Rob James

Market Outlook

Emerging Markets (Unconstrained) Outlook


Latest Emerging Markets (Unconstrained) economic and market outlook. 


We continue to be very bullish on several themes running through the portfolio. Perhaps the most important is Technology, as evidenced by our major overweights in memory, logic and advanced packaging. We believe the world is entering a powerful semiconductor cycle as structural growth from new applications such as AI and high-performance computing meets a cyclical upturn in demand following a period of destocking. The recovery cycle should be particularly strong in memory semiconductors. Having already owned the likes of Samsung Electronics, over the quarter we bought SK Square, a Korean holding company that controls the world's second-largest memory chipmaker SK Hynix. It also has the potential to be a key beneficiary of the Corporate Value-up Program that is being introduced by the Korean government. This program has parallels with Japan, where a push for corporate reform has been one of the key drivers behind a powerful market rally. That said, the holding company structures in Korea are quite different. In contrast to Japan’s true corporations, Korea has far more family-controlled chaebols. Because of Korea’s very high and strictly imposed inheritance taxes, families use a system where they maintain relatively small stakes in a holding company, which in turn owns an operating company, thereby allowing a family to maintain control of the latter whilst minimising their inheritance tax. These families have little incentive to increase the holding company share price and pay more tax. Meaningful reforms could therefore meet stubborn resistance in the absence of inheritance tax changes. Thankfully, the government has intimated that it will reduce inheritance tax after the mid-term elections, should it be successful. There are structural reasons to believe that this is more than just cheap talk. Indeed, Korean retail investors now outnumber its homeowners, meaning that the stock market will be a more important factor driving wealth creation moving forwards. Meanwhile, Korea’s pension system needs higher equity markets as it is seeing more outflows than inflows due to an aging population. 

Another major overweight is Argentina, where Milei’s economic shock treatment appears to be progressing faster than the market expected. The President’s achievements in terms of fiscal consolidation and tackling inflation have thus far been impressive. Month-on-month inflation has fallen from 25-30% to the low-teens, and is predicted to move into single digits soon. Importantly, the majority of the population remain supportive of his actions and seemingly understand that a degree of pain will be required in order to break hyperinflation. It is also encouraging that the bond market has performed very well as it tends to lead equity markets in Argentina. We still see substantial upside, despite strong performance. Having recently returned from a field visit to Vaca Muerta, we were struck by the vast scale of the opportunity for operators such as Vista Energy and YPF. For example, Vista has drilled only 9% of its current reserves, the number of which is itself growing. It was a privilege to be the very first investors in the world to meet the new CEO of YPF, Horacio Marín, who was extremely impressive. The company has both conventional and unconventional oil production. Marín is looking to divest 60% of YPF’s conventional oil production, and 40% of its conventional gas this year. These assets generate less than 1% of the company's EBITDA, but require $800 million of capex every year. Clearly, spending 16% of total capex on assets that produce almost no return is unsustainable. In our view the sell-side has so far failed to adequately appreciate the opportunity for both revenue growth and cost cutting at YPF.

The structural opportunity for India over the next decade is arguably the best in Emerging Markets. In many ways the country resembles China in the early 2000s. The perennial challenge is to find stocks where this is not reflected in the valuation, and there are undoubtedly pockets of the market that are simply too expensive. However, a recent correction in many Indian banks and some smid-cap stocks has presented us with an opportunity to make some exciting purchases. There have been mounting concerns about Indian private-sector banks as loan-to-deposit ratios have increased, meaning tighter liquidity, and potentially slower growth for these banks. We do not disagree with this analysis, but would argue that these businesses are not priced to carry on growing at their recent rates in perpetuity. Thus, a marginal slowdown is not a huge concern for us. We used recent weakness to buy HDFC Bank, the leading private-sector bank in India. Following its merger with HDFC Ltd, it has a lot of higher-cost wholesale borrowing, which over time is being replaced with lower cost deposits. Over the medium term, this trend will be very accretive to net interest margins, but in the shorter term it means that loans will grow slower than deposits. Given these dynamics, HDFC Bank was hit particularly hard after the merger, providing an attractive entry point in our view. Indeed, on most metrics the shares are as cheap as they have ever been over the past 20 years. The investment thesis is based on sustained loan growth (in the low-teens whilst the bank shifts its liability mix, accelerating to mid-teens thereafter) and improving profitability as net interest margins pick up and cost-to-income falls. There could also be a rerating from current low levels versus both history and peers.

We also added more generally to our Indian smid-cap exposure. There have been concerns about valuations in the space following extremely strong performance last year. This is supported by research from Bernstein, which found that the proportion of Indian smid-cap stocks trading below 20x earnings has shrunk from around 70% in FY07-FY13 to just 25% today. However, this must be caveated by noting that earnings revisions in India have been much better post-COVID, particularly in the smid-caps. We would also note that smid-caps have been generally growing faster than large-caps in India. Much more importantly, when we look at our own holdings, we find valuations are very reasonable. This is exemplified by Samhi Hotels and Ujjivan Financial Services. Hotel stocks tend to be valued on EV/EBITDA rather than P/E, and with good reason. A new hotel will have higher depreciation than an old one. All else being equal, it will have lower net profit, but as a new hotel that net profit will require less capex to sustain than would be the case for an old hotel. Samhi currently trades on just 13.5x FY25 EV/EBITDA. By contrast, large-cap peer India Hotels trades on 33.7x EV/EBITDA. Samhi’s valuation even appears to be good value in a global context, given that Indian consumer stocks tend to trade at a premium to Developed Market stocks due to their higher growth potential. Ujjivan Financial Services is the holding company of Ujjivan Small Finance Bank. The two entities will be merging this month, with the merger ratios already agreed. Ujjivan Financial Services trades at a 10% discount to Ujjivan Small Finance Bank, offering compelling near-term upside in our view. But much more importantly, Ujjivan Small Finance Bank, which we will ultimately own after the merger, trades on less than 8x FY25 earnings and just 1.6x book value. This looks extremely cheap for a bank that should be able to sustainably grow assets at more than 20% per year and deliver an ROE in the mid-20s.

Finally, although the Chinese macro backdrop and general sentiment appear to be improving at the margin, we continue to see opportunities elsewhere as cleaner, without the geopolitical risk. The government is likely to achieve its stated growth rate, but it’s not clear to us that Beijing is addressing the structural imbalances in the economy. Moreover, as we move closer to the US elections, bipartisan anti-China rhetoric is likely to be stepped up, which could weigh on already fragile sentiment. Of course, China is a continent-sized market and there will always be opportunities, irrespective of the macro backdrop. Our overarching thesis in the country has been to concentrate capital in companies that are not simply generating growth, but also are focused on shareholder returns. This seems to be bearing fruit, with companies that are returning cash being rewarded by the market. For example, Qifu Tech offers double-digit returns to shareholders through its dividend and buyback programme. It has been a strong contributor to performance this year, as have the likes of PetroChina and CMOC for similar reasons. 

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Nothing in this document constitutes or should be treated as investment advice or an offer to buy or sell any security or other investment. TT is authorised and regulated in the United Kingdom by the Financial Conduct Authority (FCA).

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