Emerging markets, small caps offer opportunities for investors, Templeton managers say

As a market recovery begins to set in, investors should look to emerging markets, small cap stocks and a number of other sectors for potentially lucrative returns, portfolio managers at Franklin Templeton Investments Corp. said on Thursday.

Speaking at the company’s annual Investment Outlook and Opportunities Forum in Toronto, the portfolio managers outlined a number of different investment themes that advisors should consider.

Global opportunities

Emerging markets present particularly promising investment opportunities, with strong consumer demand in these countries expected to help pull the global economy out of recession.

“All of this is very positive for global companies and global franchises that can participate in that growth,” said Lisa Myers, lead manager of the Templeton Growth Fund, Ltd.

But the portfolio managers warned that as these markets continue to attract investors, valuations are becoming expensive. Myers noted that nearly $30 billion has flowed into investments in emerging market since the beginning of January.

Still, the mangers see strong long-term opportunities in emerging markets. For safer investments in these regions, Myers urges investors to look to stable global companies with strong cash flow.

Don Reed, president and CEO of Franklin Templeton Investments and manager of the Templeton International Stock Fund, is especially bullish on China, which is driving growth in the rest of Asia, he said.

“We’ve been able to find good value in China,” he said. “We’re looking for good growth in that market.”

Within the emerging markets, investors should seek exposure to commodities, according to Mark Mobius, who directs the Templeton Global Emerging Markets Equity Group. Although commodity prices will continue to display volatility, he expects a long-term upward trend in prices.

Mobius also recommends investments in consumer sector companies.

“We want exposure to emerging market consumers,” he said. “Per capita income in the emerging markets is growing at a very fast pace.”

Small cap stocks

When it comes to the equity portion of a portfolio, investors should avoid sticking entirely to large-cap stocks, according to Brent Smith, chief investment officer at Franklin Templeton Managed Investment Solutions. While small cap stocks do not generally perform as well as large-caps during bear markets, he said investing in smaller companies could be rewarding during a market recovery.

On average, Smith said small cap stocks outperform large caps by 600 to 900 basis points during periods when markets are emerging from a recession.

“If you do think that we’ve seen the bottom in the stock market, small caps should deliver outsized gains versus large caps going forward,” he said.

Sectors: cash flow is key

In terms of industry sectors, one area showing promise for investors in the current economic environment is telecommunications, the portfolio managers said.

“These companies have good balance sheets, and management has shown a track record of trying to create shareholder value,” said Reed.

Myers agrees that telecommunication sector investments are likely to perform well going forward, particularly because of the industry’s ability to generate strong free cash flow. This allows companies to self-sustain growth while the deleveraging process takes place, which could be a lengthy process as the global economy emerges from recession, she explained.

“Companies that generate a lot of free cash can continue to grow their businesses by investing in their businesses without accessing credit markets,” she said. “The good news is that the market doesn’t seem to be crediting these companies for their free cash flow generation.”

Other sectors showing promise in terms of free cash flow include pharmaceuticals, health care, software and commercial services, Myers added.

Reed is also bullish on industrial sector stocks, which are positioned for a recovery, he said.

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