Settling for a broad brush approach towards emerging market equities is far too prevalent. Looking beyond the headlines, and appreciating the fine detail, can give investors a crucial advantage in a sector where over-generalisation often masquerades as analysis.
A common misconception is that emerging markets are completely dependent on exports of commodities or cheap manufactured goods. In reality, many of today’s emerging markets are at the forefront of fast-growing sectors like software and e-commerce. China leads the world in cashless payments systems, which its population has enthusiastically taken up. Online shopping as a percentage of total retail sales was 18.4% in China in 2018. In Germany it was only 11.0%, and in France, 8.8%1. Singles’ Day, an annual mega shopping event run by Alibaba, the ‘Chinese Amazon’, and which was kicked off this year by Taylor Swift, raked in US$38 billion in sales on 11 November 2019. Do Chinese consumers care about trade wars? Alibaba’s stellar profit growth would suggest not: up 73% during the 12 months to June 2019.
Nor do Chinese consumers skimp on price, for the right product. Kweichow Moutai, the world’s largest distillery company, sells bottles of baijiu for around US$250 per 500ml bottle. Its profit growth in the same period was 25%. Ganbei! 2
Consumer trends and fashion are becoming increasingly important in emerging markets. Take the running craze. The number entering marathon races in China has soared from a sluggish 200,000 in 2010 to a thundering 7.3 million in 20183. Anta Sports, the largest home-grown sportswear brand in China, has cashed in. Anta’s low cost base gives it a big advantage over competitors. Its profits have grown 30% in the 12 months to June 2019. If the US-China trade war fails to be resolved, and there is a reaction in China against US brands such as Nike, Anta only stands to benefit.
China, India, Brazil and Indonesia all have large internal markets and their economies will increasingly be driven by consumer spending on home-grown brands. Consumer-focused and information technology companies often have the advantage of being price-making businesses, whereas commodities producers (oil, mining) are price-taking businesses, with profits more cyclical and less consistent.
If the future belongs to emerging markets, that future is growing up now. Roughly 90% of the world’s population under 30 years of age live in emerging markets4. Which nation’s young people will be the best educated in subjects vital to economic growth? The OECD projects that in 2030, of the world’s graduates in science, technology, engineering or maths, 27% will come from India and 37% from China. Only 4.7% will come from the US5.
Part of the motivation for the US-China trade war was to protect intellectual property rights. Meanwhile, China’s ability to create its own intellectual property has increased apace. China is already the world’s number two in numbers of international patents registered, just behind the US, but ahead of Japan, well ahead of Germany, and with about ten times the UK. China’s spending on research and development is also the second highest in the world, almost double Japan’s and three times Germany’s.
The better educated demand superior housing, and will need mortgages. According to some estimates, India’s real estate sector could be worth US$180 billion by 20206, US$650 billion by 2025, and US$1 trillion by 20307. While in the developed world, many banks are becoming tightly regulated, low-growth quasi-utilities, in emerging markets there is plenty of growth to play for. The highly profitable HDFC Bank already has almost as many customers in India (49 million) as the entire population of the UK (66 million). HDFC’s profits have been growing at around 20% a year.
Winner takes all
When thinking about emerging markets, beware of focusing exclusively on what could go wrong and ignoring the importance of what could go right. Finding the winning companies of tomorrow drives long-term returns.
At any point in the economic cycle, there are always exceptional companies that do well, even while others, perhaps more exposed to macroeconomic forces, are struggling. In finding exceptional companies, we are guided by Warren Buffett’s principle of the economic ‘moat’. Having a lasting economic moat means a company’s profits are protected over the long-term by a persistent advantage that competitors cannot match. While economists often paint an unrealistic, theoretical picture of perfect and instantaneous competition, in the real world a deep, wide moat can protect a company’s competitive advantage for many years.
There are different kinds of moat. Alibaba has the moat of ‘network effect’: it is so widely used – by 12 million merchants and 755 million monthly active users – that it is a fixture in people’s lives. Kweichow Moutai has a moat of ‘intangible assets’: the power of brand. Anta has both that and also a ‘cost advantage’ moat. HDFC has a ‘switching costs’ moat: a sticky relationship with customers.
When headlines are negative, or markets are swayed by over-generalisations and oversimplifications, there is often a good opportunity to buy shares in great companies at reasonable prices. That’s why we believe in a high conviction, concentrated portfolio, and investing for the long-term shares of truly exceptional, quality businesses with strong and sustainable moats.
1 Source: Wind, Euromonitor, Morgan Stanley Research, December 2018
2 ‘Cheers!’, in Mandarin.
3 Source: http://www.athletics.org.cn, Macquarie Research, October 2019
4 Source: Euromonitor, 2014.
5 Source: OECD (2015), HSBC research