Despite rising tensions in the Middle East, the MSCI EM index outperformed the DM equivalent in the third quarter and with a year-to-date EUR return of 17% is on track for its best calendar year since 2020[1].
A big chunk of these gains has come from China, which represents 28% of the EM index, where capital has started flowing again as overseas investor sentiment has improved and money has become cheaper to borrow domestically. Fredrik Bjelland, Lead Portfolio Manager of SKAGEN Kon-Tiki, explains: “The Chinese economy has been weaker than expected and so the government launched a co-ordinated policy response with both fiscal and monetary stimulus measures. While support for Chinese households would likely provide even greater impetus, the signal from authorities to support the economy is beyond doubt and gave the Chinese stock market its best week since 2008 at the end of September”.
China pay-off
The boost to Chinese liquidity also helped SKAGEN Kon-Tiki, which is slightly overweight China versus the MSCI EM index that it currently trails by 3% year-to-date[1]. Chinese holdings provide the fund’s top three contributors this year with CNOOC, Ping An and Alibaba contributing over 10% in combined absolute returns. “We have consistently been increasing our Chinese exposure since the autumn of 2021 and our contrarian positioning and patience has paid off,” Bjelland explains, “Our stock picking has also been very strong – the fund’s Chinese holdings were flat when the market lost around half its value between 2021-2023 and have gained around twice as much as the index in 2024.”
Kon-Tiki’s other large country exposures have unfortunately fared less well with Korea and Brazil, which together make up 40% of the fund, the only two major emerging markets to post negative returns year-to-date. “There are several factors driving performance, as always, but the Korean market has been dragged down by Samsung Electronics, which is over a quarter of the index, while Brazil has struggled mainly as a result of rising interest rates and growing concerns over the country’s fiscal situation,” Bjelland adds. The underperformance means that Brazilian holdings make up the fund’s four largest detractors with Simpar, Assai, Cosan and Raizen costing around 4% in absolute year-to-date returns.
Refreshed portfolio
2024 has been a busy year of portfolio activity with eight companies entering the fund and seven departing – a turnover ratio of 30% which is in-line with the fund’s three-to-five-year investment horizon. “We have been able to bring companies into the portfolio this year that have either previously been in the fund, like Wuliangye, or that we know from owning their parent companies, such as CSAV and Grupo Vamos. This means that we are familiar with and have comfort in management,” Bjelland explains.
The portfolio managers have also taken advantage of share price weakness to increase holdings in Ping An, TSMC and Yara International at attractive prices, while Hyundai Motor, CNOOC and KB Financial Group have been sold down following strong performance. This re-jigging among the fund’s largest holdings means that the portfolio has around 40% weighted upside over a two-year investment horizon.
The Kon-Tiki portfolio currently trades at a 40-45% discount to the MSCI EM index and other EM funds on multiples of earnings and book value, with only a relatively small sacrifice on quality[2]. The fund also contains more small and mid-cap companies (26% of the portfolio) than the index (9%) and peers (12%), which Bjelland sees as an advantage: “This is where we believe the likelihood of finding mis-priced companies is highest. Smaller companies tend to be more overlooked by the market and the return on our time and analysis is likely to yield higher rewards as a result.”
EM value in an expensive world
Emerging markets are one of the few regions globally where stocks are currently valued below long-term averages, with most major developing countries except India and Taiwan looking cheap relative to historic pricing levels. This is in contrast to developed markets where company valuations are above historic averages, notably in the US where P/E ratios sit around a third higher[3].
Comparing price levels in emerging markets to the US shows a discount that now exceeds the dot com bubble – when US valuations were similarly skewed by technology stocks as they are today – and is now at a level last seen in 1969. On both previous occasions these extreme price concessions triggered long-term periods of strong EM outperformance.
Earnings growth is also expected to be relatively strong in emerging markets with EPS forecast to rise 23% next year, compared to 7% for developed markets according to consensus estimates[4]. This bodes well for future performance, as Bjelland concludes: “With valuations looking attractive relative to both developed markets and their own historic average, we believe it is an interesting time to look at emerging markets which remain a good place for stock pickers to generate positive and differentiated returns”.
All figures as at 30/09/2024 unless stated.
[1] As at 24/10/2024.
[2] Source: Morningstar, as at 31/08/2024.
[3] Source: JP Morgan. 01/01/90 – 30/09/2024. MSCI EM index current forward P/E 13x vs. 14x average, MSCI World index current forward P/E 19x vs. 16x average, MSCI US index current forward P/E 22x vs. 16x average.
[4] Source: JP Morgan.