Is now the time for investors to place their bets on the growing electronic games and gadget industry? asks JOHCM's Emery Brewer
The enormous queue snaking around Apple’s flagship store on London’s Regent Street indirectly offered a neighbourhood example of the type of investment opportunities currently to be found in emerging markets.
Uber-cool, technologically-savvy trendsetters were waiting patiently to get their hands on the latest game-changing device from the Apple stable: the iPad. My lunchtime foray into this immaculate shrine to consumer technology may not have been in the name of research, but it did serve as a potent reminder of the sources of growth we are currently targeting within our portfolio.
Rather than exploit China and associated commodity plays, we have a preference for the technology companies of the developing world producing component parts or technology that works in harmony with the likes of the highly-coveted iPad and 3G smartphones. Companies such as LG Innotek, which is widely expected to supply the camera module for the fourth-generation iPhone, and Ralink Technology, a Taiwanese producer of chip-set solutions that enables the transmission of rich digital content such as video across wireless networks, are beneficiaries of the relentless change in consumer technology.
Technology
And it is not just consumer-driven end markets where technology companies from the developing world are enjoying strong growth. We are also attracted to companies that stand to profit from increased expenditure on corporate information technology such as PC workstations and servers. These technology firms are highly cashflow generative, enjoy high profit margins and sit comfortably with our growth-oriented approach to investing. We look for companies that are demonstrating strong operational performance, such as revenue and earnings growth and rising earnings and revenues estimates. We also look for companies with the potential to develop world-class products or become market leaders within their local markets.
Asian promise
Our stock selection-driven approach to investing in emerging markets sees us currently favour Asian stocks, especially within the export-driven economies of South Korea and Taiwan, given their strengths in the technology and automotive sectors.
Historically, by nature of their strong export bias, the fortunes of the Taiwanese and South Korean economies have had a high correlation with the US economy, so we will be looking to the US for further evidence of economic recovery.
But, as ever, we must be tuned in to the risks of investing in emerging markets. The unprovoked attack by communist North Korea on a South Korean navy vessel earlier this year and subsequent imposition of economic sanctions by South Korea has escalated tensions to a high level between the two countries. It is unclear how this situation will unfold, but, while ongoing monitoring of the political risks will be required, investors in South Korean equities have always had to live with higher levels of geopolitical risk. From an investment perspective, the higher risk levels led to a heavy correction in the Korean won, which will be helpful for the country’s exporters.
Chinese property bubble?
No investor in emerging markets can avoid the question of China. We are currently underweight China versus the index but find interesting plays on the Chinese consumer. Worries that a massive real-estate bubble has developed in the country are currently the concern du jour.
Nevertheless, we are encouraged by the attempts by the Chinese Government to reduce property speculation. In the short term, this may serve as a headwind, but longer term this is a sensible move. One need only look at the damage wreaked by the property bubble in the US and UK to appreciate excessive property speculation left unchecked can have a pernicious long-term economic outcome.
The Chinese stocks we prefer tap into increased domestic consumption but tend to be exposed more to the secondary and tertiary Chinese cities, where rampant speculative property-related activity is less prevalent.
Place your bets
Staying with China, we have a large weighting in Macau-based casino owner and operator SJM Holdings, which has about one-third of the Macau gaming market. It recently reported extremely impressive first-quarter results with a much higher-than-expected 70% revenue growth and has experienced revenue and earnings revisions.
Areas of the emerging markets universe we are currently more reticent about are those commodity-focused economies such as Brazil and Russia. We prefer those countries that stand to benefit from low mineral and oil prices, and that are generally less affected if the Chinese economy does begin to slow down and if Chinese fixed investment continues to decline. More broadly, we are targeting companies that are highly cash-generative and have relatively low capital expenditure requirements, while avoiding companies encumbered with high levels of debt and firms heavily reliant on external financing or with substantial capital expenditure needs.
Emerging bargains
We see bargains appearing here and there across emerging markets. However, the question of timing is very important. We are in a traditionally weak season, with uncertainty arising from the slow and uncoordinated actions of Europe’s politicians being further fuelled by interested parties such as hedge funds, who are targeting countries perceived as exhibiting weak macroeconomic fundamentals. We may go through a summer lull, with choppy trading, volatility and relatively less liquidity.
This means the duration of the eventual recovery may be longer, even if the magnitude of the recovery is potentially very strong. Over the long term, the reasons for investing in this asset class remain compelling, even if we have experienced a historically high level of outflows of late. The confluence of growing consumer markets, an infrastructure boom, abundant natural resources and export excellence make for a powerful long-term investment case.
Emery Brewer is senior manager of the JOHCM Emerging Markets fund
