Emerging markets: why cheap is no longer enough

For years the emerging markets value playbook was simple enough to fit on an index card: find good companies trading below what they are worth, buy them, and wait for the market to notice. The waiting was the strategy. Saurav Das thinks the second half of that plan has quietly stopped working.

Das, head of research on the emerging markets investment team at Orbis Investments, argues that a low valuation is now a starting point and nothing more.

The rise of passive money has eroded the mechanism that used to turn cheap into fairly priced. Passive capital allocates by index weight rather than by prospective return. Active investors once spotted a mispriced business and bought it until the gap closed. That dynamic no longer holds with the same reliability.

“In a market increasingly shaped by passive capital, investors cannot assume an undervalued company will eventually be rediscovered,” Das says. “Many smaller, less prominent or out-of-favour companies can be overlooked for extended periods, even when their fundamentals are improving.”

The internal catalyst

Das reframes the whole exercise around a single question, and it is not the one most value screens answer.

“The difference between a ‘value trap’ and a genuine opportunity is not simply how cheap a company looks. Investors need to understand why the valuation is low, what could cause that discount to close and whether the people controlling the capital have the incentive and ability to make that happen.”

The catalyst, in other words, is no longer the market. It is management, a controlling shareholder or a policymaker choosing to act on a depressed price through disciplined capital allocation, governance reform, restructuring or buybacks.

Where those in control of the capital respond, a company can re-rate. Where they sit on their hands, it can stay cheap for as long as they like.

“Investors must therefore look for businesses capable of creating their own catalyst for change rather than relying on the market to eventually recognise their value,” Das says.

A share buyback is his cleanest illustration. It is most compelling, he argues, when management judges that the return from buying its own deeply discounted shares beats the return from investing further in the business. At that point management becomes the marginal buyer the market has failed to provide.

Das is careful not to treat corporate action as a signal in itself, and this is where the piece earns its scepticism from the source rather than despite him.

“That does not mean every buyback, restructure or board change should be viewed positively.”

Jardine Matheson

The company Orbis offers as the framework in practice is Jardine Matheson, the Singapore-listed, Hong Kong-based conglomerate with interests across property, retail, automotive and mining. Weak sentiment towards anything tied to Hong Kong weighed on its shares, despite that diversified base.

Orbis looked past the cheap price and judged that the people controlling the capital were prepared to move.

In response to the depressed valuation, the group simplified its structure, strengthened oversight and improved capital allocation, while keeping shareholders aligned through significant family ownership and management incentives tied to long-term dividend growth.

Not a single trade

What follows from all this is a way of building an emerging markets portfolio that looks nothing like the index. Orbis starts with the individual business measured against its own estimate of intrinsic value, not with country weights, sector buckets or benchmark positions.

That bottom-up discipline matters more in emerging markets than almost anywhere, Das says, because the differences that decide outcomes, governance, ownership structure, regulation, capital allocation, can be as wide within a single country as between one country and the next.

“Emerging markets should not be treated as a single trade. There are companies with poor governance or structural problems that may remain cheap for years, but there are also high-quality businesses where low prices are creating pressure for change.”

A single EM allocation, or a passive EM index, buys the value traps and the genuine opportunities in one undifferentiated parcel, and increasingly relies on a repricing mechanism that Das says is fading.

The alternative for many investors is to back a manager whose entire job is telling the two apart, and to ask that manager the question Das puts at the centre: not whether a business is cheap, but who is going to make it worth more.

Orbis, which has run the same contrarian, long-term approach for more than 30 years across a team of 60-plus professionals and about A$80 billion in assets, has an obvious interest in that answer.

The framework still holds up on its own terms. In a market where cheap no longer fixes itself, the useful question has moved from what a company is worth to who will close the gap. As Das puts it, the task for investors is to distinguish between the two.