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Why our family office believes in emerging markets

Sentiment has turned sour on emerging markets (EM). But it has now thrown up share price inefficiencies which are impossible to ignore. 

We believe EM has experienced inefficiencies all along – we don’t seek to time the market. This means EM can be best tapped for profit by active managers. In many emerging countries, this is partly because the new economy is taking on a legacy economy for the first time, transforming the investable universe.  But market P/E ratios are as low as seven.

Where do we have the highest conviction when investing in EM? Well, it’s certainly not cyclical commodities – I have no idea how much an oil barrel will be worth next week. 

We adjust our risk profile when sentiment shifts by reallocating between local emerging markets, rather than losing alpha by diversifying through a global allocation.

But if we tap into the rise of the middle class in the emerging economies, we can invest in the high-quality companies that will facilitate growth. We can pick, based on fundamentals, the best digitalization enablers that will accelerate the transformation of the economy to what we consider modern. We can discover the most innovative consumer ecosystems that will take services to lower parts of the pyramid at a cost we never dared to dream before the era of smartphones.

Therefore, our portfolio is exposed to super-trends such as the rise of the middle class, digitalization, and consumer ecosystem. Admittedly, these grow at variable speeds, but they keep growing. A family office like us, with long-term patience, can benefit from this structural growth while much of the hot money attempts to time the market or trades passively through the highs and lows. 

Understandable scepticism towards China after the regulatory crack-down started in early 2021 and the current Covid lockdown of major cities and ports are bringing more dark clouds to the horizon. Consequently, capital has escaped to markets like India – whether this is for the right reasons can be debated. 

Currently, we see a lot of interest in the ASEAN region, although there is a capacity constraint when you replace China or India in portfolios. After a decade of neglect, we are seeing institutional players in the Nordic region allocate money to Latin America, although, again, this seems tactical rather than strategic. Whether the money sticks and investors recognize the opportunities of transformed economies in LatAm remains to be seen. 

We believe in splitting global emerging markets into regional allocations. It’s important for us to keep the conviction of allocation between regions to ourselves and leave the local stock picking to our portfolio managers. We manage the overall risk by adding or shaving our top-down exposure. We adjust our risk profile when sentiment shifts by reallocating between local emerging markets, rather than losing alpha by diversifying through a global allocation.

As new generations become active shareholders, responsibility and impact arise as new goals for investment strategy. And EM exposure does bring some headaches even during good times. 

As a responsibly conscious Nordic investor, we need to emphasise ESG risk which is tricky in emerging countries. Often the data is poor and local legislation does not hold companies to the same standards as we do. Consequently, EM allocation drags the ESG profile of one’s portfolio down, even if you pick the best-in-class from a given universe. In order to sleep with clear conscience, managers have to go an extra mile with analysing stocks and their ESG profiles instead of fully relying on data providers, once again, highlighting the need for active management.

Digging deeper into responsibility, impact investing in EM looks very different to developed markets. And, here, it is easier to understand its relevance because the ideas, and solutions, are simple, and capable of resolution through existing technologies. 

You do not need to be a scientist to understand an impactful company in Tanzania building homes or in Peru providing financial services to women living in a distant village. 

We are true believers that disruptive technology is an equalizing power in EM. It is often about good practice which only appears impactful to an investor from our part of the world. 

The drivers of management are the same as in any good corporation here, making good business to create value for shareholders. And good governance prevents corruption.

In developed countries we have a lot of companies and funds riding the greenwashing wave where we cannot point out quantifiable impact, making it very difficult and time-consuming for a family office to build conviction. In EM, the answer is in plain sight, if you go about things in the right way.

Martin Rex Empacher is Chief Executive of the YardHouse Capital Group, a Copenhagen-based family office

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