Welcome to Soundbites, weekly insights on market trends and investment strategies, brought to you by Investment Executive, and powered by Canada Life.

For today’s Soundbites, we’re talking about emerging market equities with Patrick Russel, portfolio manager and analyst with Northcape Capital. We talked about headwinds, tailwinds, and names he likes. And we started by asking about demographics.

Patrick Russel (PR): Demographics is not omnipresent for the whole asset class. China has extremely challenging demographics. Its population is in decline. Its workforce is in decline. This is a massive headwind. On the other side of the coin, if we take a market like India, it’s got a beautiful demographic outlook. The percentage of the population under the age of 24 is almost 50%. There’s an enormous amount of people joining the workforce over the next five, 10, 15 years. They’re forming households. And this is a really good environment for businesses to trade in. So, there’s an enormous amount of variance across the 25 countries in EM.

Currency concerns.

PR: The most vulnerable EMs in relation to U.S. dollar strengthening are the ones that are dependent on U.S.-dollar financing because they’re running large current account and public sector borrowing requirements and they have weak foreign exchange reserves. The most vulnerable countries in our opinion at the moment are Turkey, South Africa and Columbia. Then there’s the second layer for companies. Some companies have debt denominated in U.S. dollars, but they have local currencies for their revenue. So, there’s a currency mismatch, and that’s a vulnerability in EM. So, it’s not a generic homogeneous equation that strong dollar equals weak EM. It really is a case of unpacking it and seeing where the impacts land.

Other headwinds.

PR: The predominant ones are just poor governance, and a lack of independence of the judiciary, a lack of the ability to prosecute corporate law. If that is an endemic element in the capital market, then that is a structural headwind for private investment. Period. The country that scores weakest is China because, effectively, there’s no independence of judiciary there. There’s a limited ability to prosecute corporate law. So, the ability to protect private ownership IP is limited. And you run significant risk of confiscation by the state. On the other hand, if we look at Korea, it’s actually getting better and better. It’s bringing in policies and adjusting laws to give shareholders and intellectual property and private investment greater protection.

Names he likes.

PR: Some of the companies that we think are leveraged into those things would be HDFC Bank [HDFC Bank Limited, based in Mumbai, India], the leading private financial bank in India. India is deeply under-penetrated in financial services and they’re a market leader. Another company in India is Maruti Suzuki [Maruti Suzuki India Limited, based in New Delhi, India]. Again, India is deeply under-penetrated in auto ownership. We’re now on the cusp of consumers pivoting from two-wheelers, motorbikes, to autos and they’re the dominant provider. So, we see strong demand for auto for a very, very long time. Other companies we like: GAP Airports [Grupo Aeroportuario del Pacífico, S.A.B. de C.V.], based in [Guadalajara,] Mexico. They’re a strong play on increased travel within South America. Air travel in Mexico is especially under-penetrated. The average person in Mexico takes less than one flight a year. In most other countries, it’s three or four, to give you an idea of the potential for that market to expand. We like the heavyweight TSMC [Taiwan Semiconductor Manufacturing Company Limited] from Taiwan. It’s one of the largest companies in EM, and it’s got a very strong tailwind in terms of its semiconductor business and its IP. We like Bank Central Asia [PT Bank Central Asia Tbk]. Very strong private bank based in [Jukarta] Indonesia. And, like India, it’s just benefiting from the financialization of the economy, as more people move from the cash economy into the bank economy. They’re a leading participant in that area.

And, finally, what’s the bottom line on investing in emerging markets?

PR: Well, the outlook is positive over the long term. And what we advise our clients is it’s time in the asset class, rather than timing the asset class. You have to deploy active management to get the best out of it.

Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life. Our thanks again to Patrick Russel of Northcape Capital.

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