Fund Manager Q&A

Where this fundie sees EM opportunities despite lingering COVID, war risk

Glenn Freeman

Livewire Markets

The US$1.9 trillion of stimulus the US government tipped into its economy in the first quarter of this year continues to flow through world markets. This bodes well not only for developed nations more broadly but also for emerging countries.

While retail investor exposure to emerging markets is almost always a satellite allocation, there are various reasons for its appeal, including the obvious diversification benefits – particularly for Australian investors who are notorious for their strong home bias.

In a recent chat with John Malloy, Jr, portfolio manager of the RWC Global Emerging Markets fund, he discussed where his team sees the most attractive potential. Without shying away from the undeniable risks such regions face – the threat of a "hot war" between China and Taiwan one that has gained considerable media focus lately – his team carefully considers many variables. It also calls on some of the world’s leading ex-diplomats, including former US Secretary of State Condoleeza Rice and former US Defence Secretary Robert Gates, as he explains below.

In the following wire, Malloy also reveals how RWC’s portfolio is currently positioned, his view on some of the most pressing geopolitical concerns and one of his top long-term stock picks.

How many stocks do you typically hold in your portfolio and what’s it sitting at now?

“It's been in the range of 55 to 65, and we're probably at around 63 today, but that's with a couple of positions coming out. It's generally sitting somewhere around 60, with the top 10 positions comprising around 35% of the fund.

We don't use cash in terms of a hedge or for market timing, so are fully invested, with typically only around 50 basis points or even as low as 25 basis points in cash.

Can talk me through your stock selection process?

We do have a top-down process to direct us in looking for stock ideas. We believe it’s important to understand macroeconomic risk.

And then as growth investors, we try to take a thematic approach. Both the macro and the thematic help us to narrow down a universe of stocks that we find interesting, which have the growth characteristics and the management quality that we're looking for.

All of the companies are run through our ESG scoring system, which is a big part of the process as well. And really, we're just trying to find good investment opportunities with a risk-adjusted return, that ends up being anywhere from 15 to 25% upside.

How are you allocated to specific countries at the moment?

First of all, I should mention that we do include frontier markets, those smaller or less developed emerging markets that hopefully one day graduate to emerging market status. We have about 10% exposure there.

And on an overall portfolio basis, our largest overweight would be South Africa followed by Brazil and then Korea.

Our largest underweight would be China and Taiwan. We have quite a bit of exposure that is related to China, especially in the materials themes such as copper, for example, or precious metals, which are really beneficiaries of the renewable energy theme.

We reduced our exposure there over the past six months. China did extremely well last year, and we participated in that, as well as Taiwan, but we're just finding better growth opportunities in other parts of the world now.

We still think that China and Taiwan will do well, but for one thing, the valuation opportunity isn't as great there now. And secondly, there's quite a bit of regulation going on in China. The government is very much focused on a number of industries including digital payments, FinTech and banking and they're looking at platform companies. They're also looking at education and we think that's going to continue. So, they’re other reasons we’re less constructive on that market.

How is the geopolitical situation reflected in your portfolio?

We have a consulting arrangement with Rice, Hadley, Gates & Manuel, a strategic consulting firm co-founded by former US Secretary of State Condoleeza Rice, former Secretary of Defense Robert Gates and others. We've been speaking to them for over a decade, and these people have a tremendous amount of knowledge. That's one of the tools that we have at our disposal. And we've worked in emerging markets for many years, I myself have covered the sector for three decades and my co-portfolio manager has worked in emerging markets for almost 40 years.

If you look at the issues around China, Taiwan, they're probably a risk that's going to be further down the road, not this year or next. But we do believe there is going to be a continued focus on China wanting to have more control of Taiwan, just as they have with Hong Kong. And that's going to be a difficult process. And so the geopolitical risks there also very much includes the United States.

And I think when you look at our portfolio, the fact that we're underweight China, and Taiwan at this point, I'm comfortable with that risk. There does not seem to be a very strong dialogue between the Biden administration and President Xi. In fact, Rice said she probably would have walked out of those recent US-China meetings in Alaska. So, with that as a backdrop, it just makes us more comfortable being underweight a place like China, though we aren’t super-bearish either.

Taiwan today in the index, it's about 14%. We currently have about 8%. I would say we were probably closer to 12%. And then if you look at China right now, China is 37% and we're at 29%, we were probably closer to, maybe 35%, 34%. So still underweight. We have quite a bit of exposure that is associated with China risk. And so I'll just give you an example. One of our themes is copper. We have about 7% in copper. And as you might know, China's the largest consumer of copper in the world, in terms of any country and by a wide margin. And so when we think of the risk of that theme, we very much associate it to China. And so that allows us to be pretty comfortable with that underweight position.

What are some of the indicators that individual investors need to be watching right now within emerging markets?

Obviously one of those is COVID, we're still very much tracking the COVID cases in places like India, Brazil, South Africa and Russia. Russia has actually done a pretty good job and has started to recover.

In Brazil, the numbers seem to be improving. In India, there are certain parts of the country where we are seeing some improvements, but I think that's really just probably a matter of time.

And then I would say to watch capital flows. There's a very good case that the US dollar weakens from here, and I think the beneficiary of that will be emerging market currencies. As we see money flow into emerging market fixed income and equities in those markets, I think that's a positive sign.

How would your allocation to China and Taiwan change if conflict did break out?

We could reduce our China exposure much more. We don't have a lot of state-owned enterprise exposure in China, being very much focused on the private sector. I think we would probably end up taking down our Taiwan exposure as well.

But I think it's a low probability. I think we're probably going to have more of these “tit for tat” type of activities, such as when a Chinese aircraft enters Taiwan’s territory. But when we speak to Rice, Hadley Gates, the biggest risk is some type of unexpected conflict, such as an aircraft is shot down or a ship is sunk. But I think the risk of that is incredibly low.

What's the most interesting stock in your portfolio right now?

One of our top positions is First Quantum Minerals, a copper miner listed on the Canadian stock exchange but which has operations in the two frontier markets of Zambia and Panama. It has a very strong management team that has been in the mining business for decades. They're very good operators, with very good assets and we think their cost structure is set to really benefit.

It's one of the few pure-play copper companies that are traded today, the second-largest behind Freeport-McMoRan. The market cap is around $17 billion and it trades over a hundred million dollars a day, so it’s very liquid, even though it's in a frontier market. And so we see a strong upside of around 50%, even using very conservative estimates.

The company is not for sale, but there's also a very good case that, copper ends up being much higher than the US$4.60 or US$4.70 a pound and that this price stays materially higher for an extended period of time.

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Access to the RWC emerging and frontier markets strategy is available to Australian investors via Channel Capital.


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Content Editor
Livewire Markets

Glenn Freeman is a content editor at Livewire Markets. He has around 10 years’ experience in financial services writing and editing, most recently with Morningstar Australia. Glenn’s journalistic experience also spans broader areas of business...

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