A Different Path to Growth in Emerging Markets
Oppenheimer Emerging Markets Innovators Fund
Author: Ticker Magazine
Last Update: Jun 25, 9:45 AM EDT
|In the emerging markets universe, large-cap names attract most of the attention. However, investors should also look to small- and mid-cap companies for bigger opportunities. Heidi Heikenfeld, portfolio manager of the Oppenheimer Emerging Markets Innovators Fund, navigates the area through the lens of innovation and long-term structural growth. The fund seeks companies with not only high earnings growth but also positive impact for local populations.
“There is significant wealth creation in the emerging universe and the number of companies with market cap of more than $500 million has tripled over the last 10 years and doubled over the last five years.”
Biosimilars offer a good example of how companies with high earnings growth potential can also benefit local populations—in this case, by providing cutting edge drug therapies at more affordable prices. And as these drugs start to sell in the U.S. and Europe, we believe they will help solve the problem of ballooning healthcare costs worldwide.
Q: Can you give us another example from a different industry?
We invest in K-12 education companies in Asia and Africa. Parents in Emerging Markets spend on private schools or after-school tutoring to provide higher quality education for their children. This industry is growing fast and the demand is relatively inelastic. Brand and content quality matters. In countries like China, outcomes are measurable through higher standardized test scores or entry into prestigious universities.
Our positive view on this theme has led to investment in companies such as New Oriental Education, TAL Education, Bright Scholar Education, China Maple Leaf Educational System and Four Seasons Education in China, as well as Curro Holdings and Stadio Holdings in South Africa.
Q: What is your sell discipline?
We value stocks on a 3- to 5-year horizon and portfolio turnover is approximately 30%. Since the EM space is volatile, we have to be responsive if new information causes our investment thesis to change.
If a company becomes overvalued or the position size becomes too big, we trim it. We also trim if the company gets too large. Valuations appreciated significantly at the end of last year so we have been actively trimming to reduce our exposure to the larger companies, while investing in smaller companies and in new ideas.
Q: What is your portfolio construction process?
Our largest position right now is 3% and our top 5 positions represent about 12% of the portfolio. We don’t run a concentrated portfolio; right now we own about 110 names. We’ve consistently invested between 65% and 75% in Healthcare, Technology and Consumer. We don’t invest in energy, metals or mining. We are unlikely to have positions in telecom and utilities. In terms of geography and country allocation, we tend to be closer to our peers and the benchmark but have an overweight in Asia vs. Africa or Latin America because we find more innovation in Asia. Our benchmark is the MSCI Emerging Markets Mid Cap Index.
Q: How do you define and manage risk?
Since its inception, the portfolio has had a low beta relative to the benchmark. Part of the reason is that benchmarks are very cyclically allocated. The large-cap focused MSCI EM Index actually has a higher beta than the MSCI EM Mid Cap Index. This is counter-intuitive. Typically, smaller cap funds are riskier than their larger counterparts, but this hasn’t been the case during EMI’s almost four-year existence. Aside from the more cyclical allocation of the MSCI EM Index, with its higher relative investments in commodities, financials and real estate, flows into passive EM funds magnified the volatility of the Index. In 2017 the flows into active emerging markets funds were $11.4 billion and into passive EM were $42 billion. Because almost all the money in passive instruments flows into funds that replicate the MSCI EM Index, the valuation and volatility of large cap index components has risen.
We try to reduce relative exposure to political risk, by remaining cognizant of our relative country weights.
Additionally, we think about the impact of higher interest rates on the portfolio. Our companies are net cash positive, which should create some relative margin of safety because they don’t need debt to grow and their profitability wouldn’t be impacted by rising interest rates.
Of course, as growth investors, multiple compression risk is another factor we must consider. That is why we use a PEG analysis and keep our position sizes relatively small. We try to avoid unnecessary volatility, believing that we can generate return for investors in a relatively responsible way. Our standard deviation is lower than our benchmark.
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