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July 2015
Important Information:
This webinar contains information specifically intended for institutional clients, asset consultants, advisers, platforms and researchers, who are professional investors and wholesale clients (as defined in the Corporations Act 2001).
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Bell’s $345 million global equity strategy fund has beaten the MSCI World ex-Australia index in local currency over the past five years, partly due to the fact it has almost no exposure to emerging markets equities.
The fund returned 40 per cent in the past year versus 33 per cent for the benchmark and 12 per cent for the MSCI Emerging Markets index in local currency.
Even after a 155 per cent surge in the Shanghai Composite in the year to mid June and a subsequent 35 per cent pullback, which invited unprecedented government intervention, Bell isn’t joining the chorus of local fund managers singing the praises of Chinese equities. “What’s really interesting about China is why they came out so aggressively to prop up their sharemarket,” Bell says. “It just makes me concerned that there’s something ugly happening under the surface with the Chinese consumer.”
But he says the litmus test for emerging market companies is their earnings growth, or the lack of it.
“Share prices will ultimately be driven by earnings per share and emerging markets earnings per share have fallen 10 per cent in last five years, even though they have had a growth advantage.
“So if I’m looking forward to the next five years, let’s say they maintain a 1 or 2 per cent GDP advantage, what would make me think the earnings are actually going to turn around?
”The poor performance from emerging markets equities is even starker on an industry comparison. “If you compare the various industry groups over the past five years, emerging markets equities saw 11 per cent earnings per share growth in the consumer discretionary sector, which isn’t bad, but developed markets equities saw 57 per cent EPS growth in that sector,” Bell says.
“I would argue that a lot of that growth differential has actually come from great US and European companies that have got a lot of their growth from emerging markets.
“If you look at industrials, and this is staggering to me, because one of the main growth drivers of emerging markets has been capital investment in roads and hospitals and so on, so you would intuitively expect that a lot of the local companies, like the Chinese equivalents of Caterpillar, would have been huge beneficiaries, but their actual earnings have fallen by a third, whereas developed markets industrials have gone up 25 per cent.”
The numbers highlight the difference between thematic and bottom up investing — the theme can be right, but how it’s actually played out in terms of corporate earnings can be surprising.
“If EPS has fallen that much in a positive environment, it says something about the quality of the emerging markets companies in my view,” Bell says.
“If the earnings growth for emerging markets companies isn’t going to come from a strong economic growth advantage in the years to come, it has to come from franchise factors and that’s where emerging markets companies fall down.
“Most of these companies haven’t really made their presence known on the world stage to the degree that the truly global franchises have done, so they are quite susceptible to local macroeconomic conditions.
“A hard landing in China for example could be a disaster for domestic companies and while China’s officials are working hard to avoid that scenario, truly global emerging markets franchises like Nike or Apple will hold up much better if China’s economy turns down sharply.
Environment, social and governance comparisons between emerging markets and developed markets company ratings are also becoming important for the big super funds.
“If you look at the MSCI ESG rating distribution, the scores are clearly way better for developed markets than emerging markets companies, so that underscores our intuitive position that the underlying quality of emerging markets companies themselves is not great in terms of disclosure, governance, environmental and social factors,” Bell says.
To be sure, there are great companies in emerging markets — India has 13 companies with return on capital above 20 per cent and five with foreign sales greater than 5 per cent. China has 25 that meet Bell’s high return on capital score, but none that impresses in terms of foreign sales.
Of the top 500 companies, 95 per cent are in developed markets.
Certainly on a risk adjusted basis, Bell is finding much better developed markets opportunities. While the return on capital of sector leading companies in emerging markets has been reasonable, at 12.4 per cent, it’s no better than those in the MSCI World index.
“The difference with emerging markets is the peripheral risk, whereas investors could passively own the top quartile of the MSCI World index, which is twice as profitable,” Bell says.
“So it comes back to the risk/return profile of investing in emerging markets ... do the returns really outweigh the risks? We are not advocating people should ignore emerging markets, but to take a top-down semipassive allocation to emerging markets ... the historical reason for doing that no longer exists. That’s really important because if that big economic secular (growth) driver that was there five years ago isn’t there today, it should force investors to think about the optimal way to gain exposure to invest in emerging markets.”
Bell’s $345 million global equity strategy fund has beaten the MSCI World ex-Australia index in local currency over the past five years, partly due to the fact it has almost no exposure to emerging markets equities.
The fund returned 40 per cent in the past year versus 33 per cent for the benchmark and 12 per cent for the MSCI Emerging Markets index in local currency.
Even after a 155 per cent surge in the Shanghai Composite in the year to mid June and a subsequent 35 per cent pullback, which invited unprecedented government intervention, Bell isn’t joining the chorus of local fund managers singing the praises of Chinese equities. “What’s really interesting about China is why they came out so aggressively to prop up their sharemarket,” Bell says. “It just makes me concerned that there’s something ugly happening under the surface with the Chinese consumer.”
But he says the litmus test for emerging market companies is their earnings growth, or the lack of it.
“Share prices will ultimately be driven by earnings per share and emerging markets earnings per share have fallen 10 per cent in last five years, even though they have had a growth advantage.
“So if I’m looking forward to the next five years, let’s say they maintain a 1 or 2 per cent GDP advantage, what would make me think the earnings are actually going to turn around?
”The poor performance from emerging markets equities is even starker on an industry comparison. “If you compare the various industry groups over the past five years, emerging markets equities saw 11 per cent earnings per share growth in the consumer discretionary sector, which isn’t bad, but developed markets equities saw 57 per cent EPS growth in that sector,” Bell says.
“I would argue that a lot of that growth differential has actually come from great US and European companies that have got a lot of their growth from emerging markets.
“If you look at industrials, and this is staggering to me, because one of the main growth drivers of emerging markets has been capital investment in roads and hospitals and so on, so you would intuitively expect that a lot of the local companies, like the Chinese equivalents of Caterpillar, would have been huge beneficiaries, but their actual earnings have fallen by a third, whereas developed markets industrials have gone up 25 per cent.”
The numbers highlight the difference between thematic and bottom up investing — the theme can be right, but how it’s actually played out in terms of corporate earnings can be surprising.
“If EPS has fallen that much in a positive environment, it says something about the quality of the emerging markets companies in my view,” Bell says.
“If the earnings growth for emerging markets companies isn’t going to come from a strong economic growth advantage in the years to come, it has to come from franchise factors and that’s where emerging markets companies fall down.
“Most of these companies haven’t really made their presence known on the world stage to the degree that the truly global franchises have done, so they are quite susceptible to local macroeconomic conditions.
“A hard landing in China for example could be a disaster for domestic companies and while China’s officials are working hard to avoid that scenario, truly global emerging markets franchises like Nike or Apple will hold up much better if China’s economy turns down sharply.
Environment, social and governance comparisons between emerging markets and developed markets company ratings are also becoming important for the big super funds.
“If you look at the MSCI ESG rating distribution, the scores are clearly way better for developed markets than emerging markets companies, so that underscores our intuitive position that the underlying quality of emerging markets companies themselves is not great in terms of disclosure, governance, environmental and social factors,” Bell says.
To be sure, there are great companies in emerging markets — India has 13 companies with return on capital above 20 per cent and five with foreign sales greater than 5 per cent. China has 25 that meet Bell’s high return on capital score, but none that impresses in terms of foreign sales.
Of the top 500 companies, 95 per cent are in developed markets.
Certainly on a risk adjusted basis, Bell is finding much better developed markets opportunities. While the return on capital of sector leading companies in emerging markets has been reasonable, at 12.4 per cent, it’s no better than those in the MSCI World index.
“The difference with emerging markets is the peripheral risk, whereas investors could passively own the top quartile of the MSCI World index, which is twice as profitable,” Bell says.
“So it comes back to the risk/return profile of investing in emerging markets ... do the returns really outweigh the risks? We are not advocating people should ignore emerging markets, but to take a top-down semipassive allocation to emerging markets ... the historical reason for doing that no longer exists. That’s really important because if that big economic secular (growth) driver that was there five years ago isn’t there today, it should force investors to think about the optimal way to gain exposure to invest in emerging markets.”
