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RWC Partners: How the green wave is influencing emerging markets

December 20, 2021

For professional investors only

Portfolio Manager John Malloy explores the opportunities in emerging markets with a look at China – specifically addressing why he holds a positive view on the outlook for the region, despite the challenges that it has faced over the last 12 months. John touches on the emerging market credit cycle, the impact of low rates and how that may change over the coming years with respect to inflation and provides some further thoughts on the continued technology disruption within these markets. John shared these insights during a recent investor webinar held on 24 November 2021.

Overview of emerging market performance

The RWC Emerging Markets Equity strategy performance has been strong during 2021, in what has been a distracting year for emerging markets generally. In fact, over the last 10 years, we've seen a real decoupling between developed and emerging markets – with US equities in particular performing strongly. These long-term cycles are not unusual and, looking at the underlying structural trends, we believe there will be a reversal of that US dominance moving forward.

It’s been a particularly difficult year for China, coming off a very strong market last year from the COVID lows, and ending with a frothy IPO market − a market where some stocks were up literally hundreds of percent. Right now, this situation has changed, with the current wave of regulation forcing some companies to change the way they do business, and in turn impacting the equities market.

Historically, China has seen multiple waves of reform and regulation.  Experience tells us that these reform cycles have lasted anywhere between six months to twelve months, before eventually subsiding. A year ago, we had the shock cancelation of the ANT financial IPO, and at that time, we removed our position completely in Alibaba. We sold a tremendous amount of our internet exposure within China, moving to a 9% underweight portfolio position compared to the index.

Similar to previous periods, we believe that the current reforms will subside. 2022 is a very important year for the Communist Party, as Xi Jinping looks to extend his power and lengthen his time in office. Additionally, China will host the Winter Olympics in the first quarter of 2022 as well as rollout its first digital currency.

At this time, we believe the opportunities within the Chinese market are very attractive. While some sectors such as education may never recover from recent policy actions, many will adjust and continue to thrive. We haven't seen additional regulation over the past few months and as we move toward the new year, we’re confident the People’s Bank of China will start to ease monetary policy.

Policy cycle in China

Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested. No investment strategy or risk management technique can guarantee returns or eliminate risks in any market environment.

We expect to see cuts to the reserve requirement ratio for Chinese banks and a reduction in interest rates as the central bank looks to re-stimulate growth.

The Chinese share market has continued to broaden and mature in recent years, resulting in a tremendous landscape of opportunities within local China. The themes of the Green Revolution, Technology and Urbanisation are developing on the ground in China today.

China’s long-term plan

The green wave

With the recent real estate slowdown, we believe that the government has recognised the impact the slowdown is having on broader economic growth, and as a result, has enforced local policies to help alleviate the stress in the property market.  We are not building positions in Evergrande, but there are companies within real estate services that are very interesting at this point, and we're starting to add those to the portfolio.

The portfolio has increased its China exposure and has about an equal weight to the index, which is approximately 34%. We believe the risk-reward can be very attractive in China due to the market dramatically over correcting, particularly for active managers who can selectively add positions. We’re currently finding attractive opportunities within our themes, and one that is related to the green wave is solar energy.

We have recently made an investment in LONGi Green Energy and it currently represents one of our top ten positions (3.9% of the portfolio*). The company is the largest solar panel manufacturer in the world − controlling about 25% to 30% of the global market. With the demand for solar accelerating and the need to address the climate crisis, solar is one of the key solutions that we believe will continue to be an area of focus for China.


The portfolio has focused on the Copper theme for some time now. Some might say we have invested early in this theme, but we believe it will be a continued long-term thematic. Whilst the US and other developed markets have their challenges, the world is moving forward on building out electric vehicles and expanding the electrical grid, with China and India continuing to assemble their electric networks.

China at this point is the world's largest electric vehicle market, and as we know, electric vehicles consume 4 to 5 times more copper than a traditional vehicle.

At the same time, there has been a dramatic under investment in new copper supply in recent years, despite the outlook for demand. Our forecasts suggest that by 2025 we are looking at a supply deficit of 4% to 5% of the global copper market.

Building out a new copper mine typically takes at least 7 to 8 years with costs running into the billions of dollars, meaning that this supply gap is likely to persist which could be positive for the base commodity price.

We believe that the next driver of commodities over the ensuing decade or so will be the investment in the green wave as we transition away from hydrocarbons and try to address the climate crisis, with the primary beneficiaries being emerging markets.

The credit cycle in emerging markets

There is a view that emerging markets are over-levered, which we think is misinformation. Looking at emerging market household credit to GDP, we can see there's a very large gap with developed markets. While that gap is closing, there is still a long way to go which should be positive for consumption trends.

There is a similar story with respect to corporates. Emerging market corporates appear less leveraged than US corporates with less net debt to 12 month EBITDA**.

Importantly, interest coverage ratios for emerging market corporates, whether that be for investment grade or high yield borrowers, are for the most part looking very healthy. This is reflective of both the relatively low levels of debt and strong cash flows being generated by corporates in the region.

The chart below highlights the large difference between interest rates in emerging and frontier markets and developed markets. The spread has widened this year with emerging market central banks tightening monetary policy to control the risk of inflation, as they attempt to get ahead of the curve. Although emerging market debt has underperformed this year, we think it's setting up to potentially do well in 2022 and 2023 because of these higher interest rates and very competitive currency valuations.

Emerging markets are well prepared to cope with changes in global financial conditions

Continued technology disruption

The growth in smartphones continues to be very strong − not only with handsets but also applications. The EMEA region for example, offers very strong growth as well as the African Region.

As smartphones bring services closer and closer to the consumer, the rise in food delivery is seeing tremendous growth in this area. It sounds simple as it’s basically groceries, but certain companies are moving their ecosystem into other areas, for example dark stores, where they are not just providing prepared foods, but also offering convenience goods, health and beauty goods and other items that really enhance the consumer experience. This is a huge opportunity for companies like Meituan, who has 70%-80% market share^ in the Chinese market.

Another portfolio company that has an addressable market of just under a billion customers within their footprint is Delivery Hero. The company represent a great opportunity having increased its top line results by an impressive 100%^.

We think that this technological transformation is just part of the story because of the ongoing broader development in their ecosystems and the disruption that these food delivery providers offer.

ESG in practice

The focus on ESG is gaining greater momentum. We see that consistently with our investors, portfolio companies, and our stakeholder engagement. We are proud to be signatories to the UN PRI. As part of our commitment to ESG and our involvement with the UN PRI, we have the pleasure of co-chairing a committee which forms part of the Climate Action 100.

We are engaging in ESG and have integrated this into the investment process. An example includes our active engagement with portfolio company Reliance Industries − one of the largest Asian conglomerates with a petrochemical refining business. The firm also has a large business in mobile telecommunications as well as retail, e-commerce, and bricks and mortar. We have had extensive engagement with management to assist in cutting their emissions, and as a result, the firm is taking steps to become carbon neutral by 2035 via a US$10bn^ investment in renewable generation.

Another common issue that we encounter with companies is around governance and disclosure. This is also an area that we have engaged heavily on with Reliance (and other firms) and seen significant improvement.

As companies within emerging and frontier markets continue to embrace ESG, we’ll start to see a re-rating of firms, presenting an alpha opportunity for investors.

Portfolio positioning − top ten holdings snapshot

As a snapshot, our top ten holdings are provided below. Tencent is now the number one position, having built up that exposure earlier this year. Tencent is in a very different position to its e-commerce competitors, like Alibaba or PDE, and we believe Tencent is set up to recover given its gaming platform and strong relationship with Beijing. In addition, our positions continue to be completely off index or quite different in size from the overall size of the index, for example LONGI Green Energy is 0.10% of the index and almost 4% in the portfolio.

The portfolio currently trades under 14 times earnings yet has potential earnings growth of almost 30% over the next three to five years – potentially producing a strong return on equity.

Source: RWC, FactSet, as at 29 October 2021. Figures may not add up to the total figure due to rounding.

A positive backdrop for emerging markets into 2022

As we look to 2022, we see a positive backdrop for emerging markets, especially given the outlook for China. Although the sentiment in China is negative, we see it turning positive, making the relative valuation attractive.

The central bank policies of hiking interest rates in emerging markets across Brazil, India, and Russia has led to a reduction in the level of domestic inflation, not seen in developed markets to date. As we look to 2022, we should expect rates to come down. China is a perfect example having held rates high above 3%^, much higher than other large markets and with monetary policy potentially start to ease, this should bring the cost of capital down.

*Source: RWC, FactSet, as at 29 October 2021.
**Source: BofA Global Research as at 2 November 2021. Earnings before interest, tax, depreciation and amortization.
^Source: RWC, FactSet, as at 29 October 2021.
The Responsible Entity and issuer of units in CC RWC Global Emerging Markets Fund ARSN 630 341 249 (‘the Fund’) is Channel Investment Management Limited ACN 163 234 240 AFSL 439007 (‘CIML’).  Channel Capital Pty Ltd ACN 162 591 568 AR No. 001274413 (‘Channel’) is the holding company of CIML. The Fund invests into Class F Shares in the RWC Global Emerging Markets Fund (‘Underlying Fund’) which is a sub-fund of the RWC Funds, an open-ended collective investment company domiciled in Luxembourg. The Investment Manager of the Underlying Fund is RWC Asset Advisors (US) LLC (‘RWC’). The information above is provided by RWC. To the extent permitted, all liability is disclaimed for any loss or damage incurred by any person relying on the information in this article. While every effort has been made to verify the data in the article, neither CIML, Channel nor RWC warrant the accuracy, reliability or completeness of the information nor do they guarantee the repayment of capital, the performance of the Fund or any particular rate of return. Past performance is not an indicator of future performance. The prices of investments and income from them may fall as well as rise and an investor’s investment is subject to potential loss, in whole or in part. This communication has been prepared for the purposes of providing general information, without taking into account any particular investment objectives, financial situation or needs. The Responsible Entity has issued a product disclosure statement (‘PDS’) for the Fund dated 13 February 2019 which contains important information and is available here. An investor should, before making any decision to acquire, or continue to hold an investment in the Fund, read and consider the PDS and any updated information and seek professional advice, having regard to the investor’s objectives, financial situation and needs. The information shown above is for illustrative purposes only and is not intended to be, and should not be interpreted as, recommendations or advice.

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