“Over the past four years we have never been so positive on emerging markets,” said Khemka told FSA.
The recovery in commodity prices over the past twelve months has been a major factor.
“Commodities hit a low early last year and many have since recovered a hundred percent or more. That has resulted in improved earnings for the commodities sector, and also banking and industrial sectors in many of the countries more exposed to commodities.”
Protectionist impact
Several concerns are on the horizon, however. Possible protectionist moves by the US, the rise of the dollar and an increase in the 10-year US Treasury yield, are among the macro events that could derail the EM rally.
Protectionist policies would have a significant impact on many emerging market economies, most of which depend on global trade.
But Khemka believes faster US economic growth “will have a spillover effect, particularly in emerging markets, which will outweigh the negatives of increased protectionism.
“Commodities have sort of found stability”, he said, highlighting the example of iron ore, which revived in 2016, breaking the downward trend over the past two years. “That is not going to change regardless of any kind of [US] protectionism”, he added.
In the EM equity portfolio, China exposure is the largest with 24%. Three China stocks – Tencent, Ping An Insurance and AIA – account for about 10% of the whole portfolio.
India is the second largest allocation. He believes India will be minimally impacted in a protectionist environment due economic growth based largely on domestic consumption.
“India’s domestic factors such as structural reforms and a consumption-driven recovery are the main drivers for corporate earnings and the market rather than potential effects of increased trade protectionism”, Khemka said. “India is a good example of an economy less impacted by the headwinds of slower global growth.”
Additionally, India’s economic reforms are showing some signs of progress. Specifically, he cited the introduction of a uniform goods and services tax, which FSA reported earlier.
Bottom-up approach
The portfolio has a focus on small and mid-cap companies. When vetting investments, the team tries to avoid companies in industries with intense competition, according to a report on the firm’s emerging markets equity portfolio by UK-based research firm RSMR Group.
“Whilst companies must be able to deliver reasonable growth, it must not be so fast as to attract competition as Goldman believe very strong growth means margins will eventually be eaten away,” the report said.
The price-to-cash flow ratio is used for valuation because price-to-earnings ratios can be easy to manipulate, according to the report.
“A common methodology is used across the entire emerging markets region so it is possible to make cross-border comparisons of stocks.”
The report also noted that the EM team uses a bottom-up approach with no top down input, which is different from other managers in the universe.
Khemka added that macro events are typically seen as buying opportunities.
“Uncertainties in the market do result in large deviation in individual stock prices compared to their underlying fundamentals, and we always look to capitalise on such opportunities.”
The three-year performance of the GSAM team-managed fund, the Emerging Markets Equity Portfolio versus its benchmark, the MSCI Emerging Markets Index, and the sector.
