FSSA Portfolio Manager Rasmus Nemmoe outlines his long-term positive outlook on Indian equities, while acknowledging short-term valuation challenges, and discusses emerging opportunities in China.
Emerging markets (EM) are often said to be more sensitive to macroeconomic developments than their developed market peers.
This is no surprise as the EM universe forms a vast space with many different sectors, companies and regulatory regimes, all subject to, at times, rapid changes as these economies continue to evolve and more affluent middle classes starting to emerge.
Yet, despite these influences, investors can still benefit from taking a bottom-up approach to EM companies, since it is ultimately the share in a business that investors hold, not a share in the economy.
Focussing on quality companies that display sustained and predictable growth over long periods of time can reduce risk to the investor and will dampen some of the volatility that is associated with emerging market stocks, Rasmus Nemmoe, Portfolio Manager, Global Emerging Markets at FSSA says.
“We are macro aware; it’s obviously not something that you can just ignore. But we do not construct the portfolio from a top-down perspective,” Nemmoe says in an interview with [i3] Insights.
“We don’t try to play around with companies that might benefit from this or that Fed [US Federal Reserve] policy. I mean, that could change tomorrow,” he says.
We don't try to play around with companies that might benefit from this or that Fed [US Federal Reserve] policy. I mean, that could change tomorrow
“We have a very bottom-up, benchmark agnostic approach. It comes back to having these resilient business models with strong competitive advantages, because that’s basically what gives them this resilience in times of more adverse environments.
“The portfolio is really the residual of where we see the best long-term opportunities, irrespective of benchmark inclusion or sector and country weights,” he says.
A good example of an adverse economic environment was when inflation started to rise sharply during the COVID-19 pandemic of 2020. At this time, companies with large competitive moats were better able to adjust their prices than those companies that were price takers.
“It’s important to own companies with true pricing power, companies that really have the ability to raise prices when input costs go up and without it impacting sales too much,” he says.
“In good times, everyone can raise prices, but when things are tough, it’s very few companies that can actually do so.”
Nemmoe runs a highly concentrated portfolio. Out of the 36,000 companies listed on emerging market stock exchanges, he can only own a maximum of 45. This limit is important in order to be able to show true conviction in his bottom-up picks, he says.
“If you want to truly have a portfolio of your highest conviction ideas and you want all of them to be relevant, then you need to implement a limit in terms of how many ideas you want to own in a portfolio. Otherwise, the more companies you add you will just dilute that level of conviction,” he says.
Banking on India
Indian equities are an important part of FSSA’s EM portfolio. For example, one of the fund’s largest holdings is United Breweries, a subsidiary of Dutch brewery Heineken in India.
And although valuations have increased significantly in the last two years, Nemmoe is positive on the long term outlook for the country.
“India has the highest concentration of quality companies in the emerging markets. It’s obviously got long-term, attractive growth opportunities, but it also has companies with great management teams,” he says.
“It’s always been a market where it was easy to find good quality companies and I would say for the last 14, 15 years, it has actually been relatively cheap. That is why it made sense to own a lot of India, historically,” he says.
Nemmoe is particularly positive on the country’s private banking stocks, which increasingly have been able to take market share from the big state-owned enterprise (SOE) banks.
“The banking sector is just structurally interesting because obviously penetration rates are relatively low,” he says. “But then you also have this interesting dynamic where 55 – 60 per cent of the banking industry today is still dominated by the big SOE banks, which are very inefficiently run, undercapitalised and simply do not offer their customers good service.
Not only do you have the private sector banks benefiting from this S-curve rise in penetration from rising levels of affluence, but also by taking market share every year from their big SOE peers
“They’re losing market share every year to the private sector banks that we own in the portfolio. So not only do you have the private sector banks benefiting from this S-curve rise in penetration from rising levels of affluence, but also by taking market share every year from their big SOE peers.
“So that’s an area within India that we are structurally quite positive about. And then anything consumption related, anything that benefits from the formalisation of the economy, should do relatively well over the long-term.
“And of course infrastructure, India needs a lot of infrastructure,” he says.
Since April 2020, the Indian equity market has risen quite dramatically. The country’s broad S&P BSE 500 Index increased by more than 350 per cent between 3 April 2020 and 10 October this year. It has caused Nemmoe to be a bit more careful on adding further to his India position in the portfolio.
“I’ve always been asked as an investor why I own so much in India, [but] for the first time, I’m now being asked why I don’t own more in India? In the long term, we are still very positive, but over the near to mid-term we probably want to see some curbing of that enthusiasm,” he says.
Shareholder Alignment in China
Chinese stocks haven’t had a great run in recent years, partly on the back of concerns over a potential trade war with the United States, the tensions around Taiwan, but also due to issues with the broader economy, including the country’s real estate market.
Although the Chinese government announced a new stimulus package in September, which caused some relief in the market, many investors still doubt the long term health of the Chinese economy.
But for a bottom-up stock picker, China offers plenty of opportunities as it is a very large and deep market. And the repricing of stocks in the market has created some interesting opportunities, Nemmoe says.
“I don’t think there is just one China; China is a very broad and diverse market. There are huge differences between the coast and the inland,” he says. “It is a very broad market with more than 3,000 listed companies. So, for us, it’s quite an attractive pond to fish in,” he says.
“At a time where basically everything has been thrown out with the bathwater, we have come across some fantastic businesses that, irrespective of what the economy is doing, can easily sustain a 10 per cent plus annualised growth rate.
“But you’re seeing them trade below 10 times forward P/E earnings, while they have high single-digit, free cash flow yields. If you just compared that to what else you have in the world…”
I don't think there is just one China; China is a very broad and diverse market. There are huge differences between the coast and the inland,” he says. “It is a very broad market with more than 3,000 listed companies
Nemmoe tends to avoid investing in Chinese SOEs as their objectives are often not aligned with minority shareholders. But he is not dogmatic about it and currently has Chinese brewery TsingTao in his portfolio.
“As a general rule of thumb, we don’t invest [in SOEs] unless there are good incentive structures that are aligned with minority shareholders. I would say now nine out of 10 SOEs do not have that.
“But TsingTao, which is the second largest brewery in the country and an SOE, has share incentive schemes with management KPIs that are aligned with minority shareholders,” he says.
In 2020, Tsingtao Brewery became the first company in the beer industry to implement a management stock incentive in an effort to mitigate conflicts between owners and managers, retain talent and enhance company performance.
Academics from the Siam University in Thailand assessed the performance of the brewery after the introduction of the equity incentive program and found that it had positively impacted the company’s operational performance across a range of metrics.
Value Up & Korean Companies
In South Korea, the government has also been trying to align management incentives better with shareholder interests. Historically, South Korean companies have traded at lower valuations than comparable global peers, partly because of a poor track record in corporate governance.
But in February 2024, the government announced the so-called ‘Corporate Value-up Program’, which includes tax incentives and benefits for companies that take measures aimed to increase their corporate value.
It echoes similar attempts made in Japan, where the government introduced a return on equity (ROE) index in 2014, naming and shaming companies that did not pursue the creation of shareholder value. The introduction of the index there seemed to have led to better ROEs, mostly through margin improvements.
But Nemmoe is somewhat hesitant to ascribe a wholesale change in the making to the Korean reforms.
“Korea is quite a conservative society and corporate Korea is dominated by the Chaebol, the conglomerate families. You can, to some extent, argue that the value-up program goes against their interests. So it’s going to take a while for this to truly have an impact,” he says.
“I think it will eventually pan out. But I do think that it’s something that will take quite a long time,” he says.
Nemmoe believes that real improvement is more likely to come from the changing makeup of market participants, where the country’s pension funds are increasingly becoming more active investors and shareholder activism has been on the rise.
But he suspects it will take a generation or two to get there.
“I would say in Korea, the largest companies have really set a bad example for the rest of the market. I mean, Korean Chaebols do not have particularly great corporate governance,” he says.
“That’s very different in Taiwan, where TSMC, and particularly its ex-CEO and Chairman Morris Chang, have really introduced best practice governance. And that’s very apparent also in the rest of the country.
“Taiwanese companies have, on average, I would say, some of the best corporate governance standards in Asia. And I think that really comes from TSMC setting an example for the rest of corporate Taiwan,” he says.
Disclaimer: Reference to specific securities (if any) is included for the purpose of illustration only and should not be construed as a recommendation to buy or sell the same. All securities mentioned herein may or may not form part of the holdings of FSSA Investment Managers’ portfolios at a certain point in time, and the holdings may change over time.
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