In this abridged interview, Christine Tan, Senior Portfolio Manager with Excel Investment Counsel Inc. ("EIC"), and the lead Portfolio Manager of the first quartile performing Excel Emerging Markets Fund, shares the firms's vision about EM; explains why she believes the future of investing belongs to EM; and describes how she manages money to generate the highest possible risk-adjusted returns for investors.
Dwarka: Why does EIC focus solely on EM?
Christine: We believe EM will define the future path of the global economy for several reasons. Among them are: they collectively account for 70% of global GDP growth; 35% of global market capitalization; have over 70% of the word’s foreign reserves; control more than half of the world’s purchasing power; and are home to 90% of the world’s population under the age of 30. EM also have a huge demographic dividend and a growing middle class whose accelerating purchasing power will fuel their growth.
It is also our belief that EM will continue to grow faster than developed markets (DM) for decades to come, offering a diversified pool of investment opportunities which can generate superior risk-adjusted returns. Therefore, it makes sense to focus solely on EM because we see them as the future of global investing.
Dwarka: EM is often perceived as being risky. What measures do you put in place to control risk?
Christine: The truth is: risk is a relative phenomenon. It can be argued that DM are riskier than EM over the long-term. But to answer your question, risk can be managed at two levels: country and stock. In my opinion, most EM have a predictable path to development, although there are bound to be detours along the way. What is important to understand is that the countries in the EM universe are not homogeneous in nature. Each is structurally different and has its own growth drivers, opportunities, and risks. However, while a country might have greater implied risk, for example Russia, it might still have great companies with strong growth potential.
When, using an active management style which embodies growth at a reasonable price, I focus on finding pockets of growth which have the best risk/reward characteristics, while maintaining top-down control at a country level. These companies are typically beneficiaries of secular growth themes, such as education, healthcare, smartphone penetration, etc. that are expected to continue over the years regardless of the trajectory of the country’s economic growth.
Within each growth sector, I then identify the best companies with solid balance sheets and experienced management. Among the key variables I consider in identifying quality companies are: the intrinsic value of the company must be greater than its current market value; it must have reasonable free cash flow; its return on equity, return on asset, and return on invested capital must be competitive; its business model must be scalable; and it must have superior earnings per share growth. To put my strategy in perspective, finding great businesses to invest in is like travelling back in time in Canada 15 years ago when many great companies as we know them today were still evolving. For instance, one of my favorite Canadian companies is Cineplex Inc. which years ago was in its early growth stage but today is dominant in its space. I see similar opportunities in countries like China, Thailand and Korea.
Therefore, generating superior risk-adjusted returns comes down to identifying the right stocks in sectors with sustainable growth potential.
Dwarka: Looking ahead, what will be the impact of currency movements when investing in EM?
Christine: Currency movements have been one of biggest contributors as well as detractors from performance of EM equities. They tend to be an amplifier of returns both on the upside and the downside. In my opinion, they will continue to be a major factor to consider in the short-term. Therefore, in the short-term, we may hedge certain currencies if we are worried about the economy of a country but do not hedge over the long-term because we have exposure to many different currencies. Our advice to long-term investors is that they should not be overly concerned with short-term currency movements as they tend to normalize over time.
Dwarka: Why do you believe investors are hesitant to invest in EM?
Christine: While the perception of risk is often cited as the biggest reason why investors tread carefully into EM, it is not necessarily the real reason. Truth be told, investors tend to have a home country bias, fuelled by the fear of investing in markets and companies that are unfamiliar. So we believe it comes down to educating investors that investing in EM is a great diversification strategy that can enhance the long-term returns of their portfolio. In fact, over the long-term, EM has outperformed DM, and have low correlation to DM.
Dwarka: In your opinion, what percentage of investor portfolio's should be allocated to EM?
Christine: The most important considerations in asset allocation decisions are the investor’s personal investment objectives, risk profile and time horizon. Putting this aside, if you consider that EM make up 35% of global market cap and that Canadians on average currently invest only about 2% of their assets in EM, there is certainly scope for a substantial increase in allocation, perhaps as high as 15-20%. The diversification benefit is particularly important for Canadians because the Canadian markets represent less than 4% of global market cap and is heavily concentrated in only two sectors, financial services and resources.
We believe the EM growth story is still in its early innings and that patient investors can benefit from investing in secular growth businesses in these countries.