Trump has taken office. What is going through your mind?
What’s the outlook for US monetary policy this year?
Devan Kaloo: Higher US rates are considered bad for emerging markets because they make dollar-denominated assets relatively more attractive, encouraging capital outflows from so-called ‘riskier’ developing economies. The US Federal Reserve (Fed) has steered investor expectations towards a faster pace of interest rate hikes this year: the Federal Open Market Committee (FOMC) raised the federal funds rate guidance to between 0.5 and 0.75 per cent, which suggests as many as three hikes in 2017 (as opposed to two based on earlier direction). Our fixed income colleagues are more cautious, believing the US central bank may possibly move more gradually to avoid smothering the recovery. Since Trump’s victory, US equity markets have behaved as if growth is all but assured, but financial markets are still susceptible to shocks.
We hear things are looking up at the company level in EMs?
Devan Kaloo: One vulnerability for emerging markets has been poor earnings growth, partly driven by weakness in commodity prices. However, as commodity prices recovered last year amid a modest pickup in global trade that has shown up in better export numbers, there’s also been an improvement in corporate profitability. Margins at emerging market companies are once again higher than those of firms based in developed markets. At the forefront are companies in selected cyclical sectors, such as energy/basic materials. Meanwhile, lower capital expenditure has freed up cash flow – strengthening balance sheets and providing opportunities for bigger pay outs to shareholders. Whether this is sustainable is too early to tell. But these are some of the most encouraging signs that we’ve seen for a while.
Will conditions in China stay benign?
Devan Kaloo: Conditions in China have stabilised since the market volatility that marred the start of last year after the government deployed fiscal stimulus to ensure growth targets were met. The good news is that Chinese domestic consumption remains robust, while private fixed-asset investment is improving. The bad news is that the overheating property market is a cause for concern again, as are capital outflows. Our fixed income colleagues anticipate further depreciation of the currency as more money leaves China, despite the efforts of authorities to stem this flow. This needs to be closely monitored, in addition to the well-chronicled problem of excessive debt. However, a closed economy does give policymakers considerable room for manoeuvre. This is something investors would do well to remember.
What are your views on demonetisation in India?
Devan Kaloo: Demonetisation is the term used to describe the process of stripping a currency unit of its status as legal tender. In India’s case, the government announced last November the withdrawal and replacement of selected high-value bank notes that accounted for nearly 90 per cent of cash in circulation. Demonetisation has caused hardship for many people but from a policy perspective it really was quite extraordinary. It took everyone by surprise and addresses many economic issues: it allows the authorities to get at hidden ‘black money’ – proceeds from corruption and other illegal activities; there’s been a problem with liquidity in the financial system and now billions of dollars have been pulled out of the informal economy and deposited into bank accounts; a temporary cash-crunch means people will spend less, especially in rural areas, which means weaker inflation leaving room for the central bank to ease interest rates further to support growth.
How do EM valuations stack up?
Devan Kaloo: Emerging market assets are under-owned and unloved. The extent of global funds’ underweight to the asset class has never been lower. That’s why emerging market equity valuations are more attractive than those found in the developed markets. Following the market sell-off since Trump’s election victory last November, this is even more true – on both an historical and relative basis. For example, global emerging market equities are trading at some 1.5 times book value, which is roughly on par with the average over five years, but almost 16 per cent below the 10-year average. One-and-a half times book is lower than the 1.8 times for European equities, the 2.2 times for World equities and the 2.9 times of US equities. Meanwhile, return-on-equity of 10.4 per cent is higher than all the other regions except the US (12.5 per cent).
Give some examples of corporate governance engagement
Devan Kaloo: We contacted Korea’s Naver Corp to discuss the company’s capital allocation and corporate structure, following the sale of a stake in its video messaging app, Snow, to its recently-listed subsidiary, Line Corp. We reiterated to Russian retailer Magnit the need to manage environmental and social risks in its supply chain. We made recommendations on how to do this, including drawing up a supplier code of conduct and strengthening the auditing process. Magnit promised to look into the matter and we will monitor its progress. We also met with BRF’s CEO and chairman to discuss our concerns over shareholder influence, board independence and succession planning at the Brazilian food conglomerate.
What have you been doing with the model portfolio?
Devan Kaloo: We divested Yum! Brands to invest in Yum China, a pure-play restaurant operator in China with a net cash balance sheet. We also sold out of SABMiller and exited E-mart because we saw better value elsewhere. Meanwhile, we trimmed our stakes in Banco Santander-Chile and Lukoil because recent share price gains have been excessive. Against this, we continued to build our position in the Aberdeen Global – China A Share Equity Fund, which offers a unique pool of mainland companies with exposure to the country’s growing consumption story. We also topped up our stakes in Magnit, UltraTech Cement and Yum China on attractive valuations; and in Naver on its solid fundamentals.
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