ever on the lookout for it. “China’s economic surge in the late 20th century was about cheap manufactured goods for export, and a lot of people said that was the niche where they could prosper,” she says. “But that’s not the box the Chinese wanted to stay in. They had aspirations, and they are realizing their aspirations and their potential in a compelling way.”
Compelling or not, there is a lot that happens outside the developed world that you would not see coming, if your view was strictly from the top down.
References to specific securities are for illustrative purposes only and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and along with other portfolio data, are subject to change without notice.
This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for investment, accounting, legal or tax advice.
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