The co-manager of Templeton Emerging Markets Trust (TEM), Andrew Ness, has a nice line when questioned on how these markets have changed since he started following them professionally nearly three decades ago. ‘These aren’t your grannies’ emerging markets,’ he says.

He has seen three substantive changes over that time. Emerging market institutions and policy makers have made deliberate changes to their economies to provide increased resilience at times of stress.

Economies have diversified, moving away from ‘low-cost labour arbitrage and the export of cheap stuff,’ says Ness, to being more consumption and technology driven.

Finally, at the company level, emerging market companies have been able to leapfrog more established firms in the developed world thanks to a combination of tech and innovation.

After experiencing a wave of currency crises having started his career at Glasgow-based fund manager Murray Johnstone back in 1994, Ness jokes he was thinking he ‘should have taken that UK equity job’.

‘If you look at the MSCI index back then,’ he expands, ‘it was very different, full of large commodity-centric companies. Chile, South Africa and Russia were big components of the index back then. Now, it’s a very much tech-centric, Asian asset class. Emerging market companies are a big part of the new global economy. They are change agents, with dominant manufacturers in semiconductors and firms leading the renewable energy transition.’

‘UNDER-OWNED, UNDERESTIMATED AND UNDERVALUED’

Despite this major shift in the make-up of emerging markets, Ness notes they are still ‘under-owned, underestimated and undervalued’.

‘We’ve had this underperformance versus the US for the last 11 years and there’s almost an expectation that will persist in perpetuity,’ he says.

If you look at emerging markets over the last 20 years, Ness notes they have delivered annualised returns of 10.6%. Not as eye-catching as what has been delivered by US stocks during a lengthy bull market, which may have raised investors’ expectations to unrealistic levels, but still a very healthy return.

BARGAIN STOCKS?

Ness notes that emerging markets are at a discount relative to developed markets on both a price to book and price to earnings basis.

‘Underestimation is still persistent. There’s a much higher quality of policy in this asset class, we’ve got much lower levels of debt than the developed world, whether that’s at the sovereign, corporate or household level. We are still expecting to see much higher GDP forecasts for emerging markets than the developed world.

‘People don’t recognise that emerging market companies are some of the most innovative, fast-growing, tech-centric businesses globally. This is one of the biggest underappreciated factors.’

Countries which stand out for Ness and the rest of the Franklin Templeton team are South Korea – noting a company like Samsung (005930:KRX) could be at the forefront of the so-called ‘fourth industrial revolution’.

He also sees Korea as a beneficiary of the increasingly tense relationship between Beijing and Washington and attempts to reduce US dependence on Chinese supply chains on electric vehicle batteries and renewable technologies thanks to a long history of research and development in these areas.

‘Valuations still look attractive in Korea,’ Ness adds. ‘And there’s a journey taking place of improved corporate governance and transparency in Korean companies and that will be a tailwind for the market going forward.’

CORPORATE GOVERNANCE IMPROVEMENTS

Ness notes there has always been a wider perception about a transparency and corporate governance deficit in emerging markets but the gap to the developed world is closing.

‘Governments are issuing governance codes to listed corporates to be much more transparent. There are charging the domestic investor base with becoming better stewards of capital through stewardship codes and then you’ve got investors like us, who continue to fulfil their stewardship and fiduciary roles by engaging.’ Ness says engagement on the part of global investors on these issues has really stepped up in recent years.

The fund manager likes Brazil, despite some of the political issues he acknowledges have dominated the agenda over the years. He is a fan thanks to the country’s world-class businesses and a large population of well-educated and talented people, adding that Brazil has natural resource advantages in both hard and soft commodities.

Ness notes the Templeton Emerging Markets Investment Trust portfolio have a high level of diversification and benefit from well-resourced research teams enabling them to find the ‘best ideas out there’.

Taking a pragmatic approach, no sectors are entirely off the cards although there is some resistance to investing in highly regulated utilities stocks or cyclical, fragmented, locally driven and opaque real estate firms. Ness is more positive on technology as well as companies exposed to rising consumption in the media and e-commerce spheres and emerging market banks. ‘There’s a lot more we like than we don’t like,’ he says.

As well as big and/or well-known names like Samsung, Taiwan Semiconductor Manufacturing Company (2330:TPE) and Indian bank ICICI (ICICIBANK:NSE), the portfolio also contains lesser-known Chinese electrolytes specialist Guangzhou Tinci Materials (002709:SHE) – a world-leader in its sphere. This is an archetype for the types of companies Ness and the team seek, which are ‘leaders in their respective industries with resilient business models and robust balance sheets’ enabling them to navigate a tricky backdrop.

WHAT ABOUT CHINA?

China still looms large in the emerging markets world and a slower than expected post-Covid recovery has had an impact on sentiment. Ness says: ‘Our expectation the recovery on the ending of zero-Covid was going to be slow and gradual and the market got itself far too hyped up in terms of expected “revenge spending” in China.’

He explains there had been little fiscal support for Chinese households which therefore didn’t have the comfort and accumulated savings to go out and spend on deferred acquisitions as in the West.

He sees recovery over more of a six to 18-month time frame. ‘Sentiment has been extremely negative but that has created opportunities and we are as constructive on China as we have been for some time.’

This outlook is part of a series being sponsored by Templeton Emerging Markets Investment Trust. For more information on the trust, visit here

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