"...emerging markets will grow faster than the
developed world for decades to come."

Gideon Rachman, The Financial Times

Low debt, high growth – Opportunities in emerging markets

Low debt, high growth – Opportunities in emerging markets

Although results were disappointing for many developing nations in 2011, they could well post strong performances this year. But for clients who are attracted by the opportunities in emerging markets, experts who manage investments in these regions suggest Latin America, Eastern Europe, the Middle East and Africa will be stronger in 2012.

For many investors, developing nations hold both promise and peril: the promise of tapping into strong growth but the peril of systemic risks such as corruption and the lack of key compliance structures, such as fully developed corporate governance systems.

That’s partly because many of these markets contracted last year, as investors abandoned them and headed for safety in the wake of the European sovereign-debt crisis and uncertain growth in the U.S. As a result, many emerging markets’ economies are poised for a comeback. Mark Mobius, executive chairman of Templeton Asset Management Ltd. in Singapore and a veteran in this area — he is lead manager of Templeton Emerging Markets Fund Inc. — expects that emerging markets as a whole will outperform their developed counterparts this year.

In any case, clients who enter emerging markets now are likely to benefit from good prices. Even if these markets do not post strong results in 2012 — Timothy Morris, portfolio manager with J.P. Morgan Asset Management in New York, cautions that emerging markets are not immune to global risk aversion — they still present long-term opportunities. Morris does not anticipate “any significant impact for long-term investors” in this area. With valuations relatively low, he says, now is “a favourable entry point.”

Other stock analysts agree that some of these economies are set to grow and the options in developed nations are not as rosy. According to the International Monetary Fund’s September 2011 World Economic Outlook, the economies of sub-Saharan Africa will grow by an average of 5.8% in 2012; Latin America and the Caribbean, by 4%; the Middle East and North Africa, by 3.6%; and central and eastern Europe, by 2.7%. Industrialized countries are expected to grow by an average of only 1.9%.

“The problem with industrialized economies is that they are overleveraged,” says David Kunselman, portfolio manager with Excel Investment Counsel Inc. in Mississauga, Ont. “Their average government debt, as a percentage of gross domestic product, is at 120% vs 37% in emerging markets.” This handcuffs their growth prospects, he adds, an “issue that could linger for as long as 10 years. While households are fully leveraged in developed countries, per capita household debt in emerging markets is non-existent.”

Emerging markets’ lack of debt, combined with rising incomes, is the driver of increasing consumer spending, he says, fuelling domestic output and more imports.

All is not rosy

On the other hand, all is not rosy in emerging markets. Most have had to contend with high inflation, fuelled by high energy and food prices, which has pushed consumer prices higher in those countries. However, in many cases, inflation has moderated as a result of intervention by central banks in these nations. “It is less of an issue now,” says Morris, “[but] remains a constant concern.”

In the non-Asian emerging regions, Latin America will stand out, driven by surging consumer demand, relatively high commodities prices backed by resilient industrial demand, and growing infrastructure spending. Brazil, the largest of the economies in the region, is expected to be the region’s “poster boy” for growth and, Mobius says, “is the most important place to be investing.”

In Brazil, Morris favours consumer staples and banks, especially those that benefit from low consumer debt. He also favours “down the supply chain” businesses that are associated with public infrastructure projects and large offshore drilling projects.

Mobius also likes banks in Brazil, which he believes have good growth prospects, as well as commodities-based investments and companies that can take advantage of the rapidly growing consumer market. In Chile, the Templeton fund has exposure to copper and banking; in Colombia, to oil, where investment is being driven by increasing exploration activity, and to banking. In Mexico, Mobius favours telecommunications.

Bhim Asdhir, president and CEO at Excel Funds Management Inc. in Mississauga, Ont., has his firm’s funds overweighted in Brazil and Chile, underweighted in Mexico and has investments in Colombia and Peru. In Brazil, Excel funds hold shares in Itaú Unibanco, the largest bank; Petroleo Brasiliero SA, a large oil company; PDG Realty SA, the biggest home builder; and Localiza Brasil SA, a car-rental firm. In Chile, the Excel funds have invested in copper and also own shares in Sociedad Quimica y Minera de Chile SA, a producer of specialty plant nutrients and chemicals. In Mexico, telecoms and retail are favoured.

Great exposure to Turkey

Eastern Europe will be the laggard as it struggles to deal with the fallout from the eurozone debt crisis. But resources-rich Russia will stand out in the region, followed by Turkey, which isn’t a member of the European Union and, thus, as Morris puts it, is “insulated from regional concerns.”

In Eastern Europe, Morris favours Turkey, with investments in consumer staples and telecoms.

Templeton’s biggest investments in Russia focus on nickel, uranium, oil and iron ore.

Mobius also favours consumer stocks and banks in Poland, and medium-sized consumer and pharmaceutical distribution companies and banks in Turkey.

Kunselman has his greatest exposure to Russia, Turkey and Poland. Among the companies he holds in Russia are Sberbank, the largest credit institution; Rosneft, Gazprom and Lukoil — all giants in the energy space — and Uralkali, a large potash company.

In Poland, Kunselman favours PKO Bank Polski, the country’s largest bank; and Warsaw Stock Exchange. In Turkey, his portfolio has exposure to banks and consumer discretionary companies such as BIM Birlesik Magazalar AS, which operates a chain of discount stores.

In the politically unstable Middle East, the Templeton fund has exposure to telecoms in Egypt, banks and telecom in Kuwait, and petrochemicals in Saudi Arabia.

In continental Africa, Nigeria and South Africa are the most favoured countries for growth. Morris’s portfolio is invested selectively in materials and financial services in South Africa.

The Templeton fund has exposure to Nigerian banks and sugar companies.

Dwarka Lakhan

Dwarka Lakhan

Dwarka Lakhan is a pioneer in emerging markets journalism in Canada. His first emerging markets article, “Africa Joins Ranks of the Emerging,” appeared in Investment Executive, Canada’s leading newspaper for financial advisors, in September 1994. Since then he has written hundreds of articles on the full spectrum of emerging markets and has conducted more than two thousand interviews with emerging and frontier markets investment professionals.

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