In recent years, emerging market investing has too often been a binary bet on Chinese internet companies. Asia has come to dominate the MSCI Emerging Market Index, against which many funds are benchmarked. Areas such as the Middle East, Africa or eastern Europe have become an after-thought.
Yet these markets have many of the hallmarks of ‘traditional’ emerging market investments – economies in a rapid stage of development, where growth is diversifying from a handful of industries to new and innovative areas. This is where the Baring Emerging Emea Opportunities Fund seeks to find opportunities, with Adnan El-Araby at the helm.
It is an increasingly neglected part of the market. As emerging market funds cluster in Asia-focused names, smaller sectors are often overlooked. Jupiter and Abrdn have both closed their frontier-focused investment trusts. Blackrock still runs its Frontiers trust, while JP Morgan has – for understandable reasons – broadened out its Russia trust to an emerging Europe, Middle East and Africa mandate – more in line with the Baring trust.
In the short term, it has been a difficult area to be hunting in. Smaller emerging markets took a hit in 2022 amid a general lack of risk appetite, while exposure to eastern Europe was problematic as war raged in Ukraine. Nevertheless, it still offers a fertile source of cheap, potential growth opportunities, with plenty of mispricing for active managers to exploit, and often uncorrelated to the major developed markets. This may prove important in the year ahead.
Diverse exposure
The Barings fund has around £2bn in assets under management and six dedicated analysts, each with an average of 19 years’ experience. El-Araby says: “It’s a very under-researched region, even within emerging markets. Each of the three areas – emerging Europe, Africa and the Middle East – has its own demographic and political make-up.
“In the Gulf, the ‘GCC’ countries of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates have resources and demographics drivers. Africa has entirely different drivers from Egypt to South Africa.”
He says the exposure is diversified: the trust’s largest weights are in Saudi Arabia and South Africa, but it also has exposure to Poland, Turkey, Greece, Hungary and the UAE. In terms of sectors, financials are a major part of the benchmark, while resources are also important in the Gulf markets.
According to El-Araby: “For a global emerging market investor, they will be getting a benchmark that is two-thirds in Asia, with a small diversifier in Latin America and an even smaller share in Emea. We’re saying we can offer investors better exposure to other parts of emerging markets outside of a core emerging market holding.”
The opportunities within these markets will be diverse. For example, the trust holds Safaricom, a mobile network provider in Kenya. He says: “It’s a well-run company and the country’s demographics are in its favour. This is the type of company that investors should be able to access.” He aims to gather “truly unique ideas that investors can’t get access to anywhere else”.
He points out that many of these countries are taking natural resources wealth and using it to evolve their economies. This is particularly true in the Middle East. “They are taking the oil money and reinvesting into the domestic economy. It isn’t going to happen over five years, but maybe over 10 or 15.
Even at $75 (£60.8) per barrel of oil, there is a surplus. This allows the government to develop the country’s basic infrastructure and diversify the economy.”
This is now being seen in areas such as smartphone penetration, which sits at over 90% for GCC countries as a whole. This means opportunities are emerging for investors in 5G, or digitalisation within government and the private sector.
Macro/micro balance
El-Araby says they have to be aware of macroeconomic considerations when investing in these sectors. Smaller emerging markets are cyclical, politically and economically, and he believes it does a disservice to investors to offer the excuse that “markets just didn’t go our way”. As such, the group will always have a view on the likely direction of travel for economies within their universe, even if they steer clear of ‘heroic’ assumptions on areas such as the dollar or inflation.
“At the moment, there is yin and yang on the global economy. On the one hand, China is opening up and its GDP is being upgraded. Within Europe, there are lower energy prices and inflation is peaking. Europe might have a soft landing as a result. The Ukraine/Russia situation is at a stalemate and is not escalating. As such, the risk premium remains static.
“On the negative side, there is the question over whether the US economy is in recession, and the real level of inflation. Earnings are coming down. These are the things we contend with. How do we square the circle? We look at it through earnings. For each company, we seek to understand what it can deliver on revenue and how it is financing that, particularly now interest rates are rising.”
He says the team tends to avoid extremes in their macroeconomic assumptions. They won’t assume the oil price is going to be, say, $150 or $50 in the long term, whatever the outlook for the energy transition.
“We have to be able to quantify our point of view. It is easy to read the news, but it needs to be put into context and quantified for an individual company.”
While the macroeconomic situation doesn’t dictate the weightings in the portfolio, there may be some adjustments at the margin. They saw fund flows moving out of Russia and into GCC countries after the invasion of Ukraine and adjusted the fund. In the second half of the year, news on the European economy was so negative and investors so pessimistic that valuations had started to look appealing, and that created opportunities. Equally, they have seen some commodities companies become overvalued and pulled away.
El-Araby’s bottom-up stock selection is ‘growth-at-a-reasonable-price’ in style. The team is also very aware of liquidity constraints, information shortages and the need to have open and honest dialogue with the management teams of the companies in which they invest.
He says: “No matter how sure you are of your investment, it’s an equity. There is still always downside risk. We want to have enough liquidity that if we’re wrong, if the politics change, we are able to exit or at least not take too much pain on the way out. Information is often dispersed, and the quality of the information may be low.” Having a larger team ensures they can get under the skin of individual companies and understand them.
The trust currently has a yield of over 3%. This is not a target, but many of the companies in the portfolio throw off an income. This can help mitigate some of the volatility in capital values that is part and parcel of investing in these types of markets.
Today’s positioning
South Africa and Saudi Arabia currently form 29.3% and 28.7% of the fund, respectively, with the UAE, Qatar and Poland the next largest weightings at 10%, 7.6% and 6.8%. Financials dominate the sector allocation, particularly the Middle Eastern banks Al Rajhi, Qatar National and Saudi National.
Nevertheless, there are also significant weightings in consumer services and consumer discretionary companies. The group has a holding in Prosus, which has a significant stake in Chinese internet giant TenCent, and also in Saudi Telecom.
El-Araby says: “We haven’t made too many changes over the second half of 2022. Central eastern Europe, for example, continues to work well. A lot of bad news had been priced in and the region should benefit if Europe has a soft landing on the back of China reopening and lower gas prices.
“We still like the GCC countries, but away from commodities and, increasingly, the banks, which have done well as yields have risen. We like several companies that only have a small weight in the benchmark, which are being helped as money is ploughed back into the economy from higher resource prices. The GCCs are still benefitting from some of the lowest inflation rates across the world. Above all, these countries are trying to normalise their societies, such as offering healthcare.”
The trust is also focusing on consumption in South Africa, believing there will be more e-commerce and digital advertising as it reopens.
It has been a tough period for Mena equities, but a weaker dollar may galvanise interest in emerging markets, and these markets in particular. They may offer a genuinely ‘emerging’ alternative to the more mature and sophisticated markets of Asia.
BIOGRAPHY
Adnan El-Araby is a portfolio manager on Barings’ EMEA equities team. He is responsible for the resources space, healthcare and pharmaceuticals, technology and media, and autos within the EMEA region. He is also co-manager of the Barings Eastern Europe Fund and Barings Emerging EMEA Opportunities. Prior to joining the firm in 2010, he worked at Legg Mason Capital Management.
This article first appeared in the February edition of Portfolio Adviser Magazine
