by Jake Moeller.
Lipper’s Jake Moeller reviews highlights of a presentation by Gary Greenberg, Head of Global Emerging Markets, Hermes, August 21, 2014.
It is increasingly popular for emerging markets to be contextualised within myriad acronyms such as BRIC (Brazil, Russia, India, China), MINT (Mexico, Indonesia, Nigeria, Turkey), and the unwieldy CIVETS (Colombia, Indonesia, Vietnam, Egypt, Turkey, South Africa). Gary Greenberg, lead manager of Hermes Emerging Market Equities Fund, doesn’t care much for these acronyms, believing they misrepresent the heterogeneous and fluid nature of emerging markets. For him, emerging markets can be simply defined as those within the MSCI EM benchmark, along with some of the “frontier” countries. He points out that there are some 33,000 stocks within countries represented in these regions, but only around 2,500 or so are sufficiently liquid to warrant serious consideration in a U$423 million sized mutual fund.
For investors seeking to bring order to the noise and chaos of emerging markets a pithy acronym might help. However, the Hermes process, over which Mr. Greenberg presides, may be more useful. It is genuinely multi-faceted, incorporating both top-down and bottom-up methodologies. Additionally, Hermes has an established stewardship and governance business (EOS), which—through its institutional assets under management—exerts considerable influence. Mr. Greenberg points out that his fund is not an activist fund, but the EOS relationship is helpful in improving corporate standards. He cites examples of exerting some pressure on a well-known electronics manufacturer whose suppliers were employing child labour and the appointment of two directors who represented minority shareholder interests to the board of Petrobras. Around 25% of the stocks in the emerging-market portfolio are ones with which EOS is able to engage.
Table 1. Performance of Hermes Global Emerging Markets Fund against MSCI EM World Index (from Mr Greenberg’s Tenure) in U$.
From a bottom-up perspective liquidity is crucial. Hermes filters for stocks with a more-than-US$500-million market cap and that have a US$3-million average daily trading volume, although this is de minimis and most have more. Stock modelling is extensive with a proprietary 18-factor model that includes valuation, profitability, earnings momentum, and balance sheet metrics. Mr. Greenberg highlights that the most important element within this screening is revenue analysis; each analyst undertakes a detailed and bespoke review of all elements of a stock’s revenue characteristics. A target price for the stock is established, and the individual analysts present their stock shortlist to the group of analysts and Mr. Greenberg for debate. If the analysts are able to convince the team of the investment thesis, the stock is then included in the portfolio. Company visits are also a crucial part of the review process, with the eight person strong team’s objective to undertake 1,000 company visits a year.
Table 2. Three Year Risk/ Return Graph of Hermes Global EM Fund within Lipper Global EM Sector (in U$).
Hermes also uses a top-down model that gives each of seven countries over-weights, neutral-weights, and under-weights. This is done quarterly, and each country is “treated like a stock,” being assigned a fair value and ranked by expected U.S.-dollar returns. Initially, the Hermes team considers a country’s political situation and how that influences economic policy. The “stock” is then distilled down to views on outcomes for GDP, inflation and interest rates, domestic activity, and finally share earnings. So, in the case of Brazil, which is currently a neutral allocation, the view depends on the outcome of the impending presidential election, with Mr. Greenberg believing a victory by incumbent Dilma Rousseff will result in poor infrastructure and reform decisions and unfavourable monetary conditions. Currently, China and India, which are “committed to a model to become efficient and sustainable with sensible valuations,” are the largest regional over-weights. Russia, on the back of uncertainty as to the “direction of the administration,” has been downgraded from over-weight to neutral.
Mr. Greenberg is robust in justification of combining both a top-down and bottom-up approach: “Bottom-up analysis makes implicit assumptions about the economy. Somebody analysing a car company is implicitly modelling GDP. All we do is make it explicit. Where top-down and bottom-up mesh, we end up with an ‘integrated’ stock selection idea.” The portfolio itself is quite concentrated, consisting of some 65 stocks with a very high active share of 92% and a tracking error of 4%. The portfolio has been transitioned under Mr. Greenberg’s tenure to its existing size from 120 stocks and has moved from a value bias to a more growth-oriented style with a larger mid-cap component. It is currently overweighted in consumer discretionary and IT stocks. The fund has outperformed its benchmark since Mr. Greenberg took over in July 2011.
Table 3. Performance of Hermes Global EM Fund within Quartile Rankings of Lipper Global EM Sector (from Mr Greenberg’s Tenure) in U$.
Mr. Greenberg sees 2014 as being a “watershed” for emerging markets as they face decisions at the political level to become sustainable and responsible economies. He believes the “easy ride” of low-cost labour exporting manufacturing to the Western consumer is over. He cites Mexico’s energy and financial reforms, Taiwan’s and Korea’s highly educated workforce and strong infrastructure, and the Korean and Chinese governments’ forcing companies to pay dividends as examples of how emerging markets are evolving from a tactical trade to an increasingly robust longer-term investment.
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