Finding Value in Troubled Emerging Markets

Ernest Yeung: Hello, Emma.

Wall: So, we've had an interesting start to October. Some people were saying we were on track for the worst October for markets, or Asian markets, since 2008. It has rallied a little bit towards the end of last week and we are mixed today. What has caused such a significant sell-off and do you think it's warranted? Are the fundamentals really that bad?

Yeung: Sure. Admittedly, I think 2018 has been more volatile than I initially expected. But let's put it into context. I think we have had two-and-a-half years of really good performance in emerging markets. So, I think giving something back is actually quite normal. However, admittedly, if you look at all the survey that's been done by economists, you would know that emerging markets and the US dollar rate and S&P index do have a close correlation. The correlation could be as high as 75%. So, now that the rate has been hiked, it's natural to expect that there would be some pressure on the emerging markets.

However, I would point out a very interesting point is, within the emerging markets people see that as one asset class, but we are actually talking about 30 countries with 3,000 stocks. So, some countries correctly will be under pressure like the topical countries of Argentina, Turkey. They need US dollar funding and the macro is fragile. So, I think, their correction is well-justified to some extent.

Wall: Now, I suppose the next logical question is, which are the unjustified pullbacks. Because you have a broad remit and a value focus. So, you will be looking for opportunities. Where are you seeing those opportunities?

Yeung: Sure. So, I like to look at countries that other people are not investing in or they are overlooked. So, I would give you some examples here. If you assume US dollar rate hike will continue, actually, countries like the Middle East will benefit a lot because their currency is actually packed to the US dollar. Oil is at $80 now. So, it's actually pretty good for the macro. The current account is becoming stronger and a lot of the banks will be the beneficiary of US dollar rate hikes. And there are sectors that have no barring to US dollar rate hikes as well. For example, China old economy has been undergoing significant SOE reform or supply-side reform. I think those industries are not really correlated to the US dollar or rate hike at all.

Wall: And that's quite interesting because old China is an area where a lot of other fund managers who invest in Asia and across emerging markets are actually avoiding because of the old in the name. They say that people are moving away. But you are saying actually there are opportunities within those companies.

Yeung: Yes. Bringing back to my first point. I think old economy, people hit it with bargepole and think everything is bad. There are bad apples out there, let's admit it. So, we are not going out there buying a basket of old economy stocks. However, some of them are changing. For example, we know that at the trough of 2015-16 some of these companies were at the verge of bankruptcy and that expectation is still vivid in the management's mindset. So, let it be, the government pressurising them or the management themselves are trying to change. Because they are back in the corner and they know they need to make the right decision. So, we are seeing a lot of examples like that in the emerging markets space.

Wall: And finally, I know that you don't have a crystal ball, but should investors expect this volatility to stick around for a bit longer? Is this going to be a period – like you said, we had two-and-a-half years of a very strong performance – are we going to have around two years of perhaps more difficult, more volatile times?

Yeung: So, I will answer your question in two points. First of all, like I mentioned, we have a very diversified asset base that we can invest in. So, I think, active stock selection really matters. If you go and don't just buy the index, try to find opportunities like the Middle East that I mentioned that will benefit in the current macro mindset.

However, the second point I will mention is, equity normally follows fixed income and my fixed income colleagues are actually turning very bullish. They think the real rate of many emerging markets is becoming very attractive now and they want to deploy the capital there. So, in terms of currency, in terms of fixed income, valuation and tactical are getting very attractive again. So, as a stock picker, I think they are signalling to me that capital outflow maybe subsiding somewhat, and we can go back to focusing on the fundamentals and pick out pockets that are attractive to our fund holders.

Wall: Ernest, thank you very much.

Yeung: Thank you, Emma.

Wall: This is Emma Wall for Morningstar. Thank you for watching.