Managers of emer–ging-markets funds admit stocks in those markets have taken a massive hit in the past few months. But, they argue, the punishment has been unwarranted — and excessive.

Nonetheless, responses to the meltdown have varied: some money managers have taken advantage of bargain-basement prices, while others are simply staying the course.

“This is the worst emerging-markets crisis since the MSCI emerging-markets index was introduced in 1987,” says Ruchir Sharma, managing director with New York-based Morgan Stanley Investment Management Inc. and lead manager of TD Emerging Markets Fund, sponsored by TD Asset Management Inc. “The index has fallen [by] 60%, in U.S.-dollar terms, from its peak last year, which is slightly worse than the decline in the 1997-98 Asian crises.

“But the fundamentals don’t warrant such a decline,” he adds. “Share prices are at fire-sale levels. Investors are bailing out and don’t want anything to do with the asset class.”

But this crisis is differs from the 1997-98 meltdown, in that it is focused in the U.S. and Europe. “The global credit bubble burst,” says Sharma. “But I do not see the same systemic risks that we are seeing in the U.S. and other developed markets. There is not a lot of toxic debt or derivatives exposure in Asian banks. This [bear market] is largely a case of collateral damage.”

Using a blend of top-down and bottom-up stock-picking, Sharma and co-manager Gamaliel Blanco, vice president of Morgan Stanley, have been cautiously adding to existing positions and acquiring new ones.

“We are seeing compelling values in the financial services sectors in countries such as India, Poland and Turkey,” says Sharma, noting that valuations range from one to two times book value. “But we are particularly bullish on the consumer discretionary sector.”

From a sector standpoint, 18% of the TD fund’s assets under management are in consumer staples and discretionary stocks, vs 9.8% in the benchmark MSCI emerging-markets index.

In a similar vein, 26.7% of the fund’s AUM is in financial services stocks, vs 22.6% in the index.

Conversely, Sharma is bearish on resources and commodity-oriented stocks. So, the fund has about 21.7% exposure to the sector, vs 31.6% in the index. There are also smaller fund holdings in other sectors, including industrials (6.8%, vs 7.7%) and information technology (9%, vs 10.7%).

“The resources plays are very beaten down, but they won’t come back in a strong way for three to five years,” says Sharma, adding that demand has continued to fall, which is expected to bring commodity prices even lower. “These companies will not have pricing power.”

Running a 150-name fund, Sharma has added to existing holdings, including HDFC Bank Ltd., one of top four banks in India. This retail and commercial institution reported strong results in its third quarter ended Sept. 30, with earnings up 43% year-over-year. “Its share price is down more than 50% from its peak,” says Sharma, noting that it recently traded at 1,026 rupees a share, compared with 1,800 rupees in January. “We think this is a compelling valuation.”

In a similar vein, the TD fund has acquired Garanti Bank, a bank in Turkey whose shares recently traded at 2.2 Turkish new liras each, vs 2.3 liras in June.

On the consumer side, Sharma favours Hyundai Motor Co. Ltd. “The automakers got hit by rising materials prices,” says Sharma. “But we expect them to decline, as will interest rates. A lot of the bad news is priced into these stocks.” Hyundai sends the bulk of its exports to Asian and Middle Eastern markets, Sharma notes. Hyundai’s share price was recently 54,000 Korean won, down from a high of 91,000 a share in May.

Another long-time favourite is Mexico-based America Movil SA, a leading cellphone provider in Latin America. Even though its share price has dropped to a recent 22 pesos from 36 pesos a year ago, Sharma believes the stock will recover because the company is better positioned than many of its smaller competitors.

“There is going to be a shift toward the larger, better capitalized players,” say Sharma, “such as America Movil.”



From a valuation perspective, emerging-markets stocks are at 1997-98 levels, says Pablo Salas, Orlando, Fla.-based managing director of Trilogy Global Advisors LLC and manager of CI Emerging Markets Fund, sponsored by CI Investments Inc.: “But the fundamentals are significantly better than in 1994-95, when the Mexican peso collapsed, or when Russia defaulted in 1998.

@page_break@“When you look at leverage levels and government debt levels, they are very low,” Salas says. “Russia has been one of the worst-performing markets, yet its government debt/GDP ratio is only about 8%.”

Russia, he adds, boasts US$500 billion in foreign exchange reserves, thanks to high crude oil prices and changes in the tax treatment of oil production.

“There are issues in the Russian market, in terms of the banking system, liquidity and the stock market. Yet, the situation, at least at the government level, is significantly better than in 1998,” Salas says. “But Russian stocks are trading at three times earnings — they are pricing in a similar crisis to the one in the past.”

For example, Gazprom OAO, a large natural gas producers, recently traded at 103 rubles a share, or 3.7 times 2008 earnings.

The MSCI benchmark, says Salas, is trading at a rock-bottom 10.7 times earnings, compared with the average trailing price/earnings ratio of 17 times since 1992.

“This current level is one of the lowest we have experienced,” says Salas. “In valuation terms, we are near the bottom. But, sometimes, it can overshoot on the downside.”

And falling confidence, liquidity concerns and margin calls, he adds, could drive multiples even lower: “It’s hard to tell if this is a bear trap or a buying opportunity. From a valuation and fundamentals perspective, though, there are many indications that there is very good value here. But the numbers could go lower.”

Salas is venturing into the market, but selectively. “Companies that used to trade at high multiples — that we weren’t comfortable with — have come down more than the ones that traded at market levels,” he says. “We’re looking at these opportunities. When things normalize, we believe they will have a strong business and strong growth in the future.”

Russia is providing some of the more intriguing opportunities, as that market has priced in a severe earnings contraction. On a country basis, Russia accounts for 10% of the CI fund’s AUM, vs 7% in the index. Other significant weightings include China, at 15% of AUM (vs 14% in the index), Brazil at 11% (14%), India at 6% (7%) and South Korea at 9% (14%).

Running a 90-name fund, Salas has recently added to existing holdings, including Novatek OAO, a mid-sized natural gas producer. The firm is expected to produce 29 billion cubic feet of gas in 2008, and almost 40 billion cubic feet in 2011.

“Many energy companies have trouble finding new reserves and growing their production,” Salas says, “but Novatek has very nice production growth.”

Salas believes the company will reap a windfall as domestic natural gas prices gradually climb to international levels. The stock peaked at US$96 a share in June and has fallen to US$32 recently, but Salas attributes this decline to waves of selling by leveraged investors.

“It’s trading at eight times 2008 earnings, and growing earnings by almost 20% [a year],” he says. “Even if oil prices fall to US$60 a barrel, there is still room for natural gas prices in Russia to go up, because Russia is not as negatively affected by falling crude prices.”

Salas has also increased the CI fund’s holdings of Lukoil OAO. The Russian firm has proven reserves of 20 billion barrels of oil equivalent and an enterprise value of US$32 billion, he says: “At current production levels, it has 24 years of reserve life, which is very large compared with other energy producers.”

Lukoil shares recently traded at US$31 each, equivalent to US$1.50 a barrel of reserves, vs the high of US$115 a share in May 2008.



Although stock prices have crashed, Patricia Perez-Coutts, manager of AGF Emerging Markets Fund and vice president of Toronto-based AGF Funds Inc., is waiting for the dust to settle.

“In the past two or three weeks, we have not had any activity in the mandate. I am wondering when things will settle,” says Perez-Coutts, a value manager who is fully invested and maintains a low-turnover fund. “Typically, when things settle, they start to form a bottom. There’s no rush.”

Running a fund with 79 names, Perez-Coutts began reducing exposure to some holdings this past December, when they each hit 6% of the portfolio. A case in point is the fund’s investment in Petroleo Brasil SA, the Brazilian state-owned oil giant. She trimmed the fund’s holding almost in half.

“There were several other names that we let go a bit earlier,” says Perez-Coutts.

Until this past September, she was adding to new positions, including Trakya Cam Sanayi AS, a Turkish maker of automobile and flat glass, and All-America Latina Logistica SA, a Brazilian railway logistics firm.

“We visited All-America Latina Logistica in September,” says Perez-Coutts. “Even though there was a difficult environment in the U.S. and Europe, Brazil was still fairly active with its infrastructure build-out. But in October, everything collapsed.”

Brazil’s currency came off, she adds, and matters worsened when the demand for raw materials dropped and economists lowered their GDP forecasts for 2009.

“We are facing situations in which there are vast and sharp moves, in terms of erosion in demand,” says Perez-Coutts, noting that even in China, steel producers have been revising their requirements for iron ore and scrap, which has raised concerns about economic growth in 2009. “That’s why we can’t put our fingers on where this will end ultimately. It’s a big headache for everyone,”

The AGF fund is always defensive, she says; companies must meet her value criteria. “Our companies have to generate above-average cash flow, have the ability to pay a dividend yield and their returns should exceed the cost of capital,” says Perez-Coutts, who had managed to avoid battered markets such as Russia and allocate money to more stable markets such as Malaysia.

Still, she admits, valuations are increasingly attractive: “We have companies that were yielding 8% — before the contagion swept emerging markets.”

One example is Akbank AS, based in Turkey. “[It is] well capitalized,” Perez-Coutts says. “But these days, no one respects that. You have to sit tight and be pragmatic. We are not buying — but we are gearing up to do so.” IE