Since the announcement of the first Covid vaccines in November last year, there has been a surge in optimism that after a long spell of underperformance, value strategies might be set to return to the fore for investors.
It is well known that value funds have had a long struggle, underperforming their growth counterparts for the best part of the last decade. However, one region investors might not traditionally think to when it comes to value is emerging markets, but Ernest Yeung, manager of the T Rowe Price Emerging Markets Discovery Fund, predicts better times ahead for EM value investors.
“We are of the view the current extreme growth/value divergence will prove unsustainable,” he says. “At some point, the unprecedented monetary and fiscal stimulus deployed by governments to deal with the coronavirus crisis is likely to result in a global reflation trade that can be expected to trigger a potentially sustained rebound in value stocks.”
Since the launch of the T Rowe Price Emerging Markets Discovery Fund in September 2015, up to the onset of the coronavirus crisis, Yeung (pictured) says his portfolio has been tilted toward the ‘core’ region of value.
“The extreme shifts in markets in 2020 have prompted us to favour a deeper value exposure,” he says. “We are of the view the conditions are currently being created to power a strong tailwind in 2021 for EM value investors.”
So why are emerging market value stocks so unloved by investors? Yeung says that in 2020 cyclical/old economy stocks became more forgotten and unloved than ever before.
“Looking at this opportunity set, we see no fundamental justification for value stocks to be quite so unloved, since many of them exhibit strong balance sheets and high cash flow generation, while the economic impact of the coronavirus shock should fade as vaccines become available,” he says.
Yeung does agree that the bottom 25% of emerging market stocks by quality are often ‘value traps’, which he says are justifiably ignored by foreign investors. However, among the next two quartiles – namely those stocks that can be thought of as being of average EM quality – he argues there will always be some about to move into the top 25% in terms of quality, which will rerate over time in the process.
“The change can be company specific, such as cost-cutting, change in management and divestment, or it can be external, like industry consolidation or positive government change,” he says. “We also look for a buffer, such as a strong balance sheet, which can provide a measure of downside support, potentially acting as an anchor to already cheap stocks.”
In terms of current investment opportunities, Yeung says investors have been chasing Covid beneficiaries that have not been taking into account the “solid fundamentals” of old economy stocks. This, he says, is providing the fund with a “fertile hunting ground”.
“A deep dive into EM corporate balance sheets reveals these remain intact in most cyclical industries – where banks, energy and materials industries typically have low recapitalisation risk and are fundamentally strong,” he says.
“Solid bottom‑up fundamentals coupled with the structural change in the way governments have been stimulating during the coronavirus crisis, in our view, provide the ingredients for a style regime change in the near term, and possibly the longer term. For the first time since our strategy’s inception, we see fundamental change to support a style‑based rotation.”
As multi-asset investors, Chris Rush at Iboss says it matters less about a global emerging markets value versus growth position and more, whether you invest in the region at all and if so, to what extent.
“Even within developed markets, we would argue that the value versus growth argument, while useful to demonstrate a broader point, is an oversimplification,” he says. “The same convenient labelling also applies to emerging markets but is possibly even less helpful in this space due to the range of countries in the index, many of which exhibit low correlation with each other.”
Hugo Robinson, head of research at Arisaig Partners, agrees with Rush. Not only does he think that binary distinctions between growth and value are not particularly helpful, he goes as far to say that the growth versus value debate “offers a false choice”. This, he says, is because value cannot be judged independently of growth.
“There are many so-called ‘value’ stocks in emerging markets which are given that classification simply because they have a low P/E multiple,” Robinson says. “More often than not, they trade on a low multiple for good reason, whether it is down to poor corporate governance, environmental or social risks, or lack of visibility on long term business model sustainability.
As a result, Robinson believes that simply focusing on P/E multiples is often a bad way of measuring value.
“The true value of any business is the present value of all future cash flows, and there are indeed a number of so-called ‘growth stocks’ which trade on optically high P/E multiples but which actually offer attractive value,” he says. “That is the case where there is good visibility on their ability to grow cash flows at high compounding rates for many years to come.”
Owing to many emerging markets countries’ idiosyncrasies, Rush adds that is more difficult to tilt the geographical sector overall by style.
“We would suggest that rather than even attempt to gerrymander a value versus growth position in the space; it may be beneficial to hold several managers who demonstrate an ability to move between styles and geographies as they see necessary.”
