Transcript
Hello and welcome to The Download. I'm your host, Dave Richardson, and I am always super excited to be joined by my very good friend, Phil Langham, who is the head of Emerging Market Equities at RBC Global Asset Management. Phil, it is just great to see you. Happy New Year. The family's good?
Yeah, all good. Happy New Year to you as well, Dave. Great to be here.
Yeah, always exciting. I always get excited at the start of a new year. That's why we're doing this series. Again, for those of you who are new to the podcast, please wherever you listen to the podcast, subscribe or follow the podcast. Give us a review. My mom's getting tired of writing five-star reviews, so we need some new people on there. And what we're doing is a series with about 15 different portfolio managers from all around the world, taking a quick look back at 2024, not too much, and then taking a look at 2025. And I've always found the most exciting area of investment to me anyways, if we talk geographical, is the emerging market. So a new year to me always brings particularly similar hopes of optimism for the area and particularly those exciting areas. And Phil, I don't think anyone knows the emerging markets as well as you. It's been a bit of a relatively tough run for emerging markets, similar to Canada that we talk quite a bit about here. The strength of the US markets has just been tough to keep up. And similar to Canada, emerging markets have lagged. But 2024 was a year that was a little more mixed, ultimately ended up underperforming, Phil, but was a little more mixed?
That's right, Dave. But for now, 12 or 13 years, emerging markets have underperformed developed markets and particularly underperformed the US. That's an unusually long period of time. Having said that, if we look back over the last 40 years or so, what we have tended to see is the relative performance of emerging markets compared to develop markets has occurred in very long cycles. We've had two long cycles of emerging market outperformance and two long cycles of emerging market underperformance. Nonetheless, the last 12 or 13 years has been a particularly long cycle. We were hoping that perhaps 2024 would mark the bottom and we would see a turning point. Certainly, there were some signs during the year that that might occur. But in the end, what we saw, particularly after Trump got elected was renewed underperformance towards the end of the year from emerging markets.
Yeah. We've been doing this podcast for about four years. And even when we started, I think we typically start with this conversation every time we have you on or your colleague Laurence Bensafi, who we also love having on the podcast, just the idea that it's been an extended period of underperformance. The relative valuations are incredibly attractive. And yet, here we go again, and we were starting to see some signs of strength in emerging markets, especially as the US dollar had weakened. And again, for Canadians, we need to point out that it’s not the US dollar versus the Canadian dollar, but the US against a basket of global currencies. The US dollar is strong against most currencies around the world. And whenever you get that strength in currency, that's always going to be a challenge for emerging markets. But you mentioned the other aspect, as we were talking before, Phil, that the Trump administration could potentially pose for emerging markets.
I'd say two things to think about, in particular in terms of the Trump administration. So the first one is tariffs. And then related to that is the US dollar. Definitely the threat of universal tariffs, with potentially aggressive tariffs against China, has made investors nervous. If we were to see universal tariffs implemented, certainly, there is a strong view that that could well lead to a stronger dollar. What we saw initially when Trump got elected was that the dollar, or the initial reaction was that dollar strengthened. But our feeling is perhaps taking a more medium-term view that the case for the dollar to weaken is actually now very strong. In valuation terms, the dollar really looks extremely extended. If we look at the US's current account and fiscal deficits, they really have been ballooning. Even in terms of Trump's overall policy, what he wants to do is to very much see US industry become much more competitive, and a strong dollar would really go against that. So we would say that there's a number of reasons to think that certainly over the medium term, the case for the dollar to weaken is quite strong. And then in terms of the tariffs themselves, it does look increasingly from what we're hearing as though tariff implementation won't necessarily be universal. It will be more targeted. And to a large extent, what we're seeing and what we're hearing is that Trump is very much thinking of tariffs more as a negotiating tactic. What's interesting is that if we look at what's happened overall since the trade war started in Trump's first term, first of all looking at China, if you look at China's exports to the US as a percentage of China's total exports, they have fallen from 20% to 15%. But at the same time, China has actually seen very strong export growth. It's also seeing record trade surpluses, and it's been able to substitute its exports to the US for exports to other emerging markets, and also at the same time, really start to move up the value-added curve. What we've seen in terms of other emerging markets is that actually a lot of other emerging markets, particularly Mexico and those in Southeast Asia have really benefited from the move in manufacturing away from China. A lot of those countries have become important manufacturing hubs. We would say that it's not necessarily the case that emerging markets will suffer from the talk of tariffs or what happens with tariffs. Having said all of that, we do still feel, from a bottom-up point of view, it makes sense to be somewhat cautious on exporters, on companies that are exposed to manufacturing. We've always tended to prefer domestic stocks and feel that the need to focus on quality domestic stocks in this environment is, if anything, accentuated.
Well, and maybe this is a good point for a reset, Phil. We've got so many new listeners, where our listenership is up 500% year over year. Again, that's much more than just my mom and Stu's mom as we try to define it. A lot of new listeners. The emerging markets themselves, how many countries do you cover and consider emerging markets within your scope of investment?
It's about 18 to 20 different countries. Generally, emerging markets are defined, or a country tends to be an emerging market, either because it's got a relatively undeveloped capital market or because GDP per capita is still relatively low.
Then within that, there's a wide range of different types of economies, different countries. Some are very based on natural resources. Other have, as you say, strong manufacturing sectors and with exports. Some have a strong and emerging domestic market as wealth increases in these countries. What's the mix? Where are these countries as well? How would you describe the raw number of different opportunities you can take a look at to invest in in your different mandates?
We've seen a real sea change in terms of the structure of emerging markets over the last 20 years or so. Emerging markets used to be very commodity focused. Areas such as energy and materials at the peak made up around 40% of the overall index. Latin America used to represent something like 50% of the overall index. We've seen a real sea change in recent years. Commodities, if we look at materials and energy, now represent something like 10% of the overall index. Pretty similar to developed markets. And significantly less than Canada. We've seen the real growth in domestic sectors, particularly the consumer sectors. And the other area that's really grown has been IT technology, that now constitutes a meaningful part of the overall opportunity set. And I'd say as a result of this change in the index structure, we actually have a much higher quality range of companies, companies that have consistently higher return on equity, return on capital. The opportunity set has actually dramatically improved over the last 15 or 20 years.
Yeah, and I should note, your colleague Laurence has a mandate that is exclusive to emerging market dividend payers, which I think a Canadian, looking at the Canadian market as a developed market, would be surprised to hear, as you just said, that we actually have a higher weighting of commodity and materials producers in Canadian equity markets, and that there's lots of great dividend paying companies across emerging markets. And then that from a debt perspective, and in some cases, inflation perspective, a lot of these countries have made incredible progress and have done a better job than a lot of the developed countries, particularly the US, and Canada would be included in that, no?
What we actually saw last year for the first time since I've been covering emerging markets is that interest rates in emerging markets can converge with interest rates in developed markets. If you look at fixed-income performance for emerging markets compared to developed markets, emerging markets have actually substantially outperformed. I'd say that a key reason for that, or two key reasons, have really been, first of all, how emerging markets reacted to COVID. We saw a huge amount of debt be raised in developed markets. Emerging markets weren't in a position to do that, and we didn't see anything like the same growth in overall fiscal debt. The other difference was in terms of interest rate policies. So when we saw inflation start to come through, developed market central banks were relatively slow in terms of raising interest rates. Emerging market central banks were much more aggressive. Even now, if we look at real interest rates, they're much higher in emerging markets than they are in developed markets.
Yeah. Once again, what I'm trying to make sure I paint a picture for Canadian investors is that people say emerging markets, and I guess even investment firms are guilty of packaging different investment mandates under one umbrella that they call emerging markets. But there is a wide variety of different economies and different opportunities in those countries. That's what you do with such incredible expertise is you're identifying not just, again, on a geographic basis, but right down company by company where there's great opportunities. There's an index and each different country has a weighting within that index, but you're not mandated to stick right up against that mandate. You can go where the best opportunities are.
You're absolutely right. For example, we have some countries such as Korea and Taiwan that are very tech focused. We have India that's still at a very early stage. Penetration in areas like financials or consumers is still extremely low compared to other emerging markets, and certainly very low compared to developed markets. You have markets in the Middle East or Latin America that are perhaps a little bit more commodity focused. Absolutely, there's a wide range of different markets at different stages, different sectors. So a huge amount of choice.
I always tell the story, and I don't think I've told this story on the podcast before. So if you'll indulge me, Phil. It's going to point back to you. So just stick with me. But I was in a Western European country and going into a country that would be qualified as an emerging market country. I was staying at an Airbnb. And the owner of the Airbnb came, and I said, I'm driving through this country. My wife was a little concerned about the safety of driving through the country. And he goes, oh, no, no, it's perfectly safe, but you're going to get a speeding ticket. I went, well, how do you know I'm going to get a speeding ticket? He goes, well, they're going to see your rental car with the plates from another country. You're going to be driving through. You'll be doing the speed limit, and there'll be a speed trap in the town, and they'll pull you over, and they'll demand that you drive back about an hour to pay the ticket in the next major town, and you can push and say, hey, is there anything else that you can do? And they'll push back and go, no, and they'll point to cameras in the trees, and they'll say everything's legit, but you have to go back and pay the ticket, and you just keep pushing, keep pushing them. And then eventually, you'll just slip them some euros, and they'll let you go. So sure enough, I'm driving through this country. My wife and kids are in the rental car. And sure enough, I'm in a line of about eight cars, but I get pulled out with my plates from another country. And the police officer comes over and says, you were speeding, you were doing 200 kilometers an hour in a 30 kilometer an hour zone. And my kids are laughing at me, and they go, you're going to have to drive back an hour and pay the ticket. And it's exactly the way it was described. And then they take me over across the street and everyone's honking because I'd stopped for lunch earlier and a beer was, I think, the equivalent of 30 Canadian cents. So not even a couple of shekels for you in the UK. And everyone's honking because I'm probably paying for beers that night in the town. And then ultimately, the individual has a notebook. I was taking down my license and then put the notebook up to me, and I dropped the euros in, they closed the book, and I was on my way. And I tell the story around emerging markets. And how this points back to you from an investment perspective. As Canadians, we look at a situation like that and we go, that's just not the way Canada works. And so understanding when you look at these other countries, if you haven't visited them, you think that's a bad way of doing business. It's not. It's just the way business is done there. To invest in these countries because of the enormous opportunity they have from a growth perspective, you need to have someone investing in that country who's been there, who's experienced the country, who knows the way business works, who can take a look at financial statements and see the difference between them in China versus the UK. And this is where it's so important. I keep saying, as I said at the front end, that there's so much opportunity here, that the relative valuations are such that at some point there has to be some a normalization if history repeats. When you do it, though, you want to make sure you have someone like yourself identifying those opportunities because it is a different world than the world we live in, the so-called developed countries.
Yeah. Quite a few things to unpack there. I think, first of all, in terms of the opportunity, as you say, it's like an elastic band that's getting more and more stretched. The valuation gap is at record highs. So over a 40% P/E discount, over a 50% price to book discount, it's never been as large as this. Another couple of factors that I'd say could support at some point soon the turning point coming is that we've started to see more recently relative GDP growth in emerging markets, outperform developed markets, and relative earnings growth. If you look over the next two years, again, for the first time in several years, it's expected in emerging markets to outpace developed markets. The other factor over the last three years that's been a big overhang for emerging markets is China. China, at its peak, was about 44% of the benchmark. It's now down to around about 25% having underperformed so much. But we are now starting to see much more aggressive policy coming out from the Chinese government, and that's really what's been missing in terms of supporting the economy, supporting the private sector. We actually saw as a result of this support, quite a large rally in September. It's since fizzled out, but we feel that the signs are very much there, that the government really is looking to stimulate, and we would expect to see much more stimulus definitely over the coming months. In terms of the differences between emerging markets and developed markets, again, you're completely right. The way you invest in emerging markets and think about emerging markets can be very different. Focusing on corporate governance in particular is really important in emerging markets. You touched on some of the reasons, but for us, it's always been something that's key, thinking about your management that you trust, what we find is that focusing on companies that have a strong culture, a real culture of excellence, that think long term, that don't take shortcuts, that think about their employees. All these factors are really important in terms of producing sustainably profitable growth, which is exactly what we're looking for. And really, I'd say a key difference between emerging markets and developed markets, is that you have a lot more family companies in emerging markets. A big part of the index is companies that are family-owned, and it's really important to understand how the families think, how they act, to very much focus on owners and managers, and that's much more important than it is in developed markets. I've had a crack of all your points, Dave?
All my points. Again, I want to be very specific. I'm not criticizing the way that any country does business one versus another, just pointing out that there are nuances, there are differences in the way business might operate, country to country, region to region. Again, I wanted to point out that my view would obviously be that I want to hire a professional to invest money for me wherever I am. But particularly in emerging markets, it's an area that's more challenging just because of the number of countries and the number of differences that you need to be aware of and manage through to be effective, and not just to generate returns, but I think—and I know the way you think—but to manage risk as well.
Yeah, absolutely. That's really important. I suppose when thinking about the index, one of the big differences between emerging markets and developed markets is the large number of state-owned companies or very poorly run companies. In emerging markets, around 25% of the index is in state-owned companies that often are not run for long-term shareholders. They're run for the benefit of the state. If you just invest in the index, you're often investing in a lot of these extremely poorly run companies.
Phil, as we head into 2025, is there any particular area or sector or particular opportunity that you and the team you think is going to key in on this year, at least thematically, what do you think 2025 looks like?
We definitely very much favor domestic sectors, and I'd say in particular consumer sectors and financials. Overall, domestic sectors are really supported by rising income, demographics, urbanization. And I'd say in terms of the consumer sector, what we like is that you tend to see very stable, predictable growth companies that tend to generate large amounts of cash. And consumer stocks have been relatively weak, I'd say, over the last couple of years. So from a valuation standpoint, it actually looks really good. In terms of financials, what we see is that financial penetration in a large number of areas—for example, India—is still very low. There's still that structural growth story. What we see is that the very best banks, the very best insurance companies in emerging markets are really able to maintain their advantage over very long periods of time. Again, that's something that we look for and something that we really like.
Are there any areas of emerging markets that have relatively elevated valuations, countries or sectors, and some that have relatively attractive valuations?
I'd say like developed markets, the main area where we see elevated valuations currently is in technology, and particularly any stocks that are linked to AI. Having said that, emerging market tech stocks still trade at quite a big discount to developed market tech stocks, and they haven't seen the same run as we've seen, let's say, in the big seven US stocks that have really led that US rally. But still, that would be one area that's quite elevated. We did also, particularly midway through last year, see in India certain parts of the market look expensive. So mid-caps and those stocks that are more linked to the CapEx cycle. We started to see towards the end of the year, India correct, and our feeling with India is it's now starting to look much more attractive again, having been perhaps slightly overvalued midway through last year.
Phil, have you been overweight in those areas, the technology sector, or have you been a little bit more cautious due to the valuation and risk profile of those stocks?
We were overweight for much of last year, and we've gradually been trimming that weighting down, and we're pretty much neutral overall in tech now.
Well, Phil, that was just a fascinating walk around emerging markets with a great preview of what to look for in 2025. I know where I'm sitting, as I've been mentioning on some of the previous broadcasts, I'm in the Azores, a little tiny island in the middle of the Atlantic Ocean, and the fog rolls in, and it started rolling in the first day of 2025 here, and it largely hasn't cleared a whole lot. Hopefully, we're going to get some more clarity across all markets in 2025. But you've certainly given our listeners a really good view of what they might come to expect in the coming year. Then how to think about investing in emerging markets. So Phil, always great to catch up with you. Again, all the best to you and your family this year, and hopefully, we'll be able to get you on again soon.
Great. Thanks very much, Dave.