After a long period of fragile growth, the global economy appears to be in recovery mode. Global stock markets are performing remarkably well – hitting all-time highs on the back of low interest rates. In this environment, emerging markets have piqued the interest of investors.
Dr Mark Mobius, executive chairman of Templeton Emerging Markets Group, explores the rise of emerging markets, investment opportunities and South Africa’s competitive streak in the investment realm. He regards South Africa as the most important market in Africa, but the country must focus on government reform, targeting inefficiencies, political uncertainty and corruption to achieve growth and attract sustainable foreign direct investment.
MONEYWEB: Emerging markets were initially viewed as “third-world” but it now seems that many investors are viewing emerging markets as the next growth vector. What are some of the reasons behind the interest in emerging markets?
MARK MOBIUS: There is no question that emerging markets are the next growth vector. The evidence is clear when we only look at GDP growth. GDP growth in emerging markets is double than that of developed markets. The two most populous nations in the world today are among the fastest growing. India and China (growing at 6% and 7% respectively) have a growth rate of at least three times that of the US, Europe and Japan. Emerging-market (EM) equities (as represented by the MSCI Emerging Markets Index) have extended their 2016 recovery.
In the first half of 2017, the MSCI EM Index returned 18.60%, compared with an 11.02% gain in the MSCI World Index. The strong start to the year reflects an improved macroeconomic backdrop following a period of currency and commodity price adjustments and widespread political change. The factors many investors have historically found attractive about the asset class have come back into play, including stronger earnings growth and robust consumer trends.
MONEYWEB: Is this momentum in emerging markets sustainable?
MARK MOBIUS: While areas of risk remain, our view is that we are still in the early innings of the emerging-market earnings growth upturn. We also believe valuations and sentiment continue to be supportive. Even in regions that are still going through adjustment and rebalancing, we see more visible signs of robust underlying economic conditions. Positive factors include low debt, stabilising commodity markets, reduced currency volatility and improving consumer confidence. The implementation of reforms in many countries has also been further driving market confidence. Importantly, EM corporate earnings growth hit an inflection point in 2016 after several years of decline, due in part to weaker commodity prices and slowing growth in China. Earnings growth now appears to be rebounding. Emerging-market corporations’ capital allocation and cost efficiency have also been improving, which we believe should support profit margins and lift return on equity [a key measure of the profitability of a business excluding its liabilities].
Taking a long-term view, the structural investment case for emerging markets continues to centre around demographics (including a rising middle class and a younger population now entering the most productive years of their lives and domestic consumption). We think it’s also important to recognise that there have been fundamental shifts in the corporate landscape with better corporate governance and many emerging-market companies become world class.
MONEYWEB: Has there been widespread changes in the model of emerging-market asset classes?
MARK MOBIUS: Emerging markets are more diversified than they were a decade ago. The asset class has undergone a significant transformation from the often plain-vanilla business models of the past. Older models tended to focus on infrastructure, telecommunications, classic banking and commodity-related businesses. Today, we see a new generation of highly innovative companies which are moving into much higher value-added production processes, or are on the cutting edge of world-class technology leadership.
MONEYWEB: Is it only during volatile times that emerging markets normally gain popularity?
MARK MOBIUS: No. There seems to be no direct correlation between general volatility and flows into emerging markets. In fact, we might say that there would be a tendency for volatile times resulting in investors retreating to their home countries. This would be particularly true of investors in developed countries such as the US, Europe and Japan. Many other factors go into determining fund flows and volatility would be one of many variables.
MONEYWEB: How should the currency risk of emerging markets be managed? Emerging market currencies are generally more volatile and illiquid than currencies in developed markets.
MARK MOBIUS: The range of volatility and illiquidity in emerging-market currencies is very wide so we are able to find some EM currencies that are not very volatile and having good liquidity. The good news is that any volatility will work in the investor’s favour if he can purchase an EM currency at a bargain price with his own currency.
MONEYWEB: What should the investment criteria be for investing in companies with operations in or domiciled in EMs?
MARK MOBIUS: The investment criteria are not different from investing in developed market companies: (1) good management with a clear vision (2) an industry with growth prospects (3) good corporate governance, (4) strong cash flow and strong balance sheet.
MONEYWEB: In which sector/s is Templeton Emerging Markets Group finding opportunities?
MARK MOBIUS: Templeton Emerging Markets Group has a wide investment universe to cover — tens of thousands of companies in markets on nearly every continent. While we are bottom-up investors, we also take into account big-picture context. We find opportunities in the following themes currently:
Consumer demand growth is a prominent investment thesis within our portfolios. We look for opportunities in areas relating to consumer products. These include consumer staples, retailing, and discretionary purchases such as automobiles. We also look for opportunities in services such as consumer finance where we see companies we think can achieve high growth rates and sustainable profits.
Technology is another major investment theme. Many emerging-market companies have become leading players in the adoption and development of technology, and IT has outperformed other emerging-market sectors in the second quarter and first half of 2017. Although we are cautious of the share-price advances in some internet stocks, we continue to see value in the sector across emerging markets. Our focus is on earnings sustainability as a result of innovation, dominant platforms or technology.
In addition to internet companies, which stand to benefit from the move toward more online transactions, we see potential for attractive long-term investment opportunities in many other areas. These include: shopping, targeted advertising, gaming and other services, graphic processing units for data centres and artificial intelligence applications, and connectivity and processor integrated circuits for autonomous cars and devices related to the ‘internet of things’.
In the memory segment, smartphones have been upgrading memory content for better performance, which has helped drive demand for and pricing of dynamic random access memory (DRAM) chips. Demand for DRAM chips from data centers is also picking up, which we think should further support prices.
MONEYWEB: What is South Africa’s place in the emerging market realm? Is it a market that has piqued the interest of investors?
MARK MOBIUS: We regard South Africa as the most important market in Africa, followed by Nigeria, Kenya, Ivory Coast, Ghana and Zimbabwe. Despite some near-term challenges, we hold a positive long-term view on African markets in general, as they have the potential for strong economic growth, which, we believe, produces an environment favourable to corporate profitability and earnings growth. Much of this potential has not yet been fully tapped. Many African markets not only boast significant resources of oil, gas and hard commodities but also provide means to expand the production of soft commodities. We believe the opportunity is magnified by market valuations for African corporations, which often stand below those of their peers in more developed markets.
South Africa’s political problems are certainly well known, but the good news is that the democratic process is in place even though it may take time to work. In our experience, we have found managers of South African companies to generally be very capable and experienced. Many South African companies have expanded globally, so investing in a South African company means you can often get exposure in other parts of Africa and the rest of the world. The recent political developments have not impacted many companies to a great extent, and we see good things happening in the country that make us hopeful; for example, more and more of the younger people are getting involved in making the country better. As in other parts of the world, the hope and aspirations are with the youth. I believe they can and will make their country better.
MONEYWEB: Specific to South Africa, what are the key macroeconomic concerns?
MARK MOBIUS: The key macroeconomic concern revolves around the poor credit rating the country has and the recent downgrade. This reflects a political environment of “populism” where government spending becomes excessive and more importantly those expenditures are subject to “rent seeking” by politically-connected people in the controlling party. Thus, the country does not get the infrastructure needed to promote investment and economic growth. So, the macroeconomic concerns really revolve about the political concerns and the ability of the government to deliver the services and facilities needed by the people and investors.
MONEYWEB: With the economy entering into a technical recession in the first quarter, what should South Africa be focusing on to return to a growth surge?
MARK MOBIUS: The focus must be on government reform with a clear target of inefficiencies and corruption. Growth in South Africa is projected to rise in 2017 but less than 1%. In 2018 growth should be better and perhaps over 1% but this kind of growth is very poor for a country like South Africa with a young population eager to work and progress. Private consumption and investment has been the weak spot, which has led to the country’s sovereign debt ratings downgrade. With commodity prices low we can’t expect growth from that area immediately but commodity prices have begun to even out and even climb from their low points. However, unless there is reform on the labour front we can’t expect a surge in that sector. We can expect some opportunities in the telecommunications and internet sector but we will need to be very selective in that regard.
The possibility of political reform is what investors find attractive about South Africa so there could possibly be a ratings upgrade. But there will need to be delivery on the part of the political elite before that attraction is realised.
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