Great potential in emerging markets

Dover: ‘For economies to grow, they need population growth, a favourable ratio of workforce from young to older people and emerging markets have that.’

IT’S hard to imagine anyone taking over from Franklin Templeton’s “king of emerging markets” Mark Mobius.

After all who does not know Templeton Emerging Markets’ executive chairman Mobius, who spends over 200 days a year shuttling from one emerging market to another – all in the name of finding undervalued companies.

Having invested in emerging markets for more than 40 years, Mobius has single-handedly widened the appeal of emerging-market investing. He centres his investment decisions on transparency, investor protection and good corporate governance.

After close to three decades at the helm, and in accordance with Templeton’s succession planning, Mobius has transferred the day-to-day management of the group to his chief investment officer Stephen H. Dover.

As a group, Franklin Templeton Investments has some US$733.3bil under management with more than 8,900 employees in 35 countries.

Dover, who is based out of San Mateo, California says of his new role: “I feel humbled and honoured. I have known Mobius for probably 25 years and he is one of the greatest investors of all time. He is also a great mentor. But I think I want to put my own imprint on emerging markets.”

“I am excited about the growth potential offered by emerging markets. These economies, which encompass Malaysia, have not been well understood by most investors. Emerging means growing, and it also means changing. Investors are not aware of how dramatically the Emerging Market Index has changed over the years,” he says.

Monetary leverage: The weak ringgit makes Malaysia more competitve in the electronics, rubber glove and palm oil sectors.

He thinks the trends moving forward for emerging markets continue to be consumption, however their economies will start offering higher value added industries, particularly in technology.

“Ultimately for economies to grow, they need population growth, a favourable ratio of workforce from young to older people, and emerging markets have that. I think it is time for investors to buy into emerging markets as valuations appear attractive,” he says.

Dover is the managing director and international chief investment officer for Franklin Local Asset Management group.

He is responsible for overseeing the investment functions of the locally managed and distributed products in Australia, Brazil, Canada, China, the Middle East and North Africa, Europe, India, Japan, Malaysia, Mexico, South Korea, Vietnam and the United Kingdom.

He also oversees and manages the Franklin World Perspectives Fund. Prior to serving in his current role, Dover was a founder and chief investment officer of Bradesco Templeton Asset Management (BTAM), a joint venture between Franklin Templeton Investments and Banco Bradesco.

Under Dover’s direction, BTAM became the largest joint-venture asset management company in Brazil. Dover also served on the board of directors of several publicly-traded Brazilian companies.

Reduced risks: There are opportunities and reduced risks in emerging markets because currencies in these economies are relatively low, especially for a dollar investor, and this provides some cushion of safety to investors. – Reuters

Prior to joining Franklin Templeton Investments in 1997, Dover was a portfolio manager and principal at Newell Associates in Palo Alto, California where he co-managed retail and institutional equity assets including the Vanguard Equity Income Fund.

He is a member of the board of directors of the Bootstrap Fund, a non-profit development bank focusing on microcredit. He is also on the board of trustees of Lewis and Clark College and Law School.

Dover holds a BA, with honours, in communications and business administration from Lewis and Clark College and an MBA in finance from The Wharton School of the University of Pennsylvania. He is a chartered financial analyst. Dover has lived in China, Costa Rica, England, Brazil and the United States.

The following are excerpts of an interview with Dover:

How do you feel about taking over from Mobius?

Well I feel humbled and honoured. I have known Mobius for probably 25 years and he is one of the greatest investors of all time. Hes also a great mentor. And it’s a great challenge for me especially because I haven’t been directly part of his organisation. But I think that I want to put my own imprint on emerging markets.

I actually first went into an emerging market in 1982, when I studied in China and that was when my interest in what was then called undeveloped markets was piqued.

Back then though, I still didn’t know how my career was going to develop. And then within the next 4 to 5 years, the person who really developed the China market was Mobius. He named those markets “emerging markets”.

I have spent the last 20 years developing markets in China, India and Brazil, so I have a lot of experience in emerging markets. I am very excited about working with Mark’s group. I still call it Mark’s group! Ok, my group!

You said you want to put your own imprint on emerging markets? What will that imprint be like?

I think that emerging markets are emerging, They are not static. There is a greater component to it. If you look at emerging markets over the last 30 years, the primary growth factors have been commodity, consumption growth and exports. Now that has been the great tailwind behind emerging markets. It is unlikely to be what pushes emerging markets moving forward. I think that moving forward, there is likely to be more consumption within emerging markets, and more higher value added industries such as technology.

Ultimately for economies to grow, they need population growth, a favourable ratio of workforce from young to older people, and emerging markets have that. The long-term demographic trends for developed markets are pretty negative. As a whole globally though, it looks favourable. So developed markets and emerging markets need each other. They might not admit it but they do. Its that need and support for emerging markets that I am excited about explaining. I live in the United States, and people really don’t understand emerging markets, even the sophisticated investors.

On emerging markets

What is your outlook for emerging markets for 2017?

We think there are opportunities and reduced risks in emerging markets because currencies in these economies are relatively low, especially for a dollar investor, and this provides some cushion of safety to investors.

We think there is likely to be global growth over the next few years, and that in essence will benefit emerging markets. Emerging markets are a higher beta play on global growth and will benefit from global growth.

Another tenet for emerging markets is they are seeing a turnaround in earnings growth, particularly growth relative to developed markets. This will allow emerging markets to perform well in absolute basis and better relative to developed markets.

In terms of valuation, emerging market is relatively inexpensive by any measure. If earnings go up, emerging markets will become even cheaper. I was jumping up and down about a year ago for emerging markets because they were so egregiously inexpensive.

There have been some adjustments since that time. But I still think there are opportunities in emerging markets and really no great enthusiasm yet.

Do you see investor interest in emerging markets picking up?

There is an appetite for emerging markets – partly because most investors have been underweight on emerging markets, which account for 11% of the global indices and 36% of global gross domestic product (GDP).

But big institutional investors on average have only 5% to 6% invested in emerging markets, compared to the peak of 15% in previous years. It is unlikely that they are going to be any more underweight. That’s an underlying positive for emerging market going forward.

Some of the largest investors in the world are very interested in Asean.

A lot of this has to do with a big shift from China in the sense that investors are wary of China and they are looking for alternatives, and, obviously, South-East Asia will be a great beneficiary of that.

Most investors are not aware of how emerging markets have evolved over the years. Some still think emerging market is a commodity play or an export play.

For instance, commodities, which accounted for 50% of the Emerging Markets Index in 2008, now accounts for only 15% of the weightage, while consumer sector’s weightage rose from 7% to 18%. Many investors also do not realise that information technology (IT) has a greater weight in the Emerging Markets Index than it does in the US, Japan and Europe.

Where do the investment opportunities lie?

We see great opportunities in small cap stocks, which are not very well covered by analysts, but they provide long-term potential. We also maintain a long-term consumption-oriented bias in our portfolios. What we see attractive in the sector in emerging markets is the population growth and movement away from export-oriented economies to more consumption-oriented economies.

We are also moving into some of the bigger earnings growth opportunities in emerging markets such as IT companies. We also see opportunities in some of the banks, but we are avoiding Chinese banks.

And while we’re not heavily overweight in commodities, we did take some opportunities to increase our weightings in the sector last year when commodity prices fell significantly.

We are also looking at some of the export industries that had been beaten down.

What’s your view on the Malaysian market in particular?

We look at the currency situation as an opportunity to enter new markets. So Malaysia, has become a much cheaper market to invest in than before, and we see opportunities from the equity perspective.

What we are pleased about Malaysia is despite the volatility in its currency, it has been a very resilient economy, and that it is still growing at a very healthy rate.

There has been too much concern that Malaysia is a commodity economy. Although that is still an important part of the country’s economy, commodities’ representation has reduced significantly from what it was in the past.

While we see opportunities in Malaysia, the risks of the ringgit getting weaker or GDP growth not being as great as we are anticipating are a concern.

Malaysia is very tied to global growth. If global growth were to slow down, Malaysia might slow down proportionately more. That’s a risk but that’s not what we think will happen.

I have some concern that if the currency gets too bad there might be some type of currency controls or capital controls, as had happened in the past.

Which are the sectors in the Malaysian equity market that excite you?

We have looked at the consumer sector, where we have been somewhat overweight for a period of time. This is parly due to a favourable demographic, with a population growth rate of 2%, which is one of the highest in Asia, as well as consumer-spending support from the wealth generated from natural resources.

I’ve spent six weeks travelling through Asean. It is interesting to see how well the economies in the region have done. Malaysia stands out in the region as an economy that’s really developed and has a developed consumer market.

We also see opportunities in the domestic-oriented sectors such as banks, construction, as well as in some oil and gas (O&G) companies. We’re also looking at the export industries in which Malaysia is globally competitive.

The weak ringgit makes Malaysia more competitve in the electronics, rubber glove and palm oil sectors. On O&G, it doesn’t really matter whether they are producers or service providers, as we’re looking at opportunities in both sub-sectors.

On oil prices, rate hikes and Trump

How do you think oil prices will perform this year?

Oil prices are notoriously difficult to predict. Our best prediction of oil prices is to look at the futures market which is in the range of US$50 to US$60 per barrel. We’ve been kind of constructive on energy, particularly when its prices fell.

We think there is definitely a lot of consumption if we are correct about global growth – that is obviously going to be a push to all commodities, including oil.

But there are some buffer on oil prices as well. One of that is the possibility of the US increasing supply within its market.

And I think investors also need to keep an eye on the potential changes in US corporate tax under a new administration. We don’t know exactly how it will turn out, but if it is in a way that is currently proposed, it would be negative for oil importers into US. We’re not too sure on the impact that would have on oil prices, and it is not very well understood at this stage.

How will the potential rate hike in the US affect emerging markets?

The answer to that depends on why interest rates are being increased.

If the interest rates were increased because of a rapid increase in inflation – which is generally a negative reason to raise rates – that would put a dampener on growth, and that would be negative for all economies, particularly emerging markets.

But if interest rates were increased because there is growth in the economy – which is the case for the United States – then it will be positive for emerging markets.

There is no direct correlation between rising US interest rates and the movements (up or down) in emerging markets. I think it is a false dichotomy to say if the US increased interest rates it would harm emerging markets.

Emerging markets are in a much better fiscal and economic situation than in the past when interest rates went up.

To some degree, emerging-market currencies have already fallen due to the large rise in the US dollar over the last few years. We are also in a very different economic situation than we were in the past when there was a fall in emerging-market currencies.

Since the 1997/98 Asian Financial Crisis, these curencies have already become healthier.

Emerging-market currencies are very low now vis-a-vis their underlying fundamentals.

So, the risk of them falling further is much smaller than the opportunity for them rising higher.

I think emerging markets have backended the potential for a rise in US interest rates. There was so much fear of rising interest rates and so much certainty that the US dollar was going to rise if rates were going up that people had pre-traded negatively on emerging markets.

How will Donald Trump’s presidency affect emerging markets?

If Trump’s policy stance results in acceleration in US growth, it will be good for emerging markets. Trump is probably more volatile than previous US presidents, so it is just very hard to predict how things will go with him.

Mexico is one of the interesting emerging markets that we are currently looking at.

I think the US is going to look at substitutes for China – Mexico could possibly be an ideal candidate. There is an old saying that what’s good for Mexico is good for the US in the sense that if Mexico had full employment then there would be less need for Mexicans to emigrate to the US.

I think the Nafta (North American Free Trade Agreement) will be renegotiated to work for everyone’s benefit.

What are some some the important trends you see taking place in the economy?

The biggest trends in the economy and in the world might be this rise of popularism and nativism, which is really the opposite of globalism, whereby countries will be more focused on their own self interests. That is negative for global agreements – whether trade or environmental, or even global law agreements.

What is unknown this year is the fact that many countries, particularly in Europe, will be having their elections.

I’ve been travelling to Europe in the last few months and I can tell you from the on-the-ground perspective it is hard to predict what’s going to change in Europe, except that the region could become more populist than it is right now.

In Latin America, we see some positive signs as the region seems to be turning more towards orthodox economics.

In terms of trends, I think we are going to be increasingly in the trend of automation. If we were to really look at what has displaced workers in US as well as other countries it is really automation and technology – and not imports, although imports had had some impact as well.

On capital markets

So based on what you have said so far, should we be buying equities? Because for example last year, there was a lot of fear, and people were buying bonds?

So I think that you should be buying equities partly because of bonds and the likelihoood of interest rates increasing. You can still do well in bonds over a period of time, but the short term pain is pretty great.

So I think during our professional lifetimes, I think the year was 1982, interest rates have dropped during our entire professional careers, so investors don’t have any real experience with a long period of rising interest rates.

Under rising interest rates, bonds with high yields that are reinvested can still do pretty well, but still clearly you don’t want to be long on long duration bonds when interest rates are rising.

I won’t speak for our bond group, but they have been very negative or short term duration for bonds globally, at least in the developed markets and some emerging markets.

So in terms of bonds versus equity, it looks like there is some opportunity within equity.

The part of equity that I think should be avoided are those bond like equity investments. For example the big dividend plays, the safe stocks.

When you look at the stock market and economy, what are some of the indicators you look at in guiding your decisions of the market?

So I think if it were possible to predict the economy or growth, that would be a great way to invest. But in my experience, there is so much noise, and it is very hard to catch the signal.

I talk to a lot of economists, I am sure you do to, and as you know, half the time they are wrong. So what we prefer to do is to look at companies. This is because companies are smaller data sets. It is easier to assess whether the company is going to be a good investment over a period of time.

We are very positive on the long-term growth of emerging markets, on their people, population growth, productivity and the hard work the people do.

Those aren’t economic figures per say. However, if we think we can find good investments in those countries and in good companies, that is where we will find the opportunities.

So it’s more important for us to find a company that is honest and has good corporate governance and good management, rather than to see whether the economy is going to grow.

Take Brazil for example. Its economics are terrible, the politics are terrible, but there are companies there that are terribly resilient.

I live in America but I have worked in emerging markets for long periods of time. And I feel that company managers of emerging markets have experienced volatility in politics and economics that perhaps an American company manager does not have.

So I’d much rather focus on the quality of the company and management than trying to figure out whether the economy grows 1% to 2%.

Now having said that, we also tend to be a little bit contrarion. When everone is quite negative, that is where we look for opporutnities.

This is because in all investments, people tend to get overly excited or overly pessimistic and while we don’t quite know where that direction is, we sometimes get some sense.

For example when share prices of companies go way up ahead of earnings, or using historical trends as a guide.

Markets are born on pessimism, grow on skepticism, mature on optimism and die of euphoria. Which stage are we in now for the US stock market?

The US is a funny place. Because by argument, the economy and employment are quite strong, the people are doing well, but the people are pessimistic. I try to understand that.

Firstly, it’s a little different in that we were having this monetary world over the last 4 to 5 years. So it’s a different situation and there will be a lot of writing in the future about what this all means.

But academically and intellectually, I don’t think we really understand the current situation.

We are in uncharted territory. I personally think that with the new administration, markets have gotten a bit too enthusiastic before anything has actually happened. My experience is that if we could accurately predict everything about the economy for the next three years, you still couldn’t predict the market because there is a lot of independent variables out there.