Assistant Fund Manager, Premier Miton Global Smaller Companies Fund
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
An emerging market economy is an economy that is transitioning into a developed economy. Emerging market economies typically feature a unified currency, stock market, and banking system; they are in the process of industrializing. Emerging market economies can offer greater returns to investors due to their rapid growth. What do we look at when considering companies from this group of markets?
Even though our investment idea generation process centres around bottom-up stock picking, we also believe that regional, country and macroeconomic factors can impact company earnings and valuation. These need to be incorporated into our investment analysis. Making correct predictions for the investment returns of a country over the decades is certainly not easy and so it can be challenging to cut through macroeconomic noise and focus on the potential positive or negative impact on individual company fundamentals.
Asking the pointed emerging market questions
How do we approach this? One technique for doing this is to ask more pointed questions about the specific country. Questions such as: does the educational system encourage entrepreneurialism? If the domestic industrial economy is strong, is that strength passed onto consumers? How stringent is the intellectual property and real asset regulatory environment? What is the balance of local currency vs US dollar-denominated debt? What are the current barriers to development for a business?
Dumplings for lunch?
Let’s dig into this last question to explain how this technique works in practice. The operational infrastructure of an industry could be both a barrier or an enabler for a business. If the supply chain around a business is efficient, then it helps a smaller business to grow with fewer resources. If the supply chain infrastructure is bureaucratic, then larger businesses may have an advantage via their economies of scale. If no infrastructure exists at all, it may give a company the opportunity to build up that infrastructure to suit their own revenue model, handing them a competitive advantage.
For example, let us consider the payment infrastructure in China. In 2011, as a resident of Beijing, I would use cash to pay for my dumpling lunch. Only a year later, I paid by QR code: a lightspeed jump in the dominant payment method. Prior to mobile payments, there was no consumer habit of using a debit card to pay for smaller items. Therefore, one could theorise that the progress to mobile phone payments was fast because the payment system was able to leapfrog this ‘debit card-phase.’
The investment opportunity here was to identify that the market leader in consumer mobile payments was Tencent, via its WeChat Wallet app. WeChat was the primary communication messaging service, and it was able to leverage its broad network and deep consumer base to launch WeChat Wallet, a service similar to PayPal. Unlike PayPal, WeChat Wallet did not have to engage in as much competition with the existing debit card payment providers. Limited competition is generally more conducive to rapid market share growth, and this is what occurred.
Why emerging markets are about more than hope
We often see this ‘catapult’ dynamic in our global smaller companies universe. More flexible and energetic companies take market share verses their larger and more cumbersome peers. A smaller company could develop a superior product offering than a larger peer, too focused on its legacy business to make the investment into research and development. We would have classed Tencent as a ‘smaller company’ in November 2006. At that time, the market capitalization was below US$5 billion. Tencent’s market capitalization was US$410 billion in December 2022.
TenCent Market Valuation in US dollars
Source: Bloomberg data from 30/06/2004 to 17/01/2023.
Despite their size, smaller companies absolutely can be global market leaders. Their smaller market capitalization is often only driven by the size of the addressable market, which may be larger in the future. We screen our universe for companies with strong competitive advantages, especially companies where this ‘catapult’ dynamic may be occurring. We like to see smaller companies expanding their market share or being the global market leader already. Often these companies display quality characteristics, like solid balance sheets or management teams with good track records.
The growth offered by this constantly shifting nature of the emerging markets has made it a good hunting ground for this type of company. So, we continue to believe that exposure to the region is an essential part of the investment opportunity set for a global investor.
Over the long term, we are increasingly optimistic about emerging market economies. Despite the current environment of slowing growth, rising inflation and geopolitical issues globally, we have confidence in both the emerging markets asset class and our strategies. We continue to seek high-quality business with solid balance sheets, competitive advantages and attractive valuations.