Welcome to Personally Invested. I'm your host, Dave Richardson. Last year, we introduced you to Philippe Langham. Philippe is the head of Emerging Market Equities and Senior Portfolio Manager at RBC Global Asset Management, U.K. Phil is one of the top emerging-market equity Managers in the world. And on a recent trip to London, I had a chance to reconnect with him to take a look at what's happening with emerging- market equities right now, his view of what happened in 2018, and what are the prospects for investing in emerging markets for the remainder of this year, and on into the next decade. I think you'll find Phil's insights incredibly interesting as to whether this is a great opportunity to invest in emerging markets, or just another time where you might want to sit back and wait. I hope you enjoy the podcast. So, Phil, welcome back to Personally Invested.
Very nice to be here, David.
Great to... anytime that we get a chance to spend a few moments with you when I'm over in London, and get an update on what's happening in emerging markets, is always, I think, something we have to do because a lot of Canadian investors are much more interested in investing outside of Canada. They understand-we talked about this the last time you were with Laurence Bensafi, who's part of your team here in London-that if you want to find growth around the world, you have to get outside of developed markets and look at emerging-markets investments. However, with that, Canadians think of it as very very risky, and so we like to make sure that we provide that update so that we create that sense of calm, that this is somewhere you need to be, and although there's risks, like any other investment, that if you've got the right investment manager managing those risks, it could be a great place to go. So, last year was not a particularly good year for emerging-market Equities. What would you say was the root-cause of that?
Yes, sure. We've been in an environment for emerging markets where emerging markets were quite weak between 2010 and 2015. We feel they started a recovery relative to developed markets in 2016. But you are right: last year was weak. Really, there were four key factors for the weakness last year. First of all, trade tensions, particularly trade tensions between the U.S. and China. Secondly, we saw a much stronger U.S. Dollar. Thirdly, there were fears in terms of interest rate rises, and fourthly, what we saw last year was really as the result of one of taxes, we saw much stronger U.S. GDP growth and U.S. earnings relative to emerging markets. Now, in terms of all four of these factors, we see all four as reversing. We're starting to see the pressure on interest rates to go down. There seems to be much more of a conciliatory tone in terms of trade tensions between the U.S. and China. The U.S. improvements in terms of earnings and GDP growth were very much one-off, and we're now seeing emerging markets start to look much better relative to developed markets in terms of earnings and GDP growth. And, finally, we seem to be in a period where the strength of the U.S. Dollar is topping out.
And that always seems to be something that's top of mind, when people are looking at investing in emerging markets: that U.S. Dollar strength. Of course, we've seen one of the strongest bull markets in the U.S. Dollar in history. And that has to end at some point, or at least the relative strength of that has to end at some point.
Yeah, absolutely. Dollar cycles, whether up or down, have tended to last six or seven years. We'd been in a strong dollar environment really since 2010, 2011, so this dollar cycle seems pretty long in the tooth. What we would say is that even if the Dollar does continue to be strong, we believe it's more likely to be strong against developed markets rather than the emerging markets. A few reasons for that. First of all, the most important reason would be the valuation of emerging-market currencies. So, looking at the valuation on a wide range of different measures, EM currencies look extremely cheap, really driven by the weakness that we saw in EM currencies, particularly between 2011 and 2015. But we've also seen an improvement in a lot of fundamentals in emerging markets. Current-account deficits have turned to surpluses. We've seen improvements in reserves. And finally, if you look at emerging markets, real interest rates are generally very high, if you look at developed markets, more often than not, we see that there are negative real rates around the world.
So, for listeners of this podcast over the last year, about a month and a half ago I sat down with Eric Lascelles, and we talked about China and growth in China. And obviously the importance of that growth, not just in the emerging world, but for the entire global economy. What are your thoughts on, you know, say, we seemed get to a point where we get a realistic trade deal and so the trade tensions are reduced between the U.S. and China. Where do you think the Chinese economy sits right now?
I think we're in a period of gradual slowdown in terms of China. We feel it's not something to be scared about. Growth, a decade ago, was really almost too high at around 10% or 11%. We've seen it gradually slow to last year around 6.5%. We feel that it's likely to continue to slow. The biggest risk we see when it comes to China is the amount of debt, and particularly the pace of growth of debt. So, we've seen debt as a percentage of GDP move from being around 140% a decade ago, to currently 280%. As a result, we've seen a real deleveraging campaign by the authorities. That campaign has been successful, and debt as a percent to GDP has been relatively steady over the last two or three years. And as a result, we are seeing slow growth and we expect to continue to see slow growth. But what's important about growth is the quality of growth. So when we had growth at around 10% or 11%, return-on-capital was actually quite low, because growth was very much driven by the corporate sector. We saw a lot of excess capacity in a lot of different industries. We're now seeing a number of reforms that are actually leading to an improvement in profitability. So, reforms such as constraining supply in a number of different industries; reforms such as moving the economy away from the industrial sector and more towards consumers; reforms in terms of looking to crack down on corruption. So, all of these reforms are leading to an improvement in profitability, and we believe that, despite the slow growth that we're likely to see from China, these reforms are actually a very good thing.
And that's such an important point. Slower growth, in terms of the numbers. So it's not 10%, it's 6.5%, maybe even 6%, but that 6% is better growth, and the companies that you're potentially investing in could be doing very very well or even better from a profit perspective, cause it's more sustainable growth.
Absolutely. That investment is important for...
And I guess that's an important thing when you're looking at emerging markets in general or understanding from the view of a developed market, and you're looking at any emerging market, you're going to go through that rapid growth phase, and then, eventually things are going to start to tail off, just cause the math gets harder, but the economy is-it's emerging, it's developing.
That's exactly the case. But emerging-market growth is still likely to be quite a lot higher than in the developed markets. Generally, you see emerging markets grow faster than developed markets by between about 2% and 5%. That's likely to continue, really, because the same sort of factors that drove superior emerging-market growth over the last few years are still very much in place. So, factors such as demographics, the ability to catch up in technology, and much lower penetration in a large number of different areas-say, for example; credit penetration in Emerging Markets is still a fraction of what it is in the developed world, or GDP per capita. Is still very low in emerging markets compared to developed markets.
So, before we started taping, we had just a quick check-in with you, which I always like to do with any investment manager in the sector or geographic region that they cover, and I asked: "Is emerging markets a "pound-the-table, buy now, great buy?" Or more of a "Well, it's kind of nice, it looks pretty good?" And you said?
Um, it's a bit in-between the two. (Um, we got to a point last year where, around October, valuations were very low. They didn't quite hit the sort of levels where we would say it's "close your eyes and buy" but they certainly got to very cheap levels. And we would say that, in particular relative to developed markets, where, in price-to-book value terms and in P/E terms, emerging markets are trading at something like a 25% to 30% discount. And we favour, we're more in an up cycle in emerging markets, whereas developed markets feel as though they're at a much point in the cycle. So, based on those factors, we feel that emerging markets do look attractive, but we wouldn't say it's "pound-the-table and you have to buy now"-It's more, you know, "we should expect more solid growth from emerging markets going forward."
Yeah. So, you say you've got a solid growth picture and you also have a nice story around valuation, particularly if we're comparing it to the United States and some other developed markets, and so it's a nice story. And certainly, for Canadian investors, it's a really important piece to be adding to your portfolio, certainly to diversify your holdings in Canada, but even relative to the U.S., Europe and developed-Asia.
Yeah. One thing that has changed in emerging markets is, again, perhaps a decade ago, there was a very strong link between emerging markets and the Canadian market. And really that was driven by the importance of commodities, so: energy and materials within Emerging Markets. And that's very much changed; emerging markets have moved from being driven by commodities to being much more domestically driven, so driven by factors such as consumption financials. If you look at the actual emerging-market indices, they're not that different now to developed market indices in terms of a weighting of energy and materials. So, whereas a decade ago there was a very strong link between the Canadian market and emerging markets, so you could almost invest in Canada as a proxy for emerging markets. That's no longer the case.
Yeah, and we used to actually, if I recall, when I would be out talking to Canadian investors, all of ten, twelve years ago, that was a very important distinction we were making: you could almost invest in Canada, and the segment of the Canadian Market that was commodity-focused, almost de facto gave you that exposure to emerging markets, but it's just not the case anymore, so you go back to that traditional need to more broadly diversify and really seek out a higher growth where you're going to get that.
So Phil, once again, thanks for your time, looking forward to my next visit and we'll check-in on emerging markets again.
Great. Thank you very much, Dave.
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