US and Aussie valuations are frothy. Here’s where bargains remain

Skerryvore is home to Scotland's tallest lighthouse, set upon treacherous rocks worn smooth by the rough water. Observers say it is always surrounded by sea mist that throws rainbows in the sunshine.

I can't think of a better metaphor than this for emerging markets - attraction and danger in equal measure, where the rewards are spectacular, but the possibility of being smashed against the rocks is real.

I sat down with Glen Finegan of Skerryvore Asset Management to unpack this vast investment universe and why navigating it successfully requires both conviction and caution.

A vast universe

For investors trained on headlines, emerging markets can appear synonymous with tech. Some areas, particularly parts of Asia, are tightly linked to the global technology supply chain, especially the AI boom.

"Parts of Asia are very tech-centric… that's very, very popular at the moment and a lot of those stocks have become really very, very expensive,” says Finegan. He emphasises, however, that tech is only part of the story. 

"Consumer behaviours are evolving as middle classes grow, people are adopting products and services that we take for granted in the developed world."

"Wealth management in India, pharmacy chains expanding in China, soft drink bottling in Sub-Saharan Africa - there's lots of different things outside of just tech to look at."

The governance test

The real challenge in emerging markets isn't finding growth - it's finding growth you can trust. Finegan's approach is built on a simple principle: in markets where rules don't always protect you, you need to protect yourself.

"A key part of identifying a good quality emerging market investment opportunity is understanding who the people are behind it and how they've treated stakeholders in their business over long periods of time."

Finegan cites Russia as a clear example of what happens when governance is ignored. Despite travelling extensively in the country and meeting numerous management teams, Skerryvore has never invested a single dollar.

"We never met any [teams] who we thought really cared about us as minority shareholders. Most of the businesses seemed to be run as a sort of enrichment scheme for themselves," says Finegan.

When Russia invaded Ukraine, investors who overlooked these warning signs lost everything.

This governance lens extends beyond financial statements. How does a company treat its tax obligations? What about modern slavery risks in the supply chain? Do they dump toxic waste in rivers?

“Investing in companies that are behaving sustainably is important because if they're not sustainable, what are you doing investing in them? They'll probably be bad investments.”

Finegan points out that it's not just the companies themselves that they speak to. They also talk to the network around them, including charities and NGOs that track and monitor business practices.

"Ultimately, you're minimising risk in your portfolio by backing management teams and owners who are more than likely going to do the right thing by all stakeholders."

What compelling looks like today

Despite the governance hurdles, Finegan says there are many world-class, high-quality companies across emerging markets.

Take Coca-Cola Hellenic (LON: CCH), a partnership between the Coca-Cola company and a Greek family that bottles and distributes soft drinks across Eastern Europe and Africa. The company just announced it's buying Coca-Cola Africa, consolidating the entire bottling footprint for the continent.

"Consumption per capita is very low and the demographics are very, very supportive. Populations are growing, they're young populations, so it's probably a pretty good place to sell soft drinks."

The founding family and Coca-Cola also own the same shares as minority investors. For Skerryvore, this well-aligned governance structure and the company's pursuit of a long-term demographic-supported opportunity should mean a multi-year runway for growth. 

India's mortgage market offers another example. Skerryvore owns HDFC Bank (NSE: HDFCBANK), a leading mortgage bank in a country where home loan penetration remains extremely low. The runway for growth is measured in decades, not quarters.

In healthcare, the fund holds Yifeng Pharmacy Chain Co (SSE: 603939), a medical devices business in China that supplies hospital equipment to emerging markets, along with Cipla Ltd (NSE: CIPLA), an Indian pharmaceutical manufacturer expanding access to medicines across India and Africa.

Where the value sits now

After years of tech stocks dominating returns in emerging markets, Finegan is rotating away from the most expensive names.

"Valuations there have become similar to what's happened in the US," he explains. "There's a big boom - and I'm not predicting an imminent bubble crash or anything like that - it's just that valuations are very high, and elsewhere in emerging markets, there are lots of examples of pretty good valuations."

Brazil has caught his attention. Interest rates sit at 15%, but inflation is falling, setting up a potential tailwind as rates normalise.

"If you get the economy pick up a tiny bit, interest rates coming down, that could be quite supportive for what's a very depressed market."

Skerryvore owns Raia Drogasil Sa (BVMF: RADL3), a family-controlled pharmacy chain that's corporatising Brazil's fragmented sector, as well as Itausa Sa (BVMF: ITSA4), a well-governed holding company with a stake in a leading private bank. Both trade at historically cheap valuations.

"I think Brazil looks interesting for a longer-term investor. Certainly valuation is more on your side than it is with the tech-exposed stuff today."

The lighthouse principle

The Skerryvore lighthouse is a testament to careful engineering in dangerous waters and is an apt metaphor for Finegan's approach.

"It's very rewarding when you do it safely,” he says. 

“You don't have to compromise, you don't need to buy a politically-exposed group that is highly suspected of political bribery. There's lots of really, really well-run businesses where there is no compromise."

"Via the portfolio, yes, hopefully you're getting an emerging market tailwind, but you are also investing in some of the best-run businesses in the world."

For Australian investors comfortable looking beyond domestic shores, emerging markets offer something increasingly rare in developed markets - genuine growth at reasonable prices. Navigate carefully, stay disciplined, and those rainbows are within reach. 

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Skerryvore Global Emerging Markets All-Cap Equity Fund

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