Why an Emerging Market Fund Is Sticking With Chinese Stocks
The conventional approach to emerging market investing often focuses on sectors typically associated with the asset class—such as industrials, materials, and energy.
But that top-down approach can ignore or downplay the industries now thriving in the region, like technology. Analyzing these newer entrants requires a different skill set, says Dara White, co-manager of the $2.4 billion Columbia Emerging Markets fund (ticker: EEMAX).
When White, 46, created the fund’s strategy in 2008, he assembled a team of sector specialists who build portfolios by picking stocks from the bottom up, rather than country specialists. The team, of course, doesn’t ignore the bigger picture for an emerging market country, but rather considers how regulation, demographics, and other macro factors affect the earnings and valuations of the companies they own.
This tactic has helped the fund outperform, earning it a four-star, bronze-medal rating from Morningstar. The fund has beaten the MSCI Emerging Markets index and 90% of its peers in the diversified emerging markets category on a three-, five-, and 10-year basis. Its 1.470% expense ratio is average for the category.
White, however, has one exception for the fund’s bottom-up strategy: emerging market powerhouse China.
“China is such an important market, such a difficult market, and such a diverse market that we find it to be really powerful to have two sets of eyes on the market—one from a global EM sector perspective and one from a country perspective,” White says. Co-manager Derek Lin serves as both a sector and country specialist. Three additional managers round out the team: Perry Vickery, Robert Cameron, and Darren Powell.
Chinese President Xi Jinping’s discussion of “common prosperity” has some investors worried about the future of the private sector in the world’s second-largest economy. China’s government has cracked down on tech firms and the for-profit education industry to rein in what it considers excesses.
White and Lin believe those worries are overblown: They say these recent measures are China’s way to broaden the middle class, not an effort to return to a planned economy. “Today, it’s a 400-million-person middle class. And maybe five years from now it’s a 600-million-person, true middle class. And with that, there are a lot of opportunities,” White says.
China is the top country represented in Columbia Emerging Markets’ portfolio, at 26%, versus about 34% for its benchmark. The team invests in industries that the government is encouraging, such as innovative healthcare and electric vehicles.
One example is No. 5 holding WuXi Biologics (2269.Hong Kong), a global open-access technology platform for biologics drug development, part of the portfolio since 2017. Biologics are drugs made from living organisms and include vaccines and gene therapy. WuXi has a 5% total global market share, and the team says the potential growth of biologics could parallel the semiconductor industry.
The fund also bought Chinese electric-vehicle maker XPeng (XPEV) during the company’s 2020 initial public offering. Lin sees not just an EV investment, but the potential future of autonomous driving. EV manufacturers enjoy a high barrier to entry, and autonomous driving may become a subscription-based model.
“Suddenly you’re more of a software company, with really high margins and a recurring-revenue model,” he says.
The team takes a long-term approach, focusing on high-quality firms and has held some names for a decade, which explains its 29% turnover rate. They seek companies with trustworthy management who have a strong record of being good stewards of capital. Return on invested capital is their most important metric, so they look for strong balance sheets with good cash flow.
The fund’s patient approach helps temper some volatility in a sector known for higher risk. The managers group companies into three categories: global champions, domestic champions, and future global or domestic champions. Many holdings compete against state-owned enterprises or operate in industries still dominated by mom-and-pop shops.
“If it’s truly an innovative company, truly an innovative management team, there’s often an element of exponential growth through new business lines, or new markets getting opened up that people don’t appreciate,” White says.
Technology is the fund’s top sector holding, with the managers favoring e-commerce, and fintech in particular. The managers says these companies should continue to grow rapidly in the next three to five years as e-commerce penetration expands.
The team considers Russian e-commerce platform Ozon (OZON) a future domestic champion and bought its November 2020 initial public offering. The Russian retail market is $450 billion annually, and 81% of the population uses the internet. But Russian e-commerce penetration is far below both developed markets and many emerging markets, at 10% of shopping—leaving plenty of room for growth.
The fund is also betting on low-cost Brazilian airline Azul (AZUL) as a reopening trade, White says. The carrier’s routes are 95% domestic, and Azul is the only option on 80% of its routes. During the pandemic, management focused on its cargo business, which coincided with Brazil’s e-commerce growth. Azul has a 35% cargo market share, up from 20% prepandemic.
White believes it has never been a better time to buy emerging market stocks. The quality of the companies and their management teams are stronger than they were even five years ago, and are much less sensitive to changes in the economy.
“This is a universe now that you can buy and hold,” White says. “Personally, I’ve never owned more of our own fund than I do today.”