Fund managers series

Emerging markets: Staying for the long haul

Stephen Dover, chief investment officer of Templeton Emerging Markets Group and Franklin Local Asset Management, discusses the outlook for emerging markets and equities, in the latest of our series featuring fund managers and leading market experts

Mr Dover is focusing on regions with solid growth and consumption. He sees opportunities in firms whose revenue is spread out geographically and whose cost-efficiency can boost margins.
Mr Dover is focusing on regions with solid growth and consumption. He sees opportunities in firms whose revenue is spread out geographically and whose cost-efficiency can boost margins.ST PHOTO: SEAH KWANG PENG

After three consecutive years of outflows, emerging markets saw a brief turnaround in fund flows globally last year and outdid developed markets for the first time since 2010.

With the increased possibility of protectionist trade policies and more rate hikes to come from the United States Federal Reserve, market observers are asking if there is still reason for optimism over emerging markets.

Mr Dover is responsible for overseeing emerging market strategies and investment processes, as well as day-to-day management of the team. The chartered financial analyst (CFA) oversees more than US$70 billion (S$98 billion) worth of assets globally.

He told The Sunday Times that he maintains his value investing convictions, and thrives on the adrenaline of uncovering overlooked companies with strong fundamentals.

Q Tell us how the emerging markets team at Franklin Templeton Investments has grown and evolved its research practices over the years.


We believe companies in the consumer-related and IT sectors are particularly attractive in the current environment.

MR STEPHEN DOVER, on gaining access to economic expansion in emerging markets and especially growth in consumer spending in these sectors.

A From late 2015 to early last year, we took several steps to refine our structure and process with the objective of improving investment outcomes for our clients over the long term. Apart from the senior leadership announcements, we have also appointed dedicated global sector analysts for select sectors, including Internet, technology and healthcare.

These changes align with structural shifts in the emerging markets opportunity set as well. For instance, the information technology (IT) sector was previously a small part of the MSCI EM index, but it is now very important to future investments in emerging markets. Moreover, the dedicated sector research is intended to improve consistency in micro stock research within these sectors.

The sector analysts' framework has further reinforced bottom-up idea generation, improved the breadth and depth of our coverage, and enhanced stock research consistencies within the respective sectors, which has facilitated significant portfolio investments in these areas. These changes have proved to be a success and helped the performance of our core strategies in global emerging markets and Asia.

Q Do you think the asset class recovery in emerging markets will be a sustained one? How is your team positioning itself for the turnaround in the markets?

A As a whole, emerging markets performed well last year, and we believe the momentum will continue into this year. In our opinion, the search for higher yields and improving risk perception concerning emerging markets, helped by robust economic tailwinds, could provide a basis for further strengthening in equities from these markets.

We also believe that the long-term investment case for emerging markets remains positive. It is important to note that, for the emerging markets equity asset class at large, domestic demand and reform remain the long-term drivers, with India being a good example.

Specifically, over the past decade, countries in emerging markets and their respective equity markets have changed significantly, which has made them often less dependent on commodities or goods exports, and more driven by domestic consumption growth, technology and services. This continues to provide a favourable investment backdrop for investors in emerging markets.

Moreover, the fundamentals of emerging markets continue to paint an encouraging picture, driven by equity valuations that remain cheap, paired with the inflection point seen in earnings in these markets last year. Sentiment and flows turned positive last year, which is expected to continue.

In the current environment, we are focused on opportunities presented by regions with strong domestic growth and consumption, and on firms with diverse geographical revenue exposure that might be less vulnerable to protectionist policies that could arise in the coming years.

In terms of individual companies, we see opportunities in those with the cost-curve adaptability to drive margin expansion.

Q What challenges and opportunities do you think lie ahead for emerging markets this year?

A We believe companies in the consumer-related and IT sectors are particularly attractive in the current environment. Select stocks in the consumer sectors could provide an effective way to gain exposure to economic expansion in emerging markets and, in particular, gain access to growth in spending as rising regional wealth fuels a burgeoning consumer class.

For example, the auto market is one of the most promising industries, in our view. A lot of consumer markets still have a great deal of pent-up demand for vehicles, and the penetration rates remain quite low when compared with those of developed markets.

In addition, there has been a lot of technological change in the industry, with a greater focus on efficiency and lower emissions, and a shift towards electric vehicles.

Technology and the Internet are becoming increasingly important in emerging markets. Today, they have a greater weight than the energy/materials and consumer segments, which were previously more prominent. The IT sector also has a much greater weight in the emerging market index compared with the sector's weighting in other regional indexes.

Currently, emerging markets hold a major position among the world's Internet users, and also account for the bulk of smartphone sales, making up nearly 70 per cent of all sales in recent years.

We think these trends could allow the IT sector to expand further within the emerging markets. Overall, we see interesting investment opportunities in hardware, services and the Internet.

We remain cautious over China's banks as non-performing loan recognition dampens our outlook for its financial firms. Like banks, China's real estate sector has staged a striking turnaround after a lengthy downturn, but we have remained on the sidelines, in part because of risks related to overleverage and regulation.

Q What are the economic or political risks that investors could face this year?

A Key concerns surrounding emerging markets this year include the rise of trade protectionism, the strengthening of the US dollar, the likelihood of Fed rate hikes, and the headwinds revolving around world politics. Hawkish views from the Fed point towards the possibility of three hikes this year.

However, we expect the trajectory of any rate increases to be gradual, although US rate moves that are larger or faster than expected could dampen sentiment and lead to volatility. Moreover, there might be a rising risk premium given policy uncertainties, until we are able to obtain greater clarity regarding the new administration's policy package.

Q In this low-growth and uncertain environment, do you think active managers can still unlock value and deliver yields and income?

A Yes, especially in less efficient areas such as emerging markets. Passive strategies are essentially momentum-based, and that has worked in the past few years - monetarisation of major economies has created a market environment where stocks have experienced periods of high correlation and quality stock-picking has mattered less.

Over the long term, I think most investors will want to take active positions in their portfolios - which should lead to outperformance if done prudently with a good process - and very importantly take into account portfolio risks in a way that a passive strategy cannot.

A version of this article appeared in the print edition of The Sunday Times on March 19, 2017, with the headline 'Emerging markets: Staying for the long haul'. Print Edition | Subscribe