For many investors, having a presence in emerging market stocks means investing in either an exchange-traded fund that follows a particular index or an actively managed mutual fund that takes its cue from one. But those funds are dominated by mega-exporters that rely heavily on sales to the U.S. and Europe, so they may not be the best way to take advantage of growth on these up-and-coming countries’ home turf.
The idea of investing in emerging market companies with so much skin in the Western world seems almost counterintuitive to Lewis Kaufman, who runs the $110 million Thornburg Developing World Fund. “We prefer to focus on developing market companies with strong domestic demand because they are in a better position to take advantage of growth in consumer income, spending and consumption in emerging market countries,” says the 37-year-old manager.
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At 9.2% of assets, the fund’s stake in the Philippines, well above the benchmark weighting, reflects Kaufman’s view that the area is in the early stages of a growth spurt. Coming out of the 2008 financial crisis, the country did not attract as much money as some emerging markets, and the companies there are not recognizable names to most Westerners. But low interest rates, a successful battle against government corruption and improved macroeconomic and currency stability have increased business confidence, encouraging both foreign and domestic capital to return to the region.
“It’s also a Catholic country with a high birth rate and a population of 92 million, many of whom speak English,” he says. “Since there are not a lot of jobs domestically, these people are going out of the country to work and sending money back home.” Much of that cash has been flowing into the coffers of retailers such as Puregold Price Club, the second-largest modern retailer in the country. Patterned after off-price warehouses such as Costco, the company targets middle-income consumers and derives more than 70% of its profits from food. Another Filipino holding, Security Bank, is seeing double-digit loan growth as borrowing catches on in that country.
The fund also has over three times the MSCI benchmark weighting in Indonesia, the world’s fourth-most-populous country. Over the last decade, the country, which boasts a well-capitalized banking system and solid government finances, has experienced strong economic growth and a rising consumer class. Still, Kaufman has reduced the fund’s position in the country by a few percentage points over the last year and moved the money into the Philippines, which he considers an earlier-stage growth story. The fund maintains about 10% of assets in Indonesia through stocks such as Mayora, a leading manufacturer of candy, cookies, coffee and breakfast cereals. While the company has a significant export business, it generates most of its revenue domestically.
In China, a slowdown in GDP growth in recent years has sparked concern among investors and depressed the country’s stock prices. But Kaufman believes Chinese stocks, which account for 13% of the fund, offer “the best value in emerging markets.” Economic growth will likely continue to be slower than it was a few years ago, he says. But the population is still spending. People are increasingly using credit. And their wages are rising. These forces will provide a tailwind for the economy, he thinks.
One of the fund’s holdings, Mead Johnson Nutrition, the American spin-off of Bristol-Myers that produces baby formula and other infant-care products, has benefited from the trend in rising consumption. Seventy percent of the company’s baby formula business comes from emerging markets, including China.
Other fund holdings in the region include Biostime, a premium brand for pediatric nutrition and infant-care products, and HengAn International Group, which makes diapers, women’s sanitary products and tissues. With annual earnings growth of 20% and a selling price of 20 times estimated 2013 earnings, the latter stock is “an attractive value proposition,” says Kaufman.
He’s less enthusiastic about Brazil (because of the current account deficit problem). Still, he has an allocation of about 12% to Brazilian companies such as retailer Cia. Hering, a large apparel retailer. Despite economic weakness in its home country and disappointing operating results, the stock has done well over the last year. That strength is due in part to the company’s limited credit dependence. The company also benefits from self-financed growth, and it could enjoy a rebound in consumer spending.
Peru accounts for 3.1% of the fund’s assets. With its current account surplus, the country offers a good Latin American complement to Brazil. While Peru has suffered from periods of political instability, its mining industry has supported growth, and lower interest rates are helping to stimulate the use of credit. One of the fund’s holdings is commercial banker Credicorp. With its extensive branch network and its lack of competition, this company is well positioned to capitalize on lending growth in the region.
Two Internet businesses in the fund are dominant players in Russia and China, where Internet penetration is still lower than it is in developed markets. Internet search provider Yandex, the leading search engine in Russia, has significantly higher market share there than Google, its closest competitor in the region. Yandex has the potential to grow earnings as disposable income increases, infrastructure improves and the advertising market expands.
Even with a relatively low level of Internet penetration, China already boasts the world’s largest online population. Many of those users are familiar with Tencent, a leading Chinese Internet provider with more than 500 million active users and services that include instant messaging, social networking and online gaming. The use of the company’s service should increase as Internet penetration in the country grows.
Southern Copper rounds out U.S. holdings, which account for 8.4% of assets. Headquartered in Arizona, this producer of high-quality copper derives most of its revenue from mines in Peru and Mexico. Relatively inexpensive labor, along with high-quality reserves, has helped make it one of the lowest-cost producers in the world.