Talk of trade wars became a reality this last week but many still hold out to the view that these ar...
5 Plays That Avoid US Markets Entirely
08/12/2011 11:30 am EST
Asia is our favorite region among the emerging markets and we expect the region will lead any emerging-markets rally this year, says Ben Shepherd of Global ETF Profits.
Every investor has heard the adage that it’s best to buy when there’s blood on the streets. Yet recent global events have been enough to rattle even steel-nerved investors.
From political turmoil in the Middle East and North Africa, to the ongoing sovereign debt crisis in Europe, the negative headlines confirm that the world is a scary place for investors. But the days of the isolationist US-based investor are numbered, particularly as emerging markets offer the best opportunities for growth.
I spoke with Dimitre Genov, co-manager of Artio Global Equity (JGEIX), to learn how investors can navigate these treacherous overseas markets…
Ben Shepherd: What risk does the turmoil in Europe pose to the global economy?
Dimitre Genov: We’re dealing with a structural problem in Europe, as some countries in the southern part of the continent grapple with large debt burdens.
These countries, most recently Greece, have chosen to deal with these problems with austerity measures. Unfortunately this approach hurts the local economy because it requires higher taxes or lower wages and leads to asset inflation.
The European Central Bank and the International Monetary Fund extended Greece a line of credit recently, so they kicked the can down the road for a few months. But this is not a permanent solution for Greece.
Ultimately there will be some form of restructuring, whether it’s an extension of maturities, a reduction in the interest payments, or a reduction in principal repayment.
European politicians are trying to buy time. They want the region’s banks to strengthen enough to withstand a potential reduction in the value of Greek debt. They want these economies to strengthen so they can withstand austerity packages.
Much effort has been expended to maintain the euro and the Eurozone. But if countries such as Greece, Ireland, or Portugal cannot deal with their excesses through austerity, or increase their competitiveness through growth, there will be a mechanism that will allow them to exit the EU. That will certainly lead to inflation in these countries, and rapid devaluation of their new local currencies.
The global markets are interlinked. Events in Greece have an impact on European banks, which also affect US banks and the US economy.
A large portion of the economy in Asia is export-driven, and Europe is an important trading partner with many Asian countries. If European growth slows, that will certainly affect Asia’s export-oriented economies.
Ben Shepherd: How should investors navigate this treacherous investment climate?
Dimitre Genov: Governments in the developed world are overextended, and potential austerity measures could slow economic growth. Developed-world economies will muddle through at best. Our focus is mostly on the emerging markets, particularly in Asia.
This is hardly an undiscovered trend; emerging markets have performed strongly for the past decade. In 2000 emerging markets represented 20% of global gross domestic product (GDP), and that figure rose to 35% by 2010. Emerging markets are expected to represent 55% of global GDP by 2030.
There will be ups and downs, but from a structural standpoint, emerging-market governments are underleveraged and there’s significant opportunity to boost domestic consumption in these countries.
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Ben Shepherd: What attributes should investors look for when selecting a foreign stock?
Dimitre Genov: Investors should look for companies with exposure to these growth markets. We seek companies that are market leaders, because once a company starts to gain market share, that process often lasts several quarters or even longer.
By the same token, we avoid companies that are losing market share. We want to see companies with strong balance sheets and management with a vision, whether that’s introducing new products, focusing on core businesses or returning capital to investors.
The company emerged as a major player in the Hong Kong residential and office market in the 1960s, but management early on had the vision to move into China. The firm sold some of its mature Hong Kong properties in the late 1990s and bought land in top-tier Chinese cities such as Shanghai.
Hang Lung has built premier shopping malls and office centers in key markets. Many of these properties are fully rented to premier tenants at rates much higher than market.
The rental contracts are also tied to tenants’ revenue; as revenues increase, rents increase as well. It’s effectively a play on rising Chinese consumer spending.
It’s very rare to find a real estate company that doesn’t have leverage. Usually real estate managers and owners lever up and buy land. But this company has net cash on its balance sheet. It raised money in an offering last year and has assets in Hong Kong that it can use to buy land and develop premier retail properties.
Hang Lung is looking to buy land in second- and third-tier Chinese cities where retail spending is on the rise. Management has identified 75 cities that are potentially fertile ground for expansion.
By owning shares of Hang Lung, we effectively own hard assets without leverage. These assets are also denominated in renminbi. If you believe the Chinese currency is undervalued, then the value of these assets will eventually rise, providing another layer of downside protection.
We like developed-world companies that export to emerging markets. For example, our portfolio has been underweight Japan, which has benefited our performance over the last several years. But our remaining Japanese holdings participate in emerging-market growth through exports.
Komatsu (Japan: 6301, OTC: KMTUY) sells construction and mining machinery and truck equipment. The company operates on a global scale, and a sizable portion of their exports go to China and emerging markets, where the mining and construction industries are booming.
Investors often complain that Japanese managers don’t behave like owners. They pile cash on the balance sheet rather than buying back stock or paying dividends.
Unicharm’s management owns significant shares of the company, so their interests are aligned with shareholders. The company has demonstrated an ability to increase value for investors.
Ben Shepherd: You also own sizable stakes in Russian banks. What’s your investment case for Russian banks?
Dimitre Genov: Valuations in Russia are very attractive, particularly for consumer-oriented names. For example, Russian banks trade at roughly 1.5 times price-to-book, making them attractively valued compared to similar names in emerging markets.
The penetration rate of retail deposits in Russia is about 40%, which is quite low compared to other countries. Additionally, one bank, Sberbank Rossii (Russia: SBER03, OTC: SBRBF), controls about half of the country’s deposits.
Russia’s banking sector is fairly consolidated, which provides additional opportunities for mergers and acquisitions. This consolidation allows large players such as Sberbank to run a more profitable business—there’s less competition, and scale is important in the banking industry.
Unlike Western banks that run complex trading operations, Sberbank is primarily engaged in traditional banking services, which mitigates the risk somewhat.
Although Russia’s economy was hit severely in 2009, before that the country’s GDP had grown at about 4% to 5% each year. Unemployment is fairly low at about 6%. Russian credit-default swaps indicate that bond investors are less worried about a Russian default than a default in Spain.
There’s some political risk to investing in Russia, which is one of the reasons that valuations are so low. Liquidity can also be a problem.
Corporate governance represents another risk to investors. Minority investors aren’t always treated fairly, though some companies are better than others.
Sberbank is partly owned by the Russian state, so an investment in Sberbank isn’t without risk, but the valuation and opportunities offered by this investment offset that risk.
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