Accessing emerging market themes through MSCI World stocks was a “blunt instrument” and unjustified given the improvements in the developing world’s corporate governance and sovereign risk, according to Martin Currie CEO Willie Watt. But Jeremy Podger, executive director of global equities at Threadneedle, argued that developed world companies which source much of their revenue from emerging markets provided investors with a cheaper way of benefiting from fast-growing markets such as China, India and Indonesia. The Edinburgh-based Martin Currie is only just bedding down a global emerging markets capability, which Watt admitted some investors were surprised to hear, given the firm’s well-known Chinese, Japanese, Asia ex-Japan and global equity teams.
Martin Currie poached a sixperson team from its neighbour, Scottish Widows Investment Partnership, in May and the last three members began work in late October. Watt said the team, led by Kim Catechis, had been encouraged to become “more aggressive” in implementing its fundamental research-driven approach, which had generally mirrored the MSCI Emerging Markets Index in its 10- year history under Catechis. The persistence of the theory that emerging market dynamics could be accessed through developed market stocks surprised Watt, who was sceptical of an argument he’d heard recently: that the QR National float could be a proxy for the growth of China. Podger also believed that investors’ enthusiasm for Chinese growth was approaching fever pitch.
Their high expectations of the emerging giant’s performance reminded him of a 1993 Morgan Stanley research paper – titled China! – written as the Chinese equity market boomed in the years after Deng Xiaoping morphed the nation’s economy into a marketoriented system. Then, as now, investors descended on the Chinese market in a “frenzy”, and heavy capital flows drove equity valuations to unrealistic levels. Those who bought into the Hang Seng China Enterprises Index in 1994, at the peak of the speculation, and decided to ride out the ensuing market decline had to wait more than a decade for the market to reach the same level. So how should investors approach the “two-speed world” in which indebted Western economies enter years of slow growth while emerging markets seem poised to surge?
Podger, whose team invests in both markets, said investors should find out if developed world stocks deriving much of their revenue from emerging markets could be bought at compellingly cheap valuations. The generally low equity valuations of most developed markets, caused by low rates of growth and inflation, provided arbitrage opportunities among Western world stocks with strong links into the emerging world, he said. For example, half of Tata Motors’ recent sales were derived from the Jaguar and Land Rover, which it bought in 2008. In October, the company traded on a price/earnings multiple (P/E) of 6.3x, while BMW, which gained more than half of its profits from sales in China last quarter, was valued at 3.2x. Furthermore, Japanese brewer Asahi, which owns 41 per cent of Chinese competitor Tsingtao and has multiple soft drink jointventures in China, traded on a P/E of 13x, compared to the Tsingtao’s 28x. And Unilever, posted on the New York Stock Exchange with a P/E of 13x in early October, was far cheaper than Hindustan Unilever’s 28x and Unilever Indonesia’s 31x valuations.