Rahul Chada, Malcolm Dorson at Mirae Asset GI outline EM thoughts
With concerns around the direction of Argentina and Turkey, emerging markets investors have recently been coping with ongoing heterogeneous results from their investments.
InvestmentEurope has interviewed two of Mirae’s EM experts for their outlook: Rahul Chada (below left) is co-chief investment officer at Mirae Asset Global Investments (HK), where he helps oversee the entire Investment Unit, and is a member of the investment committee for the firm; Malcolm Dorson (below below left) is a portfolio manager at Mirae Asset Global Investments (USA) focusing on the emerging markets ex-Asia, but also with experience of Brazil, Russia and Emerging Europe.
The views come in context of the manager’s recent move to raise additional funds for its GEM Sector Leader Equity fund (see boxout).
Q. How is the strategy standing up to the rigours of currency volatility and geopolitical risk as seen recently in Turkey?
2018 so far has proven to be a volatile year and the strategy has remained fairly resilient despite recent macro developments. Currently we maintain an overall constructive view, as fundamentals remain fairly sound and it appears markets have been somewhat ‘oversold’.
Currently, the biggest risk we see is if China and US trade tensions escalate meaningfully and US implements tariffs on $200bn+ worth of Chinese imports. We expect trade frictions will likely remain in the short term, particularly ahead of US midterm elections in November. However, we believe further tariffs on Chinese imports are unlikely to go ahead as imposition of first round of tariffs may create widespread local discontent in the US and put business investment on hold. Already a number of US corporates and interest groups including General Motors, Ford and Fiat Chrysler have voiced strong concerns about the tariffs implemented. There will be a lag time but as companies see higher costs; this will eventually translate to higher prices for the end consumer.
Our view regarding currency is that USD strength could persist in the short term given the stronger US economy, rising rates and investor concerns on US-China trade tension escalation. However, the US trade deficit is still large, which should in time, have a correcting effect on the currency exchange rate.
The latest concern for investors is around recent RMB depreciation. RMB has been allowed to depreciate recently due in part to broad USD strength as well as the feared impact of US tariffs. Since July, Chinese policymakers have signaled they are prepared to implement measures to cushion the economy from potential negative impact. Moreover, China’s FX reserves remain high ($3.1trn) and China has a large trade surplus which should mean we are unlikely to see excessive RMB depreciation.
Q. Does the strategy have access to specific tactical tools/solutions to manage such risk over a shorter time period, whilst still leaving the strategy mostly on track with respect to its longer term objectives?
Our strategy is underpinned by bottom-up stock picking driven by fundamental research to identify quality companies across emerging markets. In terms of tactical tools, we aim to manage short term risk by maintaining our disciplined approach when it comes to valuations. Where we see valuations becoming stretched, we are willing to trim the position. An example of this is when we trimmed our position in Tencent beginning in Q3 last year. Similarly, we will also take opportunities to add exposure into quality names during if we see a correction has potentially created an attractive entry point.The strategy adheres to strict investment guidelines generated by the risk management team to ensure a risk-controlled structure for portfolio construction. The risk team analyzes risk reports daily and confers with portfolio managers on a weekly and monthly basis. Investment guidelines keep country deviations plus or minus 10% from the benchmark. The same rule also applies to the allocation between Asia and LatEMEA regions. Sector deviations are limited to +/- 15% deviations from the benchmark. Overall, the managers construct the portfolio so that its tracking error is capped at 8%. In the case of breaches, the risk management team notifies the portfolio manager to adjust the portfolio appropriately. In the case of material or continued breaches, the issue will be escalated to the risk management committee.
Q. Have you seen the volatility surrounding the Turkey story – and other EM markets recently – as a buying opportunity? If so, which sectors/markets look most interesting; alternatively, if you feel that there is real contagion risk from the Turkey situation, how are you seeking to protect the fund from downside?
Each story (and there have been many this year) has been different. We have been slightly underweight Turkey and though valuations look compelling, we do not yet see a catalyst for change that would create a buying opportunity. Turkey suffers from a structural challenge with an elevated current account deficit, and the combination of elevated oil prices and geopolitical tension only puts pressure on the imbalance. This leads to a weaker currency and higher inflation. Now that President Erdogan has made public remarks about the alleged evils of higher interest rates, we are wary that the central bank may have lost its independence and therefor its ability to properly contain inflation. The recent political dialogue and sanctions between the US and Turkey are only putting further pressure on the situation and, though a fluid situation that could see short term sharp reversals, we are yet to see a clear long term solution.
On the other hand, in Brazil, we did see a buying opportunity around the volatility stemming from the recent Trucker Strike. Though the protests led to GDP downgrades and more caution around the 2018 Presidential election, we believe that prices dislocated from fundamentals. Many looked at the BRL around 4 and compared the current situation to Brazil in the early 2000s. We disagreed with this in that the current account deficit stands at roughly 0.5% of GDP (vs. roughly 4% of GDP in 2002). In 2002, roughly 35% of debt was indexed to the exchange rate. This created a difficult dynamic, as a strong USD put pressure on the debt market, which made people sell bonds, which put more pressure on the BRL. Today, that figure is down to about 5.5% of GDP. International reserves in 2001 stood at roughly $35.9bn vs. about $382bn today. In terms of politics, 2002 was facing a far left leaning Worker’s Party (PT). Today former PT President Lula is in prison and the party has lost a significant amount of support. Almost all candidates accept the need for fiscal reform. Whoever wins the next election will almost have to push through social security reform. If not, the country could spiral, and the elected official will have difficulty finishing his/her term. Perhaps most importantly, we are yet to see the economic impact from 700+bps in Selic cuts in the last few years. Once the election is behind us, this should lead to more borrowing and a new capex cycle.
In terms of contagion risks to Asian markets, we believe overall this risk is limited. South Asia markets, particularly Indonesia, Malaysia and Philippines are relatively more vulnerable. But importantly, the region is in better shape than 2013 during the Taper Tantrum period. Credit growth has slowed or in some cases deleveraging has occurred. There are broad based improvements in current account balances and FX reserves are generally at levels considered sufficient to fend-off liquidity shortages. Moreover, the classic signals of bull market peak – strong credit growth and asset bubbles- are still largely absent in Asia. We have selectively taken opportunities to shift our portfolio exposure to strong domestic demand plays within the region and on the back of the recent correction in healthcare sector; we have taken opportunities to add exposures to quality structural growth stories which we believe should remain resilient in the current market environment.
Q. Is China the key long term EM play, or are international investors too focused on China at the expense of other opportunities?
We believe China remains a key market by virtue of sheer breadth of opportunity offered across technology, healthcare, consumer and insurance sector at the same time India also offers many attractive opportunities. From a structural perspective India enjoys favourable demographics, growing domestic consumption and scope for economic reforms. It is also now the fastest growing major economy in the world and the government under prime minister Modi has shown that it is committed to bringing about key economic reform, financial inclusion and job creation, which will be key in driving India’s transformation to become more productive and efficient. As an example, the goods and services tax (GST) implementation marks a major reform in India. It replaced the complex and clunky indirect tax systems including VAT, excise, service etc. A single tax will lead to centralization and consolidation of warehousing facilities for businesses. The removal of inter-state tax barriers, combined with seamless input credit, will make India one common market for goods and services, leading to economies of scale in production and improved efficiency in the supply chain. GST reform should create long term benefits in the organised sectors of the economy, such as leading retail names.
Q. Has US fiscal policy overtaken US monetary policy as the key determinant of international investor confidence in EM assets – eg, because of the impact of tariffs and threats of tariffs to trade between EM/DM – and if so, is this a shift that you feel will last over the medium to longer term?
We believe that US fiscal policy has been more political than structural. Though it has been a recent driver for markets, we don’t believe that it alters the long term fundamentals behind the asset class. If anything, it can create opportunities for attractive entry points as prices dislocate from intrinsic values.Regarding the threat of tariffs, we mentioned earlier that an escalation to the trade war between US and China is the main ‘tail risk’ to our base case scenario. Recently we have seen a sharp rise in risk aversion, particularly in China. Some of the recent macro data points in China including industrial production, fixed-asset investment and retail data have shown signs of moderation. The softer data is consistent with the government’s earlier deleveraging and tightening efforts. However, in the past month China has shifted toward policy stimulus; as indicated by the central bank’s RRR cuts and fresh liquidity injection into the banking system as well as the government taking a more proactive fiscal policy stance. It is important to bear in mind that it takes time for policy easing measures to be passed on to the real economy. July consumer confidence has come off a bit from multi year highs on the back of some recent consumer finance issues and trade tensions. Our view is that as some of the concerns on trade war ease, we should see consumer spending pick up again.
Q. Are you maintaining/building/decreasing the cash holdings currently, and if so, why?
Our strategy is generally fully invested and maintains only a small cash holding for liquidity management purposes. Our investment guidelines allows a maximum cashing holding of 10%, however; in general this figure is closer to 2-3%.
Q&A on GEM Sector Leader Equity fund
Earlier this summer, Mirae Asset Global Investments announced that it was launching three new share classes for this particular global emerging market fund. The three unhedged classes are: E USD Capitalisation, E EUR Capitalisation, E GBP Capitalisation. However, the offer also noted that a hard closing would be implemented once a certain level of funds were raised across the three classes – equivalent to $100m.
Q. Why hard close at $100m, for the combined raised across the dollar, euro and sterling denominated E shares?
At $100m we expect the fund’s TER (taking into account any removal of reduced management fees) to reach an acceptable level. We also note $100m is a common threshold for institutional investors before they consider allocating a portion of their assets to a fund. Many investors also face restrictions with regards to their overall holding in a fund and at this level a 10% stake is $10m which is also a common minimum investment for some institutional investors for the investment to make sense.
Assuming the money came in dollars, and the minimum for the new E share at the 25bps cost is $250k, that equals as few as another 400 investors into the strategy?
This is correct for the E share class which is mainly targeted towards asset allocators that tend to have a long term investment horizon. The short term goal of this particular share class is not to grow the amount of investors, rather to grow the AUM to a meaningful size, which should attract more investors in the longer term. Although the E shares will close at $100m of gross inflow, the strategy remains open with other share classes continuing to accept subscriptions.
Can you confirm the exact date the E shares became available to investors – I’m assuming this was the same date globally?
They became available to investors as of 11 July, 2018 (with the exception of Switzerland).
Overall, what is the objective of seeking to attract the additional $100m? And what was the fund’s AUM the day before the E shares became available?
The objective of seeking an additional $100m is to attract long term investors who are seeking a well-established global emerging market equity strategy from a specialist in the asset class. To reward these early investors for their commitment, we offer a discounted fee structure allowing investments to prosper and grow the AUM of the fund to a meaningful size. The day before the share class became available the size of the Fund was $15.4m.