WCM Investment Management sees things differently, believing the benchmarks are the risk. The shortcomings of a passive investment approach to emerging markets can be significant, according to Greg Ise, Portfolio Manager & Business Analyst at the California-based equity investment firm. “If you look at the emerging markets indices, they tend to be dominated by lackluster businesses, including bureaucratic, state-owned enterprises (“SOEs”), and are likely to be overweight value-oriented, cyclical sectors that will slowly decline in relevance as emerging economies develop,” says Ise.
He points out that about 50% of the MSCI Emerging Markets Index is allocated to financials, telecommunications, energy, basic materials, heavy industry, and utilities companies. “These sectors grow slower than their underlying economies and are dominated by SOEs. SOEs operate for the state, rather than for private shareholders’ benefit,” says Ise.
On the contrary, emerging markets may also offer some of the most dynamic and fastest-growing businesses across the globe – companies that are leapfrogging the developed world in digital business models and/or creating entirely new services and industries. These are the types of companies WCM looks to own in their concentrated portfolios.
“Which would you rather own,” asks Ise, “an oversized, bloated Chinese bank being forced to lend for political reasons, or a privately owned, motivated technology company bringing hundreds of millions of people into the digital age?”
WCM believes their distinct, research-driven investment process is paramount to achieving sustainable excess return and mitigating downside risk. Specifically, WCM focuses on uncovering companies with growing competitive advantages (a positive “moat trajectory”), characterized by strong, adaptable corporate cultures aligned with that competitive advantage, and all supported by durable global tailwinds. Owning these types of businesses in a focused portfolio partners WCM’s investors with tomorrow’s leading companies, which potentially stand to benefit from a multi-decade tailwind of robust growth.
At the sector level, WCM’s Emerging Markets strategy looks very different from the benchmark. “A focus on innovation, long-term moat trajectory, and culture has led us to sectors like technology, healthcare, and consumer. I think those sectors are vastly underrepresented in the emerging markets indices, both in terms of their current, and more importantly, future relevance,” explains Ise.
Sector Allocation Difference of WCM Focused Emerging Markets Strategy
(as of September 30, 2020)
Source: WCM, MSCI, FactSet as of September 30, 2020
For the last twenty years, emerging market economies have substantially outgrown their developed market counterparts. Mike Tian, WCM Portfolio Manager & Business Analyst, points out that most observers expect more of the same for the foreseeable future, fueled by megatrends such as urbanization, digitalization, and the rise of the global middle class. “As a consequence, companies that are positioned and able to take full advantage of these trends stand to generate strong and consistent revenue and earnings growth, which bodes well for investor returns in the long run,” says Tian.
It is difficult to overstate the growth potential of emerging markets. For example, in just the last twenty years, more than a billion people in emerging markets have joined the ranks of the middle class, nearly two billion have moved into cities, and nearly three billion have accessed the internet for the first time.1
“With tailwinds like that, it should come as no surprise that emerging markets GDP growth has consistently surpassed that of developed markets over the last two decades. In fact, since 2000 – when the GDP of emerging markets was just 43% of total global GDP – the emerging markets portion of global production has risen to 60%.2 And there is plenty of runway left,” says Tian. With more than six billion people living in emerging markets today, which is 85% of the global population, an enormous amount of human potential is about to be unleashed.3
Broader Scope Pinpoints Opportunity
Unlike many investment firms, WCM has intentionally built a team of global generalists, with each analyst working across a variety of countries, sectors, and industries. This structure fosters the application of experience from one sector or geography to others across the world. “In other words, we’d say developed markets experience makes you a better emerging markets investor, and vice versa,” says Ise.
This wider view often provides differentiated, pattern-recognition insights that can sometimes elude a country- or industry-specialist approach. Observing and investing in the continuing development of e-commerce in the United States has taught WCM several valuable thematic lessons, many of which are applicable to emerging markets.
Another example that highlights the benefits of this approach is the global emergence of Contract Research Organizations (CROs), which outsource development and testing for pharmaceutical companies. A well-developed industry in the Western world (look no further than ICON plc), CROs barely existed in emerging markets until recent changes in Chinese regulations opened the door in Asia’s largest economy. WCM’s familiarity with CROs in developed economies has given them insights into what to look for, as well as what to avoid, in a successful CRO.
“We were able to use that global experience to quickly evaluate these new opportunities. Furthermore, because the rise of new industries like this often happens more quickly in emerging markets (think fewer burdens from legacy infrastructure, business processes, regulations, and consumer habits), the ability to use global-generalist experience for a quick evaluation and decision can result in a substantive edge,” says Ise. He states that WCM is seeing this time and again in domains such as digital wallets, mobile e-commerce, cloud computing, and online advertising.
Superior Corporate Culture Search
For years, a critical pillar of WCM’s investment process has been its focus on culture and leadership (one part of which is governance). In the past, not many considered these factors, but nowadays they are receiving ever-increasing scrutiny due to the adoption of ESG frameworks by investors. “We want to partner with capable and trustworthy management teams, running firms with cultures that are strong, adaptable, and aligned with long-term strategy. We believe this emphasis is even more important in emerging markets, where traditions and institutions of corporate governance are generally weaker,” says Tian.
Unlike developed markets, where management teams are largely professional, and capital markets are well regulated, successful companies in developing economies tend to be run by entrepreneurs – or families – who leave a larger imprint on the culture, governance, and the ultimate success of their firms. “It is here we think our long experience, and our deep, boots-on-the-ground work, gives us an edge. We strive to understand how companies tick, from the decision making of top management all the way down to the motivations of frontline workers,” explains Ise.
Focused on Less Downside, More Upside
Overall, mitigating risk is foundational and built into every aspect of WCM’s investment process. This helps to ensure portfolios participate to a much lesser degree when markets decline.
View upside, downside capture ratios and performance of WCMEX:
Ultimately, WCM believes emerging market equities continue to offer long-term investors some of the best growth opportunities in the world. Following a distinct, disciplined active investment strategy, such as WCM’s, may be a smarter route to take than benchmark-bound passive strategies.
2 IMF Datamapper, GDP based on PPP, share of world, December 2019.
3 IMF Datamapper, Population, millions of people, December 2019.
MSCI Emerging Markets Index is an unmanaged index that is designed to measure the equity market performance of emerging markets. You may not invest directly in an index.
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