Todd McClone, left, and Casey Preyss co-manage the William Blair Emerging Markets Growth fund.
Photograph by David KasnicA lot has changed since Todd McClone and Casey Preyss began investing in emerging markets in the mid-1990s and 2000s. Back then, the investible universe boiled down to Indonesian noodle manufacturers and Chinese cement companies, among a few others.
A few decades later, emerging markets aren’t only a primary driver of global economic growth, they are home to some of the world’s most innovative technology companies and a growing consumer class. “In China, the domestic market is so huge that there are companies with $50 billion market caps you’ve never heard of,” says McClone, 52. This isn’t hyperbole. The world’s largest spirits company, Kweichow Moutai (ticker: 600519.China), has a $350 billion market capitalization. “That’s twice as big as McDonald’s,” says Preyss, 44.
Therein lies opportunity, and that is one thing that hasn’t changed, say the co-managers of the $1.2 billion William Blair Emerging Markets Growth fund (WBENX). The all-cap fund ranks in the top 10% of emerging market funds for every major trailing-return period over the last decade. It has returned nearly 40% over the past year, double that of its average peer and the MSCI EM index. The fund carries an expense ratio of 1.51%.
While much of this outperformance is due to the fund’s large positions in Taiwan and China—whose economies recovered faster from the Covid-19 downturn than their emerging-market peers—McClone and Preyss base their investment decisions primarily on the prospects of individual companies. In a nutshell, they are looking for high-quality growth companies characterized by strong cash flow, high returns on invested capital, and management teams who are good stewards of capital. In typical times, they and their team of 16 global analysts meet with about 1,500 companies a year in person. Now the managers and analysts are connecting with companies virtually.
Many of the fund’s 125 holdings were first held by the $291 million William Blair Emerging Markets Small Cap Growth fund (WESNX), which McClone and Preyss also co-manage; they started at Chicago-based William Blair in 2000 within a week of each other. By their estimates, small companies account for three percentage points a year of excess return in the diversified fund.
William Blair Emerging Markets Growth
Note: Holdings as of November 30. Returns through Dec. 21; five and 10-year returns are annualized.
Sources: Morngingstar, William Blair
Still, growth tends to be easier to come by when macroeconomic winds are blowing the right direction. “We’re probably as bullish as we’ve been in the last 10 years, and for a laundry list of reasons,” says McClone. Going down that list: Many emerging countries are ahead of the U.S. in their Covid-19 recoveries, and AstraZeneca’s (AZN) vaccine holds promise for these markets; interest rates are near all-time lows; a Biden administration likely means a more predictable trade policy; and a declining U.S. dollar typically translates to emerging market outperformance.
The timing is also right. Emerging market stock valuations are 15% cheaper than their average discounts to developed markets, earnings are poised to grow 25% next year, and global fund managers are significantly underweight emerging market stocks—meaning they hold less compared with their benchmarks. “Even if global funds go back to the long-term average of 9%, that would be $350 billion of money moving into emerging market equities, and that’s still not even close to being neutral-weighted,” says McClone, adding that capital flows to these markets create a virtuous cycle in which fundamentals improve, multiples expand, and the cost of capital comes down further.
The managers first bought Chinese tech conglomerate Tencent Holdings (700.Hong Kong) in 2008, sold the position, then bought again in 2011 when the stock traded around $5 a share. They still own Tencent, and see potential for Singapore-based consumer internet company Sea Ltd. (SE)—in which Tencent has roughly a 25% stake—to apply a similar playbook for gaming, e-commerce, and financial services to Southeast Asia. “They look like Tencent 10 or 15 years ago,” says McClone, but Sea is making progress quickly, particularly with its widely downloaded e-commerce app, Shopee.
Brazilian fintech firm StoneCo (STNE) isn’t a household name among U.S. investors. The company operates exclusively in Brazil, working behind the scenes to provide small and midsize merchants with the infrastructure to process electronic payments. The stock surged nearly 40% in November, based on surprising third-quarter results, but McClone and Preyss say there is plenty of room for growth. “E-commerce penetration rates in Brazil are about 10%, which is still very low relative to developed markets,” says Preyss, noting that about 70% of transactions in Brazil are in cash. Speaking of cash, StoneCo is already profitable, generating 30% net profit margins.
StoneCo’s success is all about keeping it local, but the opposite is true for Argentina-based Globant (GLOB). The IT services outsourcing company works with such marquee companies as Walt Disney (DIS), Alphabet (GOOGL), and Southwest Airlines (LUV) on all things digital. Relative to its counterparts in other markets, such as India, the stock is more expensive, McClone says, but 55% more profitable per employee. “This is a pure play on the high-growth areas of digitization without the legacy businesses that you see with other outsourcing companies,” he says.
India’s HDFC Bank (HDB) has been a holding in the fund since the late 1990s but continues to compound earnings at about 20% a year, thanks to India’s growing middle class, relatively high interest rates, and increased demand for other products like insurance, credit cards, and mortgages. “There’s one place you can still kind of be a bank and make good returns, and it’s in India,” McClone says. At a recent 3.5 times book value, HDFC stock trades at a premium to most banks, but that valuation seems justified. “The industry is growing in the high single digits, and HDFC [growth] is more than double that,” says Preyss.
Another longtime holding, Taiwan Semiconductor Manufacturing (TSM), is the world’s largest semiconductor foundry, with hundreds of customers around the world, including Apple (AAPL). The fund first bought TSMC in 2012 and sees further growth ahead thanks to such mega-trends as 5G mobile, data centers, the Internet of Things, and artificial intelligence. The stock recently traded around $104, or about 24 times next year’s earnings, but the company has more than a 50% market share for contract chip design and manufacturing.
“The global tech sector continues to outsource more and more, and they have strong pricing power, high retention rates, and high utilization rates,” says Preyss. “Put it all together and they’re generating 35% plus returns on capital and 40% operating margins.”
Write to editors@barrons.com
December 23, 2020 at 07:00PM
https://www.barrons.com/articles/emerging-markets-stocks-mutual-fund-51608671256
This Fund Is Bullish on Emerging Markets for a ‘Laundry List’ of Reasons - Barron's
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