Some flawed thinking from emerging market investors

-- | 26/11/2018

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Glenn Freeman: I'm Glenn Freeman for Morningstar. I'm talking today to Nimalan Govender from Morningstar Investment Management on a topic of emerging markets.

Now, Nimalan, as the sector lead for emerging markets within Morningstar Investment Management, are emerging markets more or less appealing now than some of the developed market economies given that valuations are looking pretty high in parts of the U.S. and in other developed economies.

Nimalan Govender: For a period of time, we have actually seen more opportunities in emerging markets. Certainly, as we headed towards the end of last year, we were seeing closing of the gap with emerging markets performing quite impressively. They have obviously given some back. And so, once again, emerging markets for us is sort of a key investment moving forward.

Freeman: And when you are talking of emerging markets, what are the main emerging markets you look at? Is it just you are talking here of the BRICS or are you talking of some of the more frontier markets or which countries in particular?

Govender: So, we find emerging market Asia as a region to be very interesting, in particular, China as always, given how large it is and what a large portion of the Asian index it is. And within that, certainly internet service and software companies come through quite strongly. And then, moving on to Korea and Taiwan where we also find semiconductors and once again, your more IT industry stocks to be the place for interesting investments.

Freeman: And that definition of emerging markets, I mean, you mentioned China there is one that you are quite interested in. But is China still – it is still an emerging market and yet, it's also known as the second largest economy. I mean, are those definitions changing?

Govender: To be honest, it should change. The term emerging market creates a false sense of security and at times, a false sense of concern for investors. Wherein, if you think about it, you would never consider a mixture of the U.S., Canada, Japan and Europe to be developed markets. You'd never view it as a homogenous investment block. And I think the same applies for emerging markets is while it is convenient for us to call it, you know, things like EM Asia or BRICS, we actually need to break it down at the country level. There's a different type of firms, there's different cultures, managements, consumers. And to be honest, with globalization, there's a lot of multinational firms that are listed in these emerging markets and yet, also have developed market exposure or cross-emerging market exposure. So, in time, hopefully, we would move away from referring to something as an emerging market and rather just look at the underlying companies that are listed in those countries.

Freeman: Especially for Australian investors, with something of a reputation for being pretty conservative and overexposed to Australian-listed companies within their portfolios. But is there growing recognition that there's a need to look at companies in some of these emerging market economies as well as the home-based?

Govender: I would think the home bias has remained pretty steady. I think while there's been increasing awareness of international equity offerings, it sort of favoured more developed markets than emerging markets. And I think once again, what people have done is, they have encapsulated all emerging markets as volatile and risky – volatile, I should say. And while the returns, which are quite impressive, people then tend to enter these markets at the wrong time without understanding or using something like an exchange-traded fund and then getting very specific large sector or stock exposure and then bearing that assuming they have got a broad-based exposure, which is incorrect.

Freeman: And am I right in saying that there's – thinking about investing in terms of market-centric ways is not necessarily the right way to think about it either, because you were saying earlier about some of the U.K.-based – or if you think you are buying U.K. exposure, you are also getting exposed a whole lot of other companies that are just listed on the exchanges in those countries. Is that something that also applies within these emerging markets?

Govender: Definitely. So, if you take the Korean index where Samsung is a large weight in that index, and yet, when you actually at where Samsung derives its revenue, a fair chunk is actually derived outside Korea. So, once again, I think it's been quite convenient to sort of label in index by where the company is domiciled than where the actual revenue is earned. And so, what it does is it creates a false sense of illusion that you're investing in a certain country when it's the actual company that matters more. So, I think, over time, as investors broaden their appetite to go offshore, and by this, I talk about the local investor, I think the advantages are to actually look for solid quality companies in emerging markets.

Freeman: So, that point is that people need to be mindful when they are buying emerging market investments as they are with all that they know what sort of companies they are buying, not just picking because I think they are buying in one country or from one exchange?

Govender: Exactly. I think they should view their wealth and the investments in the same light as they would when it comes to buying a car that they need for their family that's going to offer a safe ride, rather than to invest in something that's totally inappropriate for what the end investment objective is.

This report appeared on www.morningstar.com.au 2022 Morningstar Australasia Pty Limited

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