Caroline Cai from Pzena Investment Management speaks to The Inside Network’s James Dunn for our IN60 series. The Inside Adviser
The historic outperformance of big tech stocks in the US may look like a global outlier, but many developed markets (including ours) have high levels of concentration risk. That may not be the case for long, with a likely softening interest rate environment set to re-order indexes around the world.
Ox sees silver lining in emerging markets sell-off
While the worst of the September-October sell-off in emerging markets is probably over, the sector is still in a tailspin. But the best thing about starting low is that can aim high.
For many investors, China’s recent regulatory crackdown has been a waking nightmare. Add on the Delta variant, rolling blackouts, and Evergrande, and it’s a little disconcerting to hear Dr Joseph Lai call the timing of Ox Capital’s launch on Monday (September 27) “impeccable”.
“We’re at a very interesting time where there’s long-term changes happening that may potentially reverse the fortunes of emerging market equities,” Lai said. “… The share prices have come off for us; the starting point is low, and low valuation is usually a good predictor for future performance over three to five years.”
Emerging market equities can be a tough sell for those who get their kicks from the S&P500. They’re prone to long periods of underperformance relative to their developed market counterparts, and the last ten years – or, about a quarter of their history – have been just that. But Lai believes this period is an anomaly; volatile commodity prices will rise and stay high, “lifting the fortunes” of those countries producing them, while the demographic powerhouse of a burgeoning middle-class will be a key engine of growth – the EM orthodoxy.
Ox is led by Lai and fellow principals Douglas Huey and Alan Zhang, and runs a portfolio of 30-50 “undervalued, well-run companies” in healthcare, insurance, technology, and internet stocks, predominantly from the Asian region.
“There’s emerging companies that are first-class in the consumer space, the retail space, and the internet space,” Lai said. “We think that despite the near-term volatility, they remain long-term winners… But the big winners of the last ten years might not persist. These extremely high valuation, hybrid growth stories where they’re on 20-times sales – I think it will be difficult for those stocks.”
Buttressing the investment process is the Macro Overlay Aggregate Tracker (MOAT), a risk management tool that quantifies around a million pieces of market and economic data to forecast how the market might behave in the near-future and second-guess the human decision-making process. The MOAT, and Ox, believe that there’s more pain to come for emerging markets as the Delta variant continues its rampage across the world, and that stability won’t come until sometime in the second quarter of next year. The risk Lai is most concerned about is global liquidity tightening as a result of rising raw material prices, but he believes that the big stories have mostly played out. Lai says: “Whenever there’s a lot of attention on something, that’s usually already in the price.”
“One has to be circumspect and try to figure out which way the wind is blowing. Doing that isn’t easy. You have to have a deeper understanding of what the intentions of the regulators are, and then try and pick stocks that are picking-up tailwinds,” Lai says. “There are all these concerns centring on China, and a lot of them are legitimate and they should be seriously considered.
“But ultimately, if we think about whether some of these companies that are enjoying regulatory tailwinds will be bigger and stronger businesses in three to five years’ time, in nine cases out of ten, most people believe they will be.”
Ox will also be taking a closer look at the renewables sector as a “perfect storm” of energy shortages rolls across the world. There’s been periodic blackouts in China, while LNG prices are at record highs. That’s likely to get worse – the northern hemisphere winter hasn’t yet arrived – but Lai believes that the tightness in energy is part of the growing pains of the fledgling renewables sector, which “aren’t quite ready to take the full load.”
“So we’re looking at that, and I think there’s still a lot of scepticism in this sector for various reasons. But it’s important to make sure the transition is smooth – so we’re looking at companies that are evolving to undertake some of these activities in a more ecological way,” Lai says. “There’s a lot of these things happening in the world, and it impacts our region, because Asia is really one of the very few regions that has seen significant growth in energy consumption. Europe’s not growing; the US isn’t growing much. So it’s very important for us to understand that.”
