SIMON BROWN: I’m chatting now with Feroz Basa. He is head of the Global Emerging Markets Fund at Sanlam Investments. Feroz, I appreciate the early morning time. A note that you put out talked around the move to emerging markets, and the story is that we’ve high yields in the US, worries about inflation, the Europe energy crisis – all of this has seen money rushing into the US. We see the strong dollar. You’re making the argument that this is actually going to reverse and that money’s probably going to find a home, and lot of it in EMs.
FEROZ BASA: Yes. Good morning, Simon. I think if you look at the current situation, it’s a normal market effect, where initially you have US interest rates going up as they try to retain inflation. Money then moves – after a long period where cash was really cheap – out of emerging markets in other developed markets, and it’s risk-off and money moves into US treasuries. The subsequent effect is that the US dollar becomes stronger. So this is a normal effect of the market, and it’s a normal cycle that we see.
But it’s very painful because the US dollar getting stronger is bad for emerging markets like South Africa and other emerging markets, and everything just becomes more expensive. But they’re trying to tame inflation above 8%, which is higher than even South Africa. This is a normal effect that we see in the market
SIMON BROWN: Part of the attraction towards EMs is that they simply didn’t pump as much cash into the economies. You mentioned our inflation [being] below the US. Every time I think about that, truthfully I scratch my head, but the data is the data. That’s because emerging markets, even China, didn’t put nearly as much money into the pandemic as for example the US did, where they were basically just doing the Ben Bernanke ‘helicopter money’ story.
FEROZ BASA: Yes, exactly. So all this money flowing back into the US market is trying to tame that 8% inflation. And, like you say, in my entire investment career I haven’t seen that US inflation higher than South African inflation. So they’ve stimulated the economy. The world went into Covid lockdown, and obviously everything stood still. And the US, Europe, Japan and the like stimulated the economy and put in massive, massive stimulus. With emerging markets and particularly in China the stimulus wasn’t nearly as much as that.
So you’re seeing the after-effects of that massive stimulation in all of these countries. Okay, Europe has the added disadvantage of the energy crisis. But they’re trying to tame this inflation by raising interest rates because of this massive stimulus.
At the same time, they’re also trying to pull some of that stimulus back, so it’s almost like a double-whammy in terms of what we see in those markets. In that particular time emerging markets didn’t do nearly as much, and the valuations were cheaper than developed markets at that starting point.
SIMON BROWN: Yes. You make a great point in your note, where you say you want to get in at the beginning, ideally not the middle of the cycle, and [you] note that that major funds are still significantly underweight EMs. In other words, this is still a little bit early. Now, early is often a scary place to be because things can get quite bumpy there. But the short answer is rather early than late.
FEROZ BASA: Yes. If you look at it, when do investors, actually retail investors and institutional investors, get into these funds? It is after that initial uplift. If you miss out on that initial uplift, you see the volatility in the market, [and] you could miss most of the upside. I think if you look at it, it’s always painful to go into an asset class when everybody’s negative. You have Russia attacking Ukraine, you have China and Euro, Covid policies and all of these issues. It’s almost like nobody wants to be there. And that’s why valuations are so low.
I always like to use the example of Turkey. Last year Turkey had significant massive inflation. The currency depreciated and investors started saying Turkey’s uninvestible. Now if you fast forward to this year, Turkey still has 80%-plus inflation. The currency depreciated by another 90%. But Turkey is one of the best-performing markets year to date – up 20% in US dollars. So it’s a very good example. Now [if] you bring that back to EMs, if you look at the emerging markets currently [they are] trading on very, very low earnings multiples, and the earnings level is low, whereas developed markets’ earnings are high. Valuations are starting to come off, but they’re not nearly as attractive as emerging markets.
SIMON BROWN: But we also make that point. You mentioned Turkey. If I think of the US market or even European markets, I can name dozens, hundreds of potential investible shares. As soon as I look at EMs, it becomes outside of course our core markets – South Africa and maybe China to a degree – it’s actually, particularly for the retail client, really, really difficult to navigate our way through. You make the point, and I appreciate you talking your book here, but I think I agree with you that in EM space funds really are the way to do it rather than DIY.
FEROZ BASA: Yes. So I think emerging markets. And that’s why it’s more risky and that’s why and trades at a discount created the discount, even though the growth potential is much better than developed markets.
So you raise a very good point. In emerging markets there are a number of state-owned entities, particularly in China. If you look at the index – China, India, and some of these other indexes – you’ve got to be very careful [of] those state-owned entities. I mean, we look at Eskom, Denel and all these other state-owned entities. [They are] not run for shareholders.
Similarly in emerging markets you need to navigate those markets quite carefully and spend time. There are really very, very good companies, but you need that bottom-up, fundamental-focused fund that can pick those stocks for you to give you that outperformance longer term.
SIMON BROWN: We’ll leave it there. Feroz Basa is head of global emerging markets at Sanlam Investments. Feroz, I always appreciate your early morning insights.
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