Glen Finegan of Henderson Global Investors believes emerging markets pose specific risks to investors – knowing local practices is key.
“You win in emerging markets by not losing,” says Glen Finegan, Head of Emerging Market Equities at Henderson Global Investors. “Go in with your eyes open [because] there are risks everywhere: the rule of law in many markets is quite weak [and] minority shareholder protection is almost non-existent.”
Equity investors often have a reputation for bullishness, and perhaps all the more so when their focus is emerging markets. Glen Finegan, however, is keener to emphasise dangers and challenges.
Appointed earlier this year to manage the Global Emerging Markets fund, Finegan argues that emerging markets come with their own problems; governments often play an outsized role and the playing field is typically tilted towards insiders. Many of the usual rules (not to mention laws) do not apply.
“Most of the companies we look at have a controlling shareholder,” says Finegan. “If [that shareholder] wishes to prevent us benefiting from the success of their business, they will find a way and there is very little we can do about it. Going to court in Moscow against an oligarch or debating the right course for a state-owned Chinese enterprise is going to be very difficult.”
Yet he views the scale and number of opportunities in emerging markets as in great part reflecting a single, but crucial, factor: demographics. While population sizes in developed countries have largely stagnated, numbers in developed markets are still rising, and are forecast to continue doing so in the coming three decades.1
“The opportunity in emerging markets is about trying to access businesses that are exposed to the long-term trend of rising living standards for billions of people,” says Finegan.
But emerging market indices are misleading, in Finegan’s view, since they have to reflect the weighting of the companies within them – and the biggest are often too politicised to operate as ordinary companies.
“Many of these enterprises might be very big but they’re not really businesses at all,” says Finegan. “A Chinese state-controlled bank is an extension of the ministry of finance, while Petrobras, the Brazilian state-owned oil company, is the ministry of oil and gas.”
Such companies are often run by bureaucrats, and their direction therefore reflects different aims than a company simply seeking to survive, compete and grow. Instead, company priorities may include increasing employment, increasing national GDP growth, or even enabling corrupt practices.
“[The aim] is rarely to produce strong results for all shareholders,” he says.
Finegan’s conservatism means that balance sheet sustainability looms especially large in his thinking. It was the differentiating factor when he was evaluating Shoprite, a South African supermarket operator, and Bharti Airtel, an Indian telecoms company. Both have invested significantly in new African markets – Shoprite over a period of 20 years, starting from its South African base; while Bharti Airtel’s first African foray was the purchase of an African telecoms business in 2010.
“Shoprite has executed a risky strategy in a conservative fashion – it’s never geared its balance sheet,” says Finegan. “Contrast that with Bharti Airtel in Africa, which borrowed in US dollars, and suffered as a result.”
When it comes to evaluating individual companies, Finegan sets great store by history and by culture. He prefers to spend longer studying a company’s history than on forecasting its future.
“We like companies with strong financial track records, of course, but we care very much about how these track records have been delivered,” says Finegan. “I’d much prefer a company with a strong track record financially that’s been delivered in a conservative manner. Many of the companies in the portfolio don’t have any debt.”
Indeed, debt can be a particular problem for companies in emerging markets – especially if it’s held in dollars. Finegan highlights the case of the Nigerian naira, which began life at parity with the dollar when it was introduced in 1973. Today you need over three hundred naira to buy a single dollar.
“If you invest in a company in Nigeria, you want to be certain that its cash flows will increase faster than the inflation that the seemingly inevitable devaluation will create,” says Finegan. “And fortunately there are some [companies like that]. Heineken’s subsidiary, Nigerian Breweries, owns the strongest brewery in Nigeria. Its track record is very strong because it owns a strong brand, which has given it pricing power. We also like to see evidence of resilience in previous downturns.”
When considering a company’s culture, Finegan spends a great deal of time looking at the controlling shareholders, whether that’s a family, founder or entrepreneur. He will study not simply how they’ve treated shareholders, but also how they treat other stakeholders in the business. In these areas, he argues, virtue can often signal a healthy sensitivity to risk.
“Do they spend their entire time trying to avoid paying tax? Are they content with their operations polluting the drinking water for communities downstream of their operations? Have they got a poor social track record or poor environmental record?” he says. “We think we can infer something about the riskiness of the people running the business if they don’t take those issues seriously.”
Henderson Global Investors is a fund manager for St. James’s Place.
The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.
The opinions expressed are those of Henderson Global Investors, and are subject to change at any time due to changes in market or economic conditions. This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any strategy. The views are not necessarily shared by other investment managers or by St. James’s Place Wealth Management.
1 United Nations’ figures: https://esa.un.org/unpd/wpp/Download/Standard/Population/