Do the math when it comes to emerging markets

By Brenda Craig | May 4, 2010 | Last updated on May 4, 2010
4 min read

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Fortune favours the bold, and emerging markets have returned some astronomical results over the past decade.

But investing in developing countries is no slam-dunk. It requires experience, a global view and hard core due diligence.

Grabbing a basket of stocks from India, China or Eastern Europe will not guarantee peak performance. Everything, from the company’s accounting procedures to the aroma of a country’s politics and its particular zeitgeist must be factored in for success, according to the experts who manage the risk and reward of emerging markets.

If the country where the company resides is on shaky ground, it’s a deal breaker. “Number one, if there is no rule of law in the country, we are not going to invest in a company there,” says Canadian James Donald from Lazard Asset Management in New York, which manages emerging market portfolios for the Bank of Montreal. “For example, in Venezuela, President Chavez has filled the Supreme Court with a lot of his friends, so we feel there is no rule of law there. That is a very big issue.”

To really know what’s going on, it’s best to be on the ground in each of the countries where you’re considering investing. It’s the best way to determine the dynamics of the government, says Bhim Asdhir, founder and CEO of Excel Funds in Toronto. “You have to know what the government’s done in the past, what is expected of them in the future, and based upon that you can invest accordingly.”

He cites Brazil as an example. “President Lula has done a great job,” says Asdhir referring to the President Luiz Inácio da Silva by the nickname that most Brazilians use for their president. “But his term is going to end later this year and he cannot run for re-election. This is important to understand.”

Asdhir is one of the originals when it comes to emerging markets investment. He began investing in India more than a decade ago, when others shied away and considered the business environment too corrupt for reliable returns.

Being on the ground Asdhir regularly travels to meetings with regulators, company executives and investment partners. In India, for example, Excel Funds has partnered with Birla Sunlife, India’s largest mutual fund company.

“They are our sub advisors’,” Asdhir says of Excel’s Birla Sunlife partner. “They live and consume the products and services of companies they invest in; they understand the language and the competition. They understand where management is moving. All these things are critical and that’s what I mean by being on the ground.”

The decisions must be made on a company-by-company basis. That’s common philosophy for portfolio professionals. “From a Beta or market-risk standpoint, emerging markets tend to move in the same direction as the rest of the global equity market,” says James Donald, “so diversification is moving much further toward specific companies.”

But the real growth opportunities in emerging markets are not necessarily in the index, says Asdhir. “In India, for example, the main stock market index is made up of the 30 largest companies,” he notes, “but that does not mean they are all globally competitive or the fastest growing.”

Whether Lazard’s emerging markets portfolio managers are looking for an asset-to-value or growth strategy portfolio, it absolutely must have the fundamentals. “It may sound a little old-fashioned,” says Donald, “but we need to see cash flow and earnings in both strategies.”

As Templeton Asset Management’s executive chairman, Mark Mobius, says the test for success is always the same, no matter where the company is located. “The ultimate objective is to identify companies which will show sustained earnings growth over the long term will limited risk,” says Mobius, who is based in Singapore and directs analysts in Templeton’s 15 emerging markets office. “That means we must look the quality of the management, the strength of the company’s balance sheet and the quality of earnings.”

The numbers must work In the final analysis, emerging market professionals say it all comes down to the books.

Mobius has more than 30 years working in emerging markets and has been with Templeton Growth since 1987. “We do a careful analysis of the balance sheets and the profit and loss statements,” he says. “Audited financial statements are very important but it is also important to look behind the numbers and do forensic analysis.

“Bad management, a weak balance sheet, poor sales outlook or anything that could impact profitability,” says Mobius and the deal is off the table.

Although less-than-perfect accounting has been a problem in the past, James Donald from Lazard believes accounting procedures have improved dramatically over the last 15 years in emerging market companies.

He adds every investment decision requires an “accounting validation,” so Lazard meets with the company executives, visits the physical plants and conducts reviews that literally look at the books and check accounting procedures for themselves.

“Of course, there is still some corruption in developing countries,” admits Asdhir. “But the majority of companies are run with global intent. They are competitive and regulators are becoming more stringent. We’ve had a lot of success in emerging markets.”


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Brenda Craig