Actively Investing In Emerging Markets

Over the three decades Matthews has been investing in emerging markets, there have been many changes and not just not in the economies and markets that we invest in but with the investment industry itself. Passive strategies that employ software programs and algorithms to replicate the performance of indices have grown in popularity while alongside this has been a significant expansion of active strategies that employ conservative approaches that also closely follow benchmarks.

We still believe, however, that to properly explore the opportunities in emerging markets, investment managers need to do their own research in order to find out where the growth potential is and where the challenges reside. Our in-house analysis of countries, markets and companies gives us the conviction and the confidence to seek more exposure in certain areas and pull back in others, irrespective of benchmark weighting. 

Truly active strategies have complete control over geographically concentration. South Korea and Taiwan, for example, have some dynamic companies but aren’t particularly large economies and yet they are a substantial part of many emerging markets indices. Active strategies can also invest off the radar in lesser-known markets with potentially fast-growing companies like Vietnam. A truly active approach also empowers us to spot budding trends and developments before the market at large does, potentially giving us early price advantage.

Equal to identifying growth is identifying and managing risk, and active management means active risk control. Risk management is always important but it is particularly crucial in the current global environment in which the macro landscape has changed rapidly since the pandemic and markets have exhibited greater volatility in many cases. We encounter and manage risk when we conduct fundamental research at the stock-picking level and when we review our holdings at the portfolio level. But we also control risk with a regional and global perspective. A market may have no shortage of quality companies but if the performance of these companies is being held back by a sluggish economy, regulatory intervention or negative global sentiment, this will impact our weighting. For example, our risk perspective can lead us to being underweight or omitting certain geographical and sector exposures that are carried in the benchmark or by our peers but that we feel are too expensive from a valuation perspective or lack robust governance or don’t meet our growth expectations. But make no mistake, how we address risk is about how we manage risk rather than how we eliminate risk. Growth and risk, in our view, come hand in hand and need to be managed equally.

“At the heart of what we do is search for quality. We assess the economic, industrial and trade prospects of countries; the valuations and liquidity of markets; and seek out strong, quality companies on the ground.”

So where do we look? As far as we are concerned the landscape is far and wide. We consider established public companies, newly-listed companies and businesses that are pre-initial public offering (IPO). We invest in small-cap companies, businesses that may be out of favour with attractive discounts, and companies that may not even be listed or headquartered in emerging markets but generate a substantial amount of business in these geographies. 

Active Exposure: Investment Philosphy and Risk Management Guides Our Positioning

Quality, quality, quality

At all times we are searching for quality. That involves assessing the economic, industrial and trade prospects of countries, the valuations and the liquidity of markets that are exposed to them, and crucially it is about identifying the strong companies on the ground. That means businesses that exhibit strong balance sheets and cash flow, have good, sustainable competitive advantage and demonstrate ‘quality,’ as expressed by returns on capital, margins, cash earnings and dividend growth.

Inseparable from screening for quality is identifying the potential for businesses to deliver outperformance over the long term. Emerging markets still offer an enormous canvas for growth. In fact, many companies in these markets have become, or are on the verge of becoming, key players in the industries of the future, like renewable energy and transportation, robotics and artificial intelligence (AI). A lot of the upstream materials and energy that are required for renewable industries, for example, are located within emerging markets economies.

To this end, all of our portfolios focus on companies that have the potential to provide attractive, sustainable growth with management teams who can translate growth and innovation into positive cash generation. Our portfolio managers and analysts dig deep to understand how companies earn their profits, what the growth drivers are and where their customers originate.

Active, differentiated portfolios

Investing in emerging markets is about looking forward and identifying companies that can power their own growth. Emerging markets recently haven’t so much been characterized by distinct themes as they have been impacted by macro headwinds, like rising interest rates, a strong U.S. dollar and China’s weak post-COVID recovery. At its core, investing in emerging markets today is about finding quality companies with promising futures that synch with our investment philosophy and meet our risk management standards. 

The DNA of Actively Managed Emerging Markets Portfolios

We bring 30 years of investment expertise and a time-tested investment process to identify opportunities that have the potential to generate long-term outperformance. Our portfolio managers leverage the full resources and expertise of the broader investment team to find attractive opportunities and construct differentiated portfolios.

Actively managing emerging-markets exposure and screening for quality means hard examination of companies and their suppliers and engaging with the management of businesses. At Matthews, our emerging market portfolios are designed to meet a wide range of investor needs, but they all honed to our long-term investment approach, strong risk controls and extensive experience investing in these markets.