Russia a ‘sideshow’ in main EM game
Investors and their fund managers have dumped Russian holdings in recent weeks amid worsening horror at the invasion of Ukraine. But active managers could lessen the blow for investors through new opportunities on the other side of a Russian trade.
For Ninety One’s emerging markets team, Russia is an “ugly sideshow” to the main investment shifts at the global level. To put Russian economic influence into perspective, Ninety One describes it as being “like Italy, but with nuclear weapons”, with the manager highlighting the relatively similar size of each country’s economy.
A lot of emerging markets managers held Russian stocks, which made up 1.5 per cent of the MSCI Emerging Markets (EM) Index on March 1, but prices were falling in the military build-up prior to then. On March 2, the MSCI announced it would remove Russian stocks from the EM index and reclassify them on a standalone basis because they were “uninvestable”.
According to Archie Hart (pictured), Ninety One’s lead portfolio manager for its EM equities strategy, the opposite side of a Russian sell-off includes opportunities for gas suppliers in other emerging markets, for example. “Qatar is a major beneficiary of the sanctions,” he said.
The same goes for commodity suppliers of other Russian exports including aluminum, copper, nickel, thermal coal, diamonds and palladium. But it is only in diamonds and palladium that Russia speaks more than 25 per cent of global supply. In thermal coal, its third-biggest export, Russia ranked behind Indonesia and Australia.
About 50 per cent of Russia’s exports were oil and gas related. Therein lies the impetus the sanctions are expected to give to the green energy transition trend globally, especially in Europe which was probably the most advanced along the journey anyway.
London-based Hart visited in early April to speak with Australian and New Zealand clients and prospects. Ninety One has about US$20 billion invested in EM, China and other Asian (ex-Japan) portfolios.
He said in an interview from Melbourne that a consensus among Ninety One’s clients was “a certain revulsion” about Russia. “Their appetite for investment there is zero. And I think that is perfectly correct.”
From an investor’s perspective, it was also the case that one couldn’t objectively do a risk-return analysis because of the current situation. As Russia amassed its troops on the Ukranian border, Ninety One began to reduce its exposure and has since sold all its Russian equity holdings, he said.
Hart’s formal presentation for Australia and NZ had four themes: Russia in context; China’s more important role; what de-globalisation looks like; and, inflation.
With China, Hart says the Ninety One spends much less time talking about the direction of the market and more time on stock-specific information and ideas.
“Yes, there are a great deal of risks with China that we all know,” he said. “But we think that if you selectively choose where to invest there are enormous opportunities. China is the second-largest economy in the world and there are over 4,000 listed companies. We’re only looking for 20-25 of the best companies to have in our portfolio.”
Energy transition was already a strong theme in China prior to the geopolitical upheaval by Russia. “The [Chinese] government wants to encourage decarbonization. There are a number of wind power, solar, electric vehicle and battery manufacturers. It’s clearly a positive trend for China and the world.”
There has also been a political trend to encourage local brands, with the Chinese becoming increasingly proud of their country. The current economic and trade disruption is the third time there has been a world-wide supply shock in four years; the first being former President Trump’s trade war with China in 2018, which continues today, and the second being the covid-19 crisis.
Ninety One says: “The world has changed in a way that will force companies to radically transform and improve their supply chains. In today’s world, yesterday’s supply chains are no longer fit for purpose. The world has changed fundamentally, with huge economic implications in the medium/long-term.”
De-globalisation is “inherently inflationary”, Hart says. But for many economists it has been a long time coming. They would agree with Hart’s assessment that “central banks have been way behind the curve”, being “far too slow to normalise the environment”.
His presentation for the Australasian investors sums up the position for emerging markets investing well. It says: “This is a time for caution, a time for careful assessment of risk, and a time for reflection. We do not believe that there will be an early resolution of the conflict in Ukraine… Such periods of market dislocation will usually offer opportunities in the long term, and we remain alert to potential corporate beneficiaries from this turmoil.”
EM equities is managed as part of Ninety One’s ‘4 Factor’ team of about 40 fundamental analysts and portfolio managers, plus six or so specialist quantitative analysts. They account for a little under one-third of the fund manager’s $US182 billion under management (at September 2021).
They include: three global equities strategies – ‘Core’, ‘Dynamic’ and ‘Strategic’; two China strategies – ‘All China’ and ‘China ‘A’ shares; as well as ‘Asia-ex Japan’; and ‘European’ equities.
Other equity strategies for the firm are a ‘Global Franchise’ and ‘Global Environment’ strategy. Firm-wide, there are separate teams on fixed income, including emerging market debt, multi-asset, sustainability and environment and single-factor quality and value.
The 4 Factor process was developed more than 20 years ago at the height of the dot-com boom, when historical valuation techniques were largely being ignored, as a way to instill more discipline.
The underlying beliefs in the philosophy are: markets are often inefficient due to behavioural errors; objective screens and objective research can cut through inefficiencies and avoid behavioural bias; that a bottom-up approach provides the most reliable opportunity for long-term alpha; and, ongoing management ensures portfolio integrity.
“We search for high-quality attractively valued companies with improving operating performance that are receiving increasing investor attention,” Hart says. On a style basis, this translates to a combination of quality, value, earnings momentum and sentiment.
“The four factors can individually drive share prices,” Hart says, “and in combination can drive long-term outperformance.”