Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
EM investors see a stock picker’s dream
The woes never seem to end in emerging markets, but their proponents see the current upheaval as a chance to take advantage of dirt-cheap valuations.
China’s regulatory crackdown still has investors running scared, but Joseph Lai, chief investment officer of Ox Capital, says he and his team are like “kids in a candy shop”. Lai has previously been bemused at the speed of the investor flight away from China and sees the recent regulatory crackdown as just the latest in a series. The ethos is the same as for any downturn: buy when there’s blood in the street.
“An industry in China can go from zero to 100 in just a couple of years, and when it grows so fast there’s bound to be dysfunctionalities,” Lai said. “The regulators come in and put guard rails in designed to improve their stability and reduce their risk so the long-term development of the industry is ensured.”
“It never feels good. The market always feels uneasy and uncertain, because there’s winners and losers and the participants in the industry tend to slow down their investment as they wait for more clarity. But my experience has been that during these lulls of uncertainty is a great time to invest in these industries.”
Chinese companies also don’t face some of the same headwinds as their Western counterparts. China’s central bank began tightening monetary policy as soon as it realised the pandemic was mostly under control in the second half of 2020, and the rest of the emerging markets set followed suit. As a result, both equity markets and economies were hit hard – but they’re now not experiencing the same inflationary pressures as their advanced economy counterparts, with China reporting roughly two per cent inflation.
Ox’s investment thesis is based around identifying long-term secular trends – the consumer spending story or vehicle electrification – throughout the emerging markets set and then not paying up for the companies that tap into that trend. Discount e-tailers, insurance companies and Indonesian telecom companies have all found their way into the portfolio, of which around 45 per cent is allocated to China.
“In the next decade, there won’t be many assets in the world that can provide you with this growth,” Lai said. “What we’re seeing in emerging markets are companies that are going to keep growing and growing as these countries industrialise and urbanise. But valuations in almost the entire class of emerging market equities are dirt cheap right now.”
And it’s Lai’s assessment that Chinese companies will still welcome foreign investors, given that the government has mostly been encouraging it; indeed, global investment banks are making slow but steady progress on the mainland after a requirement they partner with a local business was thrown out during the pandemic in 2020.
Of course, there’s one headwind to rule them all. Lai doesn’t seem particularly bothered by the prospect of geopolitical conflict (or a return to the trade war that dominated much of the Trump Presidency) but Ox is focused more on domestic companies that would be less exposed to changes in sentiment or sanctions if the situation escalated. You wouldn’t “back a Facebook” in China and expect it to have a good time, but its local equivalent is a different story. Still, few investors – aside from maybe Lai’s old shop, Platinum – seem in a rush to increase their China exposures anytime soon.
“It’s extremely difficult to time the exact bottom of this market,” Lai said. “They’ve come down a lot, but it’s hard to know exactly when the inflection point is going to come… But from experience and history we’re confident that the time is coming soon.”
