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Welcome to Soundbites – weekly insights on market trends, and investment strategies, brought to you by Investment Executive, and powered by Canada Life.

For today’s soundbites, we discuss emerging market equities with Ross Cameron, a portfolio advisor and analyst with Northcape Capital. Ross is based in Tokyo, Japan, and we started by asking his long-term view of emerging market equities.

Ross Cameron (RC): We know that long-term factors like demographics, urbanization, financial penetration – these are the ultimate important drivers of equity return. And emerging markets offer much more attractive exposure to these areas than developed markets. This throws up so many attractive investment opportunities for managers. And that structural growth will be a multi-year tailwind for investment returns in the equity market.

About the challenge of investing in emerging markets.

RC: The biggest challenge for the emerging markets group as a whole is investor perception. This is not a homogeneous group. It’s a varied collection of countries all muddled together in the same index. So, you have India and Philippines — countries very early in their development — in the same index as countries like Korea and Taiwan which have 10 times the GDP per capita. Really, emerging markets require the selective approach. Sovereign risk really matters, currency variation is much larger in emerging markets. You can’t just be a stock picker in emerging markets because if you get the currency wrong, the currency can confiscate all of the investment returns.

The classic example is Turkey. Had you invested in Turkey a decade ago, the equity returns in Turkish lira look pretty good. The index has compounded a little over 5% per year over the last decade. But, of course, international investors don’t look at their returns in Turkish lira. They look at their returns in their local currency. And in U.S. dollars, it’s lost half of its value over the same period.

So, this is a category that really requires an approach that really understands the geopolitics, the sovereign risk of the countries themselves, not just the stocks listed in these countries.

What countries he’s avoiding right now.

RC: South Africa, I think, is concerning. The economy was in not very good shape heading into coronavirus, and they have serious issues with this pandemic. The other one that we are becoming a little bit more concerned about is Brazil. Brazil had serious fiscal problems heading into the pandemic. That fiscal situation has deteriorated further. So, there is the risk in Brazil of debt deflation. And, like South Africa, Brazil has its own variant of coronavirus that seems to be more infectious and potentially more deadly. So, those are both relatively big countries where we have very little exposure.

And what countries look good.

RC: I think India looks to be in very, very good shape. The Indian economy right now is flying. India is kind of the poster child for that beautiful tailwind of structural growth that I talked about: a young population, good population growth, increasing urbanization, increasing infrastructure, improving telecommunications, a very talented population. We also like [South] Korea and Taiwan. Korea has produced some of the very best companies in the world. Samsung Electronics is the world’s leading player in D-RAM and NAND memory. And on the computing power — the logic chip — side, TSMC [Taiwan Semiconductor Manufacturing Company] in Taiwan is the undisputed leader. So, the world has changed. And now emerging markets are the technological leaders in their respective fields, ahead of the U.S. or Europe.

And, finally, what’s the lesson here, when it comes to emerging markets?

RC: Ultimately, stock market returns benefit when there is underlying structural growth. This is what really long equity bull markets require. And the developed world is really struggling for that. Everything that is a tailwind for emerging markets is a headwind for developed market equities. So, I think investors that have a relatively long-term view are going to be well rewarded by being overweight emerging markets relative to developed markets.

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Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life.

Our thanks again to Ross Cameron, portfolio advisor and analyst at Northcape Capital.

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