State of decay: Does government control erode EM value?

In more developed markets, concern over state intervention centres around central bank policymaking. While that is of course highly relevant across emerging markets too, there is in fact an even larger state-led consideration when investing in these markets: the fact that c.23% of the MSCI Emerging Markets index is comprised of state-owned enterprises (SOEs).

The majority of these companies are not run with profit-maximising intention. They tend to be strategic state assets such as banks, or utility and resources companies, with heavy capital-expenditure burdens. This tends to make them poor stock investments over the long term, though a major commodity bull market can change the optics temporarily. Return on equity (ROE) is usually less important than other strategic desires of the state in capital-allocation decisions.

State ownership can provide stability, but this may involve significant shareholder value dilution, as minority investors tend to be a low priority in stressed situations or in capital-allocation decisions. Interestingly, we saw such dilution with many Western banks following the global financial crisis, and emerging-market companies are perhaps even less likely to focus on shareholder value in such situations.

We currently take zero exposure to SOEs and find the technology, consumer and health-care sectors are relatively free from state control and are where we find the most interesting investment opportunities.

Naomi Waistell, portfolio manager Emerging and Asian equity team. Newton Investment Management – a BNY Mellon Company

In more developed markets, concern over state intervention centres around central bank policymaking. While that is of course highly relevant across emerging markets too, there is in fact an even larger state-led consideration when investing in these markets: the fact that c.23% of the MSCI Emerging Markets index is comprised of state-owned enterprises (SOEs). The majority of these companies are … read more

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Tied to the benchmark?

Market cap-weighted benchmarks rose to prominence in the decades following the 1950s, when the concept of market ‘beta’ (representing the ‘fully diversified market portfolio’) was developed as part of modern portfolio theory[1]. Benchmarks are now the common proxy for beta. Originally, these benchmarks were used as a guide to help measure a manager’s performance. However, over time, market participants became fixated with analysing every difference between a portfolio and its benchmark, potentially tying investors closer to them and away from their core objectives.

With the rise of benchmark-aware investing, either explicitly (through passive mandates) or implicitly (via ‘closet’ indexing active portfolios) much of the industry has appeared to lose sight of this income-oriented objective, focusing instead on price moves in a market where the instruments redeem at par.

In our view in the credit markets, this obsession with benchmarks raises four key problems: indices are structurally-biased towards the most indebted issuers, market weights can lead to concentration risks, passive funds are prone to forced selling and ‘closet’ indexing can tie active funds to flawed benchmarks.

In our view, being more benchmark-agnostic, through looking for the most compelling credit opportunities, maximises the potential to capture beta and alpha more efficiently. In turn, we believe flexible strategies can help investors exploit the artificial barriers created by benchmarks.”

Gautam Khanna and James DiChiaro, senior portfolio managers. Insight Investment – a BNY Mellon Company

[1]Source: Portfolio Selection, Harry Markowitz, The Journal of Finance, 1952. 3 Bloomberg, Bank of America Merrill Lynch, Insight, as at June 2018

 

Market cap-weighted benchmarks rose to prominence in the decades following the 1950s, when the concept of market ‘beta’ (representing the ‘fully diversified market portfolio’) was developed as part of modern portfolio theory[1]. Benchmarks are now the common proxy for beta. Originally, these benchmarks were used as a guide to help measure a manager’s performance. However, over time, market participants became … read more

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Aviation finance – something in the air?

One investment area attracting increasing interest is aviation finance. Air passenger numbers have grown by about four or five per cent a year, with growth driven primarily by Asian emerging markets – in markets such as China – which have seen a steady rise in the number of middle income families. When people earn more they tend to fly more and the growth in tourism is another factor favouring the aviation sector.

Other factors underpinning the health of the sector include low oil prices, growing liberalisation of the aviation sector, and the development of airliners with increased capacity, such as the double-deck Airbus A380.

In a world where the search for yield continues and we have limited avenues to attain that, aviation finance is an area in which significant yield can be generated as long as investors are careful about the types of contracts they enter into. The good thing about the aviation finance industry is that contracts tend to be very tight, very specific and fully insured. Because aviation is such a regulated industry regulatory checks take place all the time and that can also deliver a degree of comfort for investors.

Paul Flood – multi-asset manager, Newton Investment Management

One investment area attracting increasing interest is aviation finance. Air passenger numbers have grown by about four or five per cent a year, with growth driven primarily by Asian emerging markets – in markets such as China – which have seen a steady rise in the number of middle income families. When people earn more they tend to fly more … read more

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