Subscribe
Share
Share
Embed
TCW is a leading global asset management firm with over 50 years of investment experience and a broad range of products across fixed income, equities, emerging markets, and alternative investments. In each episode of TCW Investment Perspectives, professionals from the firm share their insights on global trends and events impacting markets and the investment landscape.
Welcome to the TCW Investment Perspectives Podcast, where
our investment professionals share their insights and
expertise on how to make the most of your portfolio.
Today we are exploring trends in emerging market equities,
with an emphasis on how small and mid-cap investments
can offer unique opportunities for alpha generation.
I'm Anisha Goodly, head of the Emerging Markets
Global Fixed Income Portfolio Specialist team at TCW.
I am delighted to be joined by Prashant Khemka, founder
of White Oak Capital Partners, a $9.5 billion investment
management firm based in Singapore and Mumbai.
TCW and White Oak have partnered to launch the actively
managed TCW White Oak Emerging Markets Equity Fund.
Prashant, welcome to our podcast.
Thank you, Anisha.
Pleasure to be here.
Prashant, I want to kick off just talking about
your outlook for returns in emerging markets.
As we know, EM has disappointed relative to
the U.S., despite being 80% of global growth.
What's your take?
Certainly, Anisha.
So we can think of emerging markets from several perspectives.
One is the economics, let's say, and then corporate
earnings, and the market returns, so on and so forth, right?
So how we think in terms of, from a macroeconomics perspective,
see, emerging markets are several very large countries.
China, India, Taiwan, these are individually 20 to
25% of the EM basket, and then you have Korea at 10%.
So amongst these four, you have about 75% of EM.
And then 25% is made up of different regions,
Middle East, LATAM, EMEA, and ASEAN.
And so if you were to truly speak about macroeconomics, we
have to delve deeper into some of these individual countries.
And I'll leave that aside, because each country in some ways has a set of common
factors that affect them, but also a variety of country-specific factors.
And if you look at how EM has done since the turn of the century, since
2000, EM returns have been very much in line with the returns in the U.S.
at around 8% or so.
Going forward as well, our expectation is that corporate earnings growth in
dollar terms should be in the mid to high single digits, call it 5% to 7%, which
is not too different from nominal GDP growth over an extended period of time.
Add on top of that dividend yield, and it's reasonable to
expect 6% to 7% dollar returns from the EM basket, which would
be very similar to what expectation would be for the U.S.
Now, what makes EM more compelling to me as an investment
apportionment-- and by the way, I did live for 11 years in the U.S.
from '95 to 2006-- but my belief then, as is now, remains that emerging markets
are more inefficient compared to U.S., and hence allow for, if you do it
right, they allow for a greater degree of alpha generation or outperformance.
Let me pick up on what you just mentioned in terms of the
inefficiencies and the potential for greater alpha generation.
One of the unique aspects of White Oak is that you pursue
investment opportunities beyond traditional large cap companies.
You're identifying companies in small caps and mid caps as well.
Can you tell us a little bit more?
Can we delve into that, your philosophy and
process, and how you identify those opportunities?
Our approach to investing is as if it's our chosen sport.
If you are a teenager or a youngster who've dedicated
yourself to pursuit of a certain sport with all your
passion, you'd want to be the number one in that sport.
If it's 100-meter sprinting, your goal should be to run
that 100 meters in less than 9 seconds, beat Usain Bolt's
track record, and win the gold medal at the Olympics.
You would not set the target as you want to be top quartile in sprinting.
That means 25% of your neighborhood would be running faster than you.
So with that kind of approach or mindset or culture where everyone
is driven towards a single-minded objective because the game here,
like in sprinting, it's running 100 meters as fast as you can.
In this sport of investing, the game is to deliver
higher return to your investors than anybody else.
Now, to generate higher return, you have to capitalize on
every opportunity out there of generating alpha or as many
opportunities to generate alpha to as great an extent as you can.
Now, we all can agree, and intuitively, we can agree, and there is a lot of
empirical evidence that also shows that in any given market, including in the
US, but definitely so in emerging markets as well, that mid and small caps are
more inefficient segments of the market, which, if you extend the argument,
would mean if a fund manager or an investment team is strong at generating
alpha, they ought to be able to generate higher
alpha in mid and small caps than in large caps.
I want to clarify, I don't mean to say that you can simply
invest more money in small caps and outperform the benchmark.
No.
Large cap, mid cap, small cap, in aggregate, they
can be expected to perform in line going forward.
But mid and small caps being more inefficient, you
can generate greater alpha in mid and small caps.
And then how do you risk manage that?
First and foremost, you have to know what you're investing in.
So you can't outperform by just spraying money.
You can lose a ton of money in small caps by doing so.
So to be able to capture the alpha in mid and small
cap, you have to do very thorough due diligence.
In case of small caps and mid caps, if you don't do
thorough diligence, you can lose your shirt in those names.
There can be disasters waiting to happen.
And one of the greatest value addition of a good
team is in avoiding those landmines or disasters.
And for that, you need a highly talented team and a large team.
If you don't have strong talent, you'll do shallow resource.
So you'll be inch deep and mile wide.
But if you have very strong talent but very small team, then you can go maybe
a mile deep, but you'll be inch wide or a smaller area you'll be covered.
So you need a large team and a strong team to go a mile wide and a mile deep.
That's your best defense against the risk in small and mid cap.
And of course, then there are all the usual
tools and metrics that you would follow.
How much overweight you are to small caps, to mid caps, to large caps, in
which sector, and so on and so forth, which we obviously do day in day out.
Thanks, Prashant.
And I want to delve in a little deeper on that too.
So you've often spoke how you're fully invested in the stock market.
So putting that all together, what you just talked about in
terms of your philosophy and process and the opportunity set,
where do you think the best opportunities are right now?
And are there any regions or sectors that you're avoiding?
In terms of opportunities, where these funds are finding opportunities
are going back to starting with the premise that all markets are
going to deliver similar returns over a long period of time.
That's the fundamental premise we believe in, which is 5 to 7 percent.
All sectors are going to deliver similar returns.
So we look for alpha-rich segments of the market and have
heavier allocation to alpha-rich segments of the market.
So we already spoke about small caps and mid caps.
It's a structural higher allocation to small and mid cap.
Then there are good governance companies and poorly governed companies.
In our view, better governed segments of
the market have higher alpha proportion.
Again, I'm not saying that better governed segments would
outperform in aggregate the poorly governed segments of the market.
Intuitively, one may tend to think so.
But I'm not even taking that as an assumption, just like I'm
not assuming that small caps in aggregate would outperform
large caps, even though intuitively one may think so.
There's no evidence to support that.
Similarly, it's more that the alpha proportion in better governed
companies is higher than that in poorly governed companies.
So our portfolio tends to skew higher allocation in better governed companies.
As an example, we have far lower allocation in SOEs.
So SOEs make up about 20 percent of emerging markets.
In our portfolio, it may be low to mid-single digits, because
it's a struggle in that segment of the market to have
confidence in alpha generation, barring very few opportunities.
Similarly, we believe countries that are more authoritarian
in nature, in regime, have lower alpha proportion, whereas
the democratic regimes have higher alpha proportion.
You can go into reasons why and why not.
But as a result of our such assessment, we have lower exposure to more
authoritarian markets and higher exposure to more democratic markets.
So that's where we have higher allocation, higher allocation
in SMIT caps, higher allocation in democratic markets, and
higher allocation in better governed segments of the market.
I want to pick up on that just briefly and think about, you know, what you're
seeing in the market has been this general trend, let's say, away from China
and into India, an area of your expertise and where part of your team is based.
How do you think about those allocations?
Excellent question, and I've been asked that quite a few times.
We have fortunately a home ground advantage in a country like India, which is
today one of the largest components of the emerging market, benchmark, and
certainly of our portfolio, the largest many a times at about 20 plus percent.
It's also, in my view, the most alpha rich market.
If you think of the some of the aspects that we talked about, SMIT caps, India
is one of the largest SMIT cap pool of companies to pick and choose from.
We talked about, you know, non SOEs.
India has one of the lowest SOE weight in the market.
So India's SOE weight is about 10 percent compared to EM average of
20 and China, since you asked me to compare to China, China is 30.
So the effective investable universe, which is X SOEs, if you were to take
in India, that is 90 percent of the market and in China, that's 70 percent.
So I just did for that.
India is already the largest market.
And then third, also, it's a democratic country, well functioning
democracy, which, as I said, we believe is conducive to higher
alpha generation than the authoritarian regime you have in China.
Going forward, we believe India and China
should perform in line at a market wide level.
But India would present a lot more alpha potential to us than China.
And hence, we'll have higher allocation in India,
just like we have higher allocation in SMIT caps.
And now I know your process really lends itself to very rigorous
due diligence on individual names, bottom up stock picking,
right, while managing some of the macro exposures.
The last question I'll ask you is that just as you think
about EM overall, what do you find most surprising?
See, more than the always events that are happening
all the time that would surprise you at the time.
But those are very much part and parcel and to be expected.
What surprises me more than anything else at this time is just the
general apathy towards EM amongst investors globally, because last
decade or a dozen years have been fairly poor returns from EM.
On one hand, I don't blame investors, because
they've been so disappointed by the returns from EM.
But on the other hand, we all know that yes, this is recency bias.
And the recency might have extended to a decade or longer.
But still, that's history.
It does not say anything about tomorrow and what would the next decade
or next year or five years or decade or 12 years would hold for EM.
So if you look at since the turn of the century,
first 12 years, EM delivered low teens returns.
US delivered almost nothing, a low single digit.
At that time, the narrative was EM is where the growth is.
EM was the fancy of investors.
That was where the future was.
And that was the narrative built, because in the prior
decade or so, EM convincingly outperformed by double
digit outperformance of developed world, including of US.
The last 12 years has been the other way around.
EM has delivered low single digit returns,
and US has delivered low teens returns.
Mirror image.
And now the narrative is US is exceptional.
US is the place to be.
Some pockets of EM are non-investable, and so on and so forth.
What holds in future is impossible to know.
So it's important to not ignore any asset class of size and scale that is of EM.
And hence, what is most surprising to me at this time is
how many people are quite indifferent or skeptical of EM.
Prashant, thank you for taking the time to speak with me.
We are excited to partner with you and the
White Oak team on emerging markets equities.
For more information on TCW strategies, please visit our website at tcw.com.
Thank you for listening, and we'll pick up next time exploring
trends and opportunities that are shaping global markets.
Thank you for joining us today on TCW Investment Insights.
For more insights from TCW, please visit tcw.com/insights.
This material is for general information purposes only and does not constitute
an offer to sell or a solicitation of an offer to buy any security.
TCW, its officers, directors, employees, or clients may have
positions in securities or investments mentioned in this
publication, which positions may change at any time without notice.
While the information and statistical data contained herein are based on sources
believed to be reliable, we do not represent that it is accurate and should
not be relied on as such or be the basis for an investment decision.
The information contained herein may include preliminary information
and/or "forward-looking statements." Due to numerous factors,
actual events may differ substantially from those presented.
TCW assumes no duty to update any forward-looking
statements or opinions in this document.
Any opinions expressed herein are current only as of
the time made and are subject to change without notice.
Past performance is no guarantee of future results.