The perennial problem for investors is how to avoid getting caught in the value trap – when stocks are attractive because they are cheap, but they end up staying cheap over the longterm due to company or sector specifics.
Emerging markets tend to trade at a discount to developed markets and the S&P in a range from 10% to 35%. Today, said Dali: “The price/earnings discount is around 25% and on a price/book basis it’s almost a 40% discount to the S&P today, which is the cheapest it’s been in 10 years.”
Dali said one way to avoid getting caught in the emerging markets value trap is by underweighting cyclical value-oriented stocks, or even avoiding them altogether.
“It is always a value-oriented market, stuffed full of materials, energy and financials. All these sectors are somewhat cyclical and they’re the root cause of most of emerging markets’ volatility over time. So, the investor can get stuck, unfairly, for quarters if not years, in a value trap. A really good example is the period 2011 to 2015.”
The rationale for avoiding a company that operates in a cyclical sector like energy or materials, is that cashflows and revenues tend to be less predictable. “We don’t find that to be attractive,” said Dali.
Better benchmarking is another solution. Dali said most major emerging markets indices do not represent the best current opportunities. “We believe there are some exciting investable themes, such as the rise of the Asian consumer, which could be one of the strongest investable themes in recent history.
“MSCI emerging markets and the ETFs that follow it typically have less than 25% consumer and healthcare sector representation. Even if you include the broader definition of consumer to include online shopping and some financial services, I still think these indices dramatically under-represent the opportunity. Healthcare is less than 3% of the MSCI equity EM index, yet it’s over 14% of the S&P500.”
Asia is now 70% of the MSCI EM index, but Dali notes that the next generation of Asian tigers have a small representation in the major benchmarks. “Countries like Indonesia, India, Vietnam, Pakistan, Bangladesh, the Philippines – they are all sizeable and are growing at an aggregate of more than 5.5%, but they are sparsely represented in indices, if at all.”
Another opportunity for asset managers to beat the value trap is to pair some of the new fast-growing economies with some of the more developed emerging markets.
“That increases your diversification and reduces your correlation to developed markets,” said Dali. “You get both with very little volatility and a lot of alpha potential. Few of the companies in these fast-growing economies are within benchmarks at all and are not covered by sell-side analysts.”
