Interview with Tim Barrett - part of the Investing in Emerging Market Equities, North America 2016 Report

David Grana: How do emerging markets look overall as a sector? Is it the right time to invest?

Tim Barrett: Emerging markets look relatively cheap in aggregate, versus a range of valuation factors relative to other regions and to their own history. When thinking of the world as developed markets and emerging and frontier markets, emerging and frontier markets are a clear overweight.

Emerging markets look attractive compared to developed markets from the perspective of earnings yield, book value and cash flow yields. In addition, technical flows have been positive this year.

The equities and debt in emerging markets are both relatively attractive. From a currency standpoint, emerging market currencies have depreciated pretty substantially against the dollar, providing an increase in protection, and signaling that local currency exposures should be considered.

With all that said, emerging markets tend to disaggregate with the individual parts, gravitating around specific events. Though technical inflows have lifted all boats (a continued reach for yield globally), it is important that it not overshadow the more granular currency, commodity and geopolitical risks.

David: Are there specific countries or industry sectors that look more attractive than others?

Tim: As mentioned, emerging markets are not monolithic, and there are very important individual cycles within the group. Currently, there are attractive markets that have real growth, such as Vietnam, India and China, but the rule of law can be a real challenge. There are also great opportunities in Brazil and Argentina. Argentina, in particular, with its ability to raise capital, should over time push interest rates down, causing risk assets to rise. Unfortunately, the vast majority of opportunity in Argentina resides in the private markets, as the public markets are not very deep.

As to sectors, the continued growth of the consumer in emerging markets makes small cap exposure there more attractive. In Argentina, financial institutions, as well as energy, are interesting opportunities. Financial institutions will benefit from an expanding economy. From an energy perspective, Argentina has the world’s second largest shale play, which provides excellent opportunities for private investments. Vietnam should continue to be the beneficiary of the U.S. as it appears to be a strategic relationship, given the perceived Chinese aggression over territorial rights. Also noteworthy are the wage pressures in China. As their economy continues to develop, more and more the lower skilled jobs are being outsourced to the less developed Asian nations. Indeed, China is in a transitory state, which should continue to open up new and interesting opportunities.

David: Where do you see private markets looking more attractive than public markets?

Tim: Private exposures in equity and loans are attractive in many emerging markets. And in some ways, a better way of accessing many markets. I gave the example of Argentina earlier, which is a perfect example of a market where private investments have a clear advantage. Across many emerging economies, public debt and equity markets are quite limited. Thus, to access great opportunities requires local access to private companies.

David: What are some of the downside risks that investors should be especially wary of?

Tim: Downside risks are always substantial in emerging markets, but can be mitigated by ensuring you have managers with local expertise in navigating the minefields. A prime example is understanding the country’s rule of law. For example, if you were structuring a private loan in India, you would want to be sure to ring fence the equity, where you took control without court intervention, should there be a default. A U.S. style loan would wind up in Indian courts and it would be 10 years later before you potentially were repaid. A good manager should be able to address the rule of law concerns in how they structure private investments. This typically requires that the manager have tenured experience in the various countries in which they invest and local counsel to assist. On the public side, one can access strategies that are long only or ones that involve hedging. This allows one to mitigate some of the downside volatility associated with emerging markets. For instance, an emerging market manager can hedge using equity indicies, commodity futures or options, as well as credit default swaps. All of these tools are useful in mitigating specific risks.

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