Last updated: 21:48 / Wednesday, 18 October 2017
Interview with Emily Leveille

Nordea: "We Still Believe That the Risk Aversion Towards Emerging Markets is Too High"

Nordea: "We Still Believe That the Risk Aversion Towards Emerging Markets is Too High"

The current economic fundamentals in many emerging countries, along with the perception that they involve too much risk, generate interesting opportunities for investors with a medium to long-term investment horizon according to Nordea's Emily Leveille. In this interview with funds society she discusses Emerging market opportunities.

Apart from valuations, which other attractions do the Emerging Markets investments currently have?

We still believe that the risk aversion towards emerging markets is too high; this is partly based on concerns over the impact on these markets of the Federal Reserve raising interest rates. In our view, however, the current economic fundamentals in many emerging markets, combined with this perception that they are too risky, creates an attractive investment opportunity for investors with a medium to longer term horizon. We acknowledge that EM in general have been performing well recently – particular in 2017 – but because of valuations, which are still at a discount to developed markets, growth rates which are higher than in developed markets, and the great companies that we can find in emerging markets, we still see an attractive long-term opportunity here.

Are all the regions cheap, or are there some cheaper than others?

We are bottom-up investors, so we don’t have strong views about the valuations of particular markets, but what I can say is that we find a lot of opportunities across regions in companies exposed to domestic development. These could be companies focused on urban consumers in India, healthcare companies in China, or education businesses in Brazil. We also find lots of innovative companies in the technology space in emerging markets, where we see that there is a lot of potential for earnings growth that is not being priced by the market.

Which are the main challenges that the emerging countries are facing? Would they be affected by FED’s monetary normalization? Mainly in Latin America? 

We believe there is already a sufficiently large valuation buffer that exists between emerging markets and developed markets due to the expectation of monetary tightening in United States, such that emerging markets are able to stomach future increases in the Fed’s benchmark rate.  When we look at the underlying medium to long-term economic drivers of a large number of EM countries relative to a group of DM countries – and here of course as the key benchmark the USA – and look at the 10 year yield, we see a significant risk premium already priced into EM. In particular when we look at the underlying growth and debt dynamics of EM vs DM, and how EM has improved since 2013. Of course, we cannot rule out some short-term volatility in EM, particularly if the Fed increases rates at a faster pace than the market expects, but we would argue that this would be a an opportunity for adding to the asset class.

In order to look for opportunities in the Nordea 1 – Emerging Stars Equity Fund…which are the most important criteria for you? And, following these criteria, in which region do you see more opportunities?

When we look for new investments for the Emerging Stars Fund, we look for high quality businesses that can grow their earnings sustainably for many years to come, and then we make sure that we buy them at a discount to their intrinsic value. We can find companies like this all around the world, but as an example, right now we find a lot of interesting companies in India, where you will see we have a big overweight positon. Many of the reforms implemented by the current administration have created a more favourable business environment and lowered the cost of investing, creating many new opportunities for good businesses to take advantage of. 

Focusing in Latin America (where we have a lot of audience), which are the opportunities, divided by sectors or type of company, that you see? Could you give any example? Is it key to have a fundamental bottom-up focus or is the macro view important for you as well?

We see a lot of opportunities in industries like healthcare and education, particularly in Brazil, where an ageing population and rising middle class provide a tailwind for higher spending in these areas. We also still see that banking penetration is very low in many countries across the region, and the competitive environment for banks is very favourable, so we also have a positive view on banks like Banorte and Itau, for example.

With regards to the importance of macroeconomics- for us, the most important thing is to find good businesses that generate returns above their cost of capital for many years. We often find however, that there are many more investable companies in countries with stable macroeconomic environments, because it is difficult to grow a company and invest in a market which experiences a lot of economic volatility. Furthermore, when we make projections as part of our valuation work, we of course take into account projections of inflation, GDP growth, and interest rates and we can have a higher degree of confidence in these projections if there is a stable macroeconomic backdrop.

By countries, in Latin America, where do you see a more promising economic situation that can lead to the creation of investment opportunities in these markets and why?

We have been very impressed by the reforms being implemented in Argentina since the change in administration. The equity market is still very small, but with reforms in monetary and fiscal policy, we are already seeing a lot of businesses coming to the market that want to grow because the economy is growing and the political environment is more stable. In Brazil as well we are encouraged by the economic recovery, very low inflation, a consumer with less leverage, and recent reforms in the labour market and long term interest rates, though we still need to see reform to the pension system in order for us to feel comfortable with debt dynamics longer-term. Finally in Mexico we see a government and central bank committed to prudent fiscal and monetary policy and the ongoing adjustment to government spending due to falling oil production. We believe that the energy reform will be transformational to many sectors of the economy and is already creating many new investment opportunities.

In which Latin American markets is Nordea 1 - Emerging Stars Equity fund overweight?

We currently have no overweight positions in any markets in Latin America, but that is not because we do not find interesting companies in which to invest. Our process is a bottom-up, company by company analysis, and our under- and overweight positions are a result of individual companies that we find to invest in at the right price. We are invested in a concentrated group of companies that we like very much in the region, but we happen to have more investments at the moment in Asia and India primarily.

Does the region face a wave of positive changes and reforms for its equities?

Every country is so different in Latin America, from their size to the components of their economy and their politics. Though we have seen some positive and market-friendly reforms in recent years in places like Brazil, Argentina, and Mexico, I do not necessarily see these as related to some sort of general consensus in the region about a move to the right or to the left of the political or economic spectrum. Each case has been very much related to specific domestic situations.

The weakness of the dollar ... how is it helping the region? Do you consider currencies when investing or covering them?

We do consider currencies in our fundamental analysis as we think about the impact of currency movements to the operating profits of our investments, but we do not try to predict currency movements and we do not cover our currency exposures from being invested in local markets. The weakness of the dollar helps certain industries and hurts others- in general, because commodity exports are a big portion of many Latin American economies, they tend to benefit from the inverse correlation between the dollar and commodity prices; furthermore, the weak dollar makes imported goods in local currency more affordable. However, a dollar that is too weak can also overly inflate the value of Latin American currencies and reduce their relative competitiveness in manufactured exports, as we saw during the financial crisis in 2008-2009, but we are not seeing these types of movements at this point.