With emerging-markets stocks showing renewed vigour in the past 18 months, Mark Mobius, executive chairman of San Mateo, Calif.-based Franklin Resources Inc.’s Templeton Emerging Markets Group in Singapore, is casting his net into less discovered areas for the bargain-priced stocks that will provide the best returns.

That means Mobius is venturing into small- and mid-capitalization stock territory, where an active fund manager can ferret out stocks that may not be included in broad market indices and, therefore, may have been overlooked.

“We must be extremely selective and are going where the valuations are most attractive,” Mobius, the 80-year old, fit and well-travelled emerging-markets veteran, told Investment Executive in an interview on Monday. “Many attractive small- and mid-cap companies have not been recognized yet.”

Mobius is also spotting opportunities in some of countries that would be classified as “frontier markets.” These nations are at an earlier stage of economic development than the larger, more established emerging markets such as China and India. Vietnam is one country in which he’s been doing some buying.

“Stocks in India, for example, have had a great run, and the [price/earnings] ratios are high in some cases,” he says. “With interest rates creeping up in some emerging markets, the pricier stocks are more vulnerable.”

The soaring global popularity of ETFs is drawing more money to emerging markets as investors find them a convenient and inexpensive way to gain diversified exposure, Mobius says. However, he adds that many ETFs are tied to stock portfolios that simply duplicate market indices — and this has resulted in the large-cap, index-listed companies being overbought.

“The ETF surge has been a critical development in emerging markets,” Mobius says. “When the money comes into ETFs, it’s invested indiscriminately in the large-cap companies that make up the indices, so the big get bigger in terms of market value. ETFs are not looking at the quality of company management or valuations.”

As such, active fund managers are under pressure to be different from the index to earn their higher management fees relative to low-cost ETFs and index-linked portfolios, he says.

“Active managers must work hard to generate better returns, and there must be divergence in thinking,” Mobius says. “In the old days, it was risky for active managers to stray too far from the index, as that was the yardstick by which we were measured — no matter what the index did. But with competitive pressures rising from ETFs, we are under pressure to be different.”

Templeton Emerging Markets Fund, sponsored by Toronto-based Franklin Templeton Investments Corp., showed a one-year gain of 39.2% as of May 31. Since its inception in 1991, it has averaged a 6.3% annual gain.

After a three-year lull, international investors have raised their holdings in emerging markets significantly since January 2016 as the U.S. stock markets have flattened out after several years of superior gains, Mobius says.

Although the threat of rising U.S. interest rates is a worrying sign for investors in U.S. stock markets, he says there’s no consistent inverse relationship between the direction of U.S. interest rates and the performance of emerging markets.

Emerging-markets stocks account for 30% of the market cap of globally listed stocks and emerging markets are still underrepresented in most investors’ portfolios, Mobius says. In terms of global economic productivity, emerging markets account for an even higher 35% to 40% of activity, if imports and exports are accounted for, he adds.

It terms of themes, Mobius is enthusiastic about the influence of the Internet on emerging market growth, and top holdings in Templeton Emerging Markets Fund include China-based online retailers TenCent Holdings Ltd. and Alibaba Group Holdings Ltd. The biggest holding is South Korea-based Samsung Electronics Co., a manufacturer of smartphones as well as memory chips, screens and home appliances.

Of the billion cellphones sold around the world on an annual basis, 70% are sold in emerging markets, and they are revolutionizing these economies, Mobius says.

“The Internet gives people incredible power to observe, record and exchange information,” he says. “A lot of political movements have come about as a result of the internet. There’s exposure of political corruption, and faster access to information — the spread of knowledge is unprecedented.”

The potential for Internet shopping is also huge, he says. In one “singles day” in China — a bargain day for shoppers — more than US$16-billion worth of goods were sold online through Alibaba, which is more than is sold online in the U.S. in an entire year, he says.

The level of assets managed in Templeton Emerging Markets Group has grown to US$26 billion compared with US$100 million when Mobius started with the company in 1987. At the same time, the number of emerging countries represented has grown to 70 from six. Currently, the largest country weightings in Templeton Emerging Markets Fund are China, South Korea, Taiwan, India, Russia and Brazil.

“Central bankers and politicians are realizing the only way to achieve growth is to have a market economy, and that the state-controlled economy doesn’t work,” Mobius says. “There is huge potential for privatization in many countries and lots of room for emerging markets to grow.”

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