The emerging market equity universe has undergone a massive transformation in a very short time.
In the past four years, the MSCI EM Index weighting to tech has doubled to more than 26% while the share of commodity companies has dwindled.
And EM tech companies have made their presence felt this year. The sector has been single-handedly responsible for this year’s
outperformance of EM equity markets. JP Morgan AM has calculated that the tech sector has punched far above its already quite sizeable weight, accounting for almost half of all returns year-to-date.
The largest tech companies such as Samsung, Taiwan Semiconductor Tencent and Alibaba have done especially well, with the former three all seeing their share price more than double in US dollar terms this year.
“Everything tech has had a great year. Moreover, apart from tech the real estate sector is the only sector that has outperformed the EM equity index (+21% in euro terms) as a whole,” says Daniel Tubbs, head of emerging market equities at Mirabaud AM.
“2017 has all been about tech and internet-related companies such as Alibaba and Tencent.”
Tech can make or break a manager
And Tubbs has profited from this outperformance. His Mirabaud – Equities Global Emerging Markets fund has comfortably beaten the MSCI EM Index this year thanks to its overweight to tech stocks.
Those managers who have found themselves on the wrong side of the tech trade, however, have suffered. In more than respect. According to Morningstar data, the two GEM funds with the largest net outflows from European investors this year, Skagen Kon-Tiki (-€3.9bn) and Aberdeen Global Emerging Markets Equity (-€3.29bn), both have strong underweights to tech which has significantly impacted their performance.
And investors have made these funds feel the consequences of missing out on the tech rally, preferring those funds that have a large tech allocation.
After all, investing in an actively managed EM fund is currently the only way for European investors to be overweight EM tech (apart from buying the tech shares separately).
Europe ETFs focus on FAANGs
When stocks perform as well as EM tech (or, actually, it would be fair to say Asian tech as almost all tech companies apart
from perhaps Argentina’s MercadoLibre and Russia’s Yandex are based in Asia), it’s not more than logical for investors to start asking questions about the durability of such a rally. The benign macro conditions in 2017 (accelerating global growth, a weakening dollar, strong inflows, accommodative central bank policy and persistently low inflation) have undoubtedly helped EM equity performance.
“It’s an environment of reflation without inflation, as inflation has fallen markedly in countries like Brazil and Russia and remains contained elsewhere. Emerging markets are also the beneficiaries of a likely peak in the multi-year US dollar bull market,” says Luke Richdale, a member of JP Morgan AM’s EM equity team.
“Flows have been very important. A lot of flows have also come from the Chinese mainland to companies like Tencent. I don’t think this is hot money as all these companies have beaten already very high earnings expectations. Tencent and Alibaba deserve to have performed as they have.
The rally has been driven by solid fundamentals. If they keep going up at this pace that may change but we are not there yet,” adds Tubbs.
EM tech companies no longer look cheap, with the exception of Samsung perhaps, but they provide a secular opportunity too.
And on many metrics they are more attractive than US tech companies which arguably have seen much larger inflows over the past few years.
“Tech is growing irrespective of global growth. Valuations of Asian tech companies are very attractive compared to the US, and growth opportunities are higher,” says Tubbs.
EM overtakes the West
Not only do many emerging markets have a lot of catch-up to do, they are also adopting tech-based solutions at a quicker pace than in Europe, especially in Asia.
“One area where emerging market consumers have leapfrogged the West is in adopting mobile payments by moving to eWallets. These are used now very broadly offline, not just for simple purchases of consumer goods. In China, we do have exposure to Alibaba and Tencent have vast user bases (Alibaba 450m users, Tencent over 900m active users) and big ecosystems of products and capabilities and are using big data to get a better understanding of consumers and their financial habits,” says Richdale.
The fast adoption of digital payments in China contrasts with a lack of pace in developed economies. A recent report by the ECB highlighted that eight in 10 payments in the eurozone are still made in cash. And with the exception of the UK and the Netherlands, contactless payments haven’t seen a significant uptake in Europe. In the US and Japan, contactless payment methods are almost completely absent.
“Tech is a big part of the Asian consumption story,” says Ayesha Akbar, a portfolio manager at Fidelity’s multi-asset franchise in London, who is also overweight the theme. “We expect the presence of tech will continue to grow over the next five to 10 years, especially in areas like artificial intelligence and robotics,” she adds.
However, Tubbs has been reducing his overweight to the Asian mega tech stocks as valuations have risen and trades have become more crowded.
“We are redeploying that into the smaller tech companies. At the beginning of the year we were 10% overweight mega tech. We still are overweight, but much less now as we have taken some profits,” he says.
Perhaps a focus on smaller tech companies could inspire a catch-up rally by EM small cap stocks, which have lagged their larger peers this year. And Mirabaud’s Tubbs may be right in saying Asian tech’s rise this year is justified due to long term growth prospects for the sector, but it would be worth keeping in mind the love of Chinese investors to chase high returns, creating stock market bubbles in the process.
It’s worth remembering that it’s only a little more than two years ago that the Chinese A-share market collapsed. It’s not unconceivable that the same investors who drove the rally back then are now going big in hot ‘consumer stocks’ like Alibaba and Tencent.