The themed approach provides quite a different perspective of risk and reward at the stock level, rather than slavishly following short-term market noise and chasing earnings momentum, according to Marshall-Lee.
Some examples of investment themes in emerging markets include the electric-vehicle supply chain, healthcare and the consumer story in India.
“This allows a differentiated long-term return outcome, together with the aim of reducing absolute risk through a strong focus on attributes such as superior corporate governance, robust businesses, better growth prospects and stronger balance sheets,” he said.
All eyes on China
Newton Investment Management is cautiously optimistic in its outlook for 2018. On one hand, the global economy has continued to recover and China’s growth has slowed less than expected. Yet Marshall-Lee still believes credit growth and housing-related activity will be a drag on Chinese growth over the next 12 months.
“We believe the banks remain a high-risk investment, since many need significant capital injections.”
At the same time, however, an economic collapse or credit crisis is unlikely any time soon. “The Chinese authorities seem increasingly aware of the risks present in their banking system and shadow finance sector,” he added. “They continue to ramp up their regulatory focus.”
Another focal point in China relates to the ratio of private credit-to-GDP. Many market commentators have highlighted the large growth of this ratio in recent years.
According to Marshall-Lee, it is important to understand that a very significant portion of this – and probably the majority – relates to state-owned entities. “These companies owe debt to state-owned banks within a tightly-controlled capital account,” he said. “This is not a healthy situation, but it is also rather less likely to result in a precipitous ‘Lehman Brothers’ moment.”
Instead, he believes some banks are likely to be squeezed and consolidated. At the same time, some debts will be extended and restructured, with selective write-offs and bankruptcies being managed to try to prevent moral hazard and over-confidence in the Chinese communist party providing a backstop for credit expansion.
The key driver behind Chinese growth, as the economy transitions from manufacturing to consumer services, is the domestic consumer. Examples of investment opportunities include education, recruitment and e-commerce. “This is where we tend to find the best long-term growth opportunities.”
On the flipside, he is wary of the sustainability of construction-led growth and the more cyclical parts of China’s economy.
Finding the opportunity
In identifying the right investment angle for emerging markets, it is important to note that current accounts in many emerging economies suggest that currencies have become too cheap.
“Emerging market equities still seem relatively cheap on through-cycle measures relative to most asset classes, though we would not argue that all equities are cheap,” Marshall-Lee said.
The job of the stock-picker is to understand the context of the valuation and risk profile, he explained. “We consider a five-to-10-year horizon when assessing prospects for companies and their ability to compound cashflows.”
He said Newton Investment Management also pays a lot of attention to the potential for companies to reinvest in growth at attractive rates of return-on-capital. “We consider this in our valuation scenarios.”
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