PM CAPITAL warns bumpy outlook in emerging economies to be intensified for ETF’s
8 August 2013; Sydney-based specialist equity fund manager, PM CAPITAL, today warned that investment into Emerging Asia ETFs is a dangerous strategy because the instruments are heavily skewed to businesses that are at the mercy of the macro environment and dominated by questionable state-owned enterprises (SOEs).
Kevin Bertoli, portfolio manager for the PM CAPITAL Emerging Asia Fund, said although the timing is uncertain, when the cracks in emerging economies proliferate, it would cause serious problems for ETF’s.
“Emerging markets are typically dominated by businesses that have a high degree of uncertainty, such as those driven by the macro environment or businesses of lower quality with no long term sustainable advantage. Additionally, the recognition by the Chinese banking system of deteriorating asset quality and liquidity tightening could prolong this year’s disappointing results.”
Mr Bertoli said the equivocal outlook for the region highlighted the importance of active management and a maintaining a high degree of conviction in investment decisions.
“A large portion of the market
is investing solely for broad base thematic reasons, such as the rise of China. These investors will typically buy the market as opposed to diving deeply into the underlying stocks, and this can be seen in the rise of ETF’s in the region over the last decade.
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However, these investors typically have a low level of confidence in the underlying earnings power of the investment, so when sentiment turns they tend not to differentiate between good and bad businesses. This mentality creates the opportunity to invest in the 10 to 15 per cent of the market that represents good value.
Mr Bertoli said the dominance of state-owned enterprises (SOE) could also create problems for ETF investors.
“On top of the widely know issues surrounding transparency, SOEs ultimately act as leavers for their majority government shareholders to grow the economy. This often results in management being little more than ‘yes men’ who often make irrational investment decisions for the benefit of the country as a whole, rather than in the interests of shareholders.
“Additionally, long term success in China requires the economy to transition to one driven by the public sector; this is going to have a negative impact on SEOs. Around 43 per cent of China’s total industrial and business profit comes from SOEs, which have showed significant growth reductions over the past twelve months.”
In the first quarter of 2013, SOEs reported 5.3 per cent growth, compared with 2012’s first quarter growth figure of 7.7 per cent*.
“For this reason, we cannot stress the importance of investing from the bottom up, based on fundamentals and in genuine businesses where the valuation displays a meaningful dislocation from its share price. Investors should also not be investing for investing sake, or for fear of underperforming if you miss a market rally. But with market volatility on the increase, we believe there is ample opportunity for us to deploy our strategy and take advantage of the market mispricing.”
PM CAPITAL’s Emerging Asia Fund delivered 45.7% for the financial year and a five year annualised return of 20.5% (the Fund’s inception date) – the strongest performing Emerging Asia Fund recorded by Morningstar. This lies in stark contrast to the iShares MSCI Emerging Markets ETF return of 18.82% return for the 2013 financial year (0.93% 5 year annualised return).
PM CAPITAL adopts a concentrated approach to investing where underlying portfolio holdings are driven by bottom up stock specific stories and not broad based macro themes. The Emerging Asia Fund is ideally looking for opportunities that are being driven by underlying structural dynamics, which have been seen to play out in other parts of the world and can easily be repeated. The Fund is not investing in exotic Asian companies, instead they are simple businesses similar to Australian businesses such as Seek Ltd., Woolworths or Asciano.