Investors should be high conviction in their stock selection, look carefully for value opportunities and completely avoid any area of the market that they think could lose money is the best strategy for an emerging markets investor, according to Newton’s Rob Marshall-Lee.
Macro headwinds such as slowing growth in China, falling commodity prices, geo-political tensions and the strength of the US dollar have meant emerging market equities have had a torrid time over recent years, especially compared to developed markets.
Performance of indices over 5yrs
Source: FE Analytics
Those losses have been compounded by the events over the past few months with fears over a ‘hard-landing’ in the Chinese economy and a potential rate hike in the US.
All told, it means sentiment towards emerging markets is nearly as low as it was during the worst of the Asian financial crisis of the late 1990s with many managers severely underweight the asset class within their portfolios. 
However Marshall-Lee (pictured), the manager who runs the five FE Crown-rated Newton Global Emerging Markets and has managed to comfortably outperform both his peers and benchmark over recent years, says investors can still make money from the bombed out asset class despite the persistent headwinds towards the developing world.
Speaking at FE’s latest ‘Select’ event yesterday which was attended by the likes of Whitechurch’s Ben Willis and Rowan Dartington’s Tim Cockerill, the manager says being unconstrained is key as he has an active share of 90 per cent and doesn’t see any benefits in turning to benchmark weightings when making investment decisions.
For instance, he holds 20 per cent of his £41m fund in internet holdings, is four times overweight on healthcare and only 1.2 per cent of his portfolio is state-controlled compared to 28 per cent of the MSCI Emerging Markets index.
“That’s the advantage of being an active manager,” he said. “We want companies that are being run for their shareholders where they’re going to take your money, treat you right and re-invest for the benefit of shareholders as opposed to for their government.”
Marshall-Lee’s fund, which consists of 60 stocks, has a 40 per cent weighting in its top 10 holdings, which include the likes of Taiwan Semiconductor Manufacturing, Baidu, AIA Group and Naspers.
Five of these stocks are in the consumer discretionary sector while three are in consumer staples and two are information technology stocks.
The manager says that the weightings of the portfolio are determined by a balance of risk versus reward of the stock and argues that, despite holding large weightings in consumer discretionary and consumer staples stocks, the exposure of the fund is highly diverse.
“We have 20 career analysts. They’re very seasoned, they understand their sectors inside out and they dovetail nicely with the portfolio managers on a regional basis,” he explained.
“We’re very, very focused on the consumer and healthcare areas. It looks like a big number but actually it’s split into a number of different sub-sectors, so there is good sector diversification there and good regional diversification as well.”
Newton Global Emerging Markets has a 34.1 per cent weighting in consumer discretionary and 15.2 per cent in consumer staples. All of its China weighting, which is at a 4 per cent overweight relative to its benchmark, is invested in the service space, which consists of consumer stocks.
“We’re avoiding all the banks in the region, we’re avoiding all the heavy industry, we’re avoiding all the property developers and we will continue to do so. We think that’s where we’re going to lose money and likewise with commodities,” Marshall-Lee continued.
“We’re fully expecting oil to stay in the $40-ish range over the next couple of years as the Saudis try to squeeze out the shale supply. They need to do that to get below their cost curve.”
Performance of index in 2015
Source: FE Analytics
The manager also expects iron ore to stay at low prices and even to move lower because of the huge excess supply in the market, following the slow in China’s demand and the growth in supply over recent years.
Part of his high conviction towards the consumer sector derives from his sentiment towards E-commerce, which he says is a rapidly growing industry within emerging markets.
Marshall-Lee partially attributes this to the release of the low-cost smartphone, and says that emerging markets are not yet used to PC-based broadband so there is a transformation shift following the arrival of mobile internet.
“Five or 10 years ago we were big investors in mobile telecom companies, now we’re very focused on different parts of the value chain. We think they’re having a much tougher time and having to put a lot of capex in and aren’t getting pricing power,” he said.
“We have no handset companies because they’re not capturing growth. Instead, the guys who are capturing the growth are the electronic components. They sell into the handset growth but they’re not subject to the same level of competition - profitable growth is the key, we don’t blindly invest in a theme to tick a box, we’re trying to find companies that can make really good capital returns with reasonable levels of risk. That’s why we now have no telcos in the portfolio.”
Instead of telecoms, the manager has invested in internet holdings, which make up 20 per cent of his portfolio and also attribute to its large weighting consumer stocks.
This number has recently been increased due to the huge growth potential that Marshall-Lee believes sees in the sector. Because the area of the market is also out of favour at the moment, he has used this as a buying opportunity to increase his exposure to Chinese e-commerce company Alibaba.
“We have the opportunity to invest with a five year time horizon and not worry about the next one or two months,” he said.
“The really good thing [about these companies] is their business models. They’ve got strong barriers to entry, very good brands, huge control of the consumer, growth and penetration as the handset cycle takes off and as networks get more and more popular and are more connected with everyday living. So the companies have good cash flows, high returns on capital and have been reinvesting in their businesses.”
“These are companies you can pick up on 20/25 times [earnings], they’re growing at 30 to 40 per cent per year with a return on capital, strong cash generation and strong value opportunities, and they’re privately driven and are not state enterprises.”
The other sector within emerging markets that Marshall-Lee is bullish on is healthcare, due to the growth of the middle-class across regions such as China.
“There are great private sector opportunities here because the government is well behind the curve on what the consumer really wants so we have multi-decade opportunities in these sectors, in companies which are very cash generative and high-return private enterprises,” he continued.
“There is a 2.5 per cent weighting in the index for healthcare, we’re 10 per cent so that’s another advantage of being active.”
“You’ll see with the lack of government provision in the likes of India and Indonesia, they’re very under-penetrated in terms of infrastructure. We own hospital companies in UAE, Indonesia and India. We even hold them in South Africa which is an investment region we don’t like very much at all. It really is because the incompetence of the governments provides a sector opportunity.”
Over Marshall-Lee’s two-year tenure, Newton Global Emerging Markets has produced a top-decile return of 3.12 per cent, outperforming its sector average and benchmark by 10.71 and 10.65 percentage points respectively.
Performance of fund vs sector and benchmark over management tenure
Source: FE Analytics
It has also achieved a top-decile alpha and Sharpe ratio, which measures risk-adjusted return, over the same time period. Newton Global Emerging Markets has a clean ongoing charges figure of 0.95 per cent.
