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BlackRock hunts alpha in emerging markets

Despite historical underperformance relative to developed markets, BlackRock believes emerging markets are positioned to provide diverse and real alpha.
by Andrew Crooke
Both the GAM and JP Morgan funds invest in Asia-Pacific including Japan, but the main difference is the markets they invest in. GAM is more focused on developed markets, while JP Morgan has a mix of both developed and emerging markets. The difference lies in their benchmarks: GAM’s benchmark index, the MSCI Pacific Index, captures only five developed markets in the region, according to Ng. JP Morgan’s benchmark index, the MSCI AC Asia-Pacific Index, includes five developed market and nine emerging market countries in Asia-Pacific. Fund vs benchmark index (top five country allocations) GAM fund MSCI Pacific Japan 60.16% Japan 65.71% Australia 16.20% Australia 20.06% Hong Kong 15.91% Hong Kong 10.05% China 3.61% Singapore 3.71% Singapore 2.70% New Zealand 0.48% JP Morgan fund MSCI AC Asia Pacific Index Japan 39.50% Japan 37.99% China 19.30% China 17.01% Australia 9.80% Australia 11.60% Hong Kong 8.40% South Korea 8.54% Taiwan 6.20% Taiwan 6.93% Source: MSCI, GAM, JP Morgan Asset Management Ng noted that the GAM fund has an unconstrained strategy and does not need to follow the benchmark. However, its portfolio somewhat resembles the MSCI Pacific Index on a country level. “When I look back to its portfolio history, I think the country allocation has been similar to that of the benchmark that they use,” Ng said. Not only do their benchmarks differ in country allocations, but in sectors as well. On the benchmark level, one of the key differences is the allocation to information technology: the MSCI Pacific only has around 8% in the sector, while the MSCI AC Asia Pacific Index has 20% in IT. It is not surprising then that the JP Morgan fund has 25% in IT, Ng said. Fund vs benchmark index (top five sector allocations) GAM fund MSCI Pacific Financials 23.97% Financials 21.51% Industrials 22.40% Industrials 16.78% Consumer discretionary 21.66% Consumer discretionary 15.03% IT 8.77% IT 8.40% Real estate 7.62% Materials 7.99% JP Morgan fund MSCI AC Asia Pacific Index Financials 26.80% Financial 21.32% IT 25.80% IT 20.46% Consumer discretionary 15.50% Consumer discretionary 12.49% Industrials 9.20% Industrials 12.18% Materials 8.70% Materials 6.97% Source: MSCI, GAM, JP Morgan Asset Management Although both funds look for growth opportunities in the region, the GAM fund prefers equities with lower valuations than the JP Morgan fund, Ng said, adding that the GAM product has a lower price-per-earnings multiple. In comparison, the JP Morgan fund is more growth-oriented and the managers are willing to pay for companies with higher valuations provided they show long-term sustainable growth prospects, he added. Differences in strategy Both funds use different investment strategies. For the GAM fund, managers Michael Lai and Ben Williams employ a top-down and bottom-up approach, according to Ng. The top-down approach is mainly a decision about the fund’s allocation to Japan, depending on macroeconomic factors. After that, they use a bottom-up approach to pick the stocks in Japan and the rest of the APAC markets based on various fundamentals. For the JP Morgan fund, the fund managers, Aisa Ogoshi, Mark Davids and Robert Lloyd, identify “core franchise” and “quality growth” stocks, according to Ng. Core franchise stocks refer to companies that have financial strength and strong corporate governance attributes.. Quality growth stocks are those that have long-term growth prospects.

High earnings growth potential, stock return volatility and structural shifts from re-globalisation offer enticing opportunities in Emerging Markets (EM) for active investors.

Although global EM have underperformed developed markets amid Covid-led lockdowns in China, the war in Ukraine and geopolitical tensions, BlackRock believes EM remain a source of alpha with unique economic and political cycles across many countries.

“Finding opportunities in this type of market regime can be difficult, but… EM are positioned to provide diverse and real alpha,” said Belinda Boa, head of active investments for Asia Pacific and chief investment officer of EM at the US fund house.

Supportive market and macro shifts
While the responses of EM to the pandemic were varied, these economies generally saw little balance sheet expansion and made more benign initial rate cuts compared with developed markets.

EM central banks were also quicker than their developed market peers to act against rising inflation – resulting in positive real interest rates today across various economies.

Driven primarily by domestic demand, the growth differential between earnings in EM versus developed markets are projected to grow by 61% by 2025 from 2022 levels, according to Refinitiv Datastream MSCI data as of May 2023.

“Building off this, one of the main trends we believe will continue to fuel alpha opportunities are the structural shifts in EM,” explained Boa.

In particular, BlackRock expects the redistribution of supply chains to benefit EM in the long run.

“We also think it’s important to keep an eye on ‘resource nationalism’,” explained Boa, “where commodities linked with renewables are seeing a focus from policy makers.”

As a result, countries like Indonesia will likely see a move up the value chain, while other, like South Korea and India, are now positioning themselves for supply chain diversification.

By contrast, in China, the once-promising growth story has been dampened as traditional growth drivers have cooled, demographic headwinds have strengthened and geopolitical relations with the US present complications, added Boa.

Yet despite these challenges, a focus on China should not be ignored, she added.

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