Evaluating the Covid-19 Pandemic Risks & Resilience in the World’s Emerging Markets
How are emerging market economies placed to cope with the current and anticipated fallout from the Covid-19 pandemic? Boston-headquartered GMO has introduced a disciplined and proprietary assessment and comparison framework to help assess the impact. Amit Bhartia, Portfolio Manager for GMO’s Emerging Markets Equity team, based in Singapore, ‘met’ by video call with Hubbis recently to elaborate on a White Paper the firm published in mid-April on emerging markets and their abilities to withstand the impacts of Covid-19. We were treated to an invaluable tour of the major EM economies and how their investment markets might play out in the foreseeable future.
Launching straight into the rationale for the White Paper, titled - Covid-19: Risk and Resilience in the Emerging Markets, it’s explained that GMO had decided to publish in order to help investors navigate what are uncharted waters through the world’s emerging markets using a variety of tools at their disposal. GMO felt that the firm needed to express its views in as disciplined a way as possible, adopting an in-house delivered methodology that GMO believe will help position its portfolios as the firm, like the rest of the globe, deals with the current and coming shocks to the EM universe, noting that how these countries work to mitigate those risks is central to the outlook for those markets, from an investment perspective.
A coherent framework
In its new White Paper, GMO explains its comprehensive way in which it combines a country’s ‘Covid-19 Vulnerability’ score with its ‘Ability to Respond’ score to allow for the identification of safe and risky country clusters. “The result of combining the two scores gives us a clearer understanding of a country’s ability to mitigate the risks presented by the pandemic. Our data indicates that China, Taiwan, and South Korea, which together account for 60% of the MSCI EM Index, are relatively safer countries. Indonesia, Mexico, Turkey, Malaysia, and Brazil, with a combined 14% weight in the index, are the higher-risk countries,” explains the Paper.
Bhartia comments that GMO had thought long and hard before adding to the piles of Covid-19 related reading material their clients have strewn across their home desks and their email in-boxes.
“What we decided is that the lack of a coherent framework to address the vulnerability of the EM equities asset class needed addressing from a capital markets viewpoint, as this will, we believe, be particularly acute in emerging markets.”
In the new White Paper, GMO has of course focused on which countries can best handle a pandemic, which countries can manage the social unrest that might ensue if income inequality increases to dangerous levels. “These are very important questions for investors looking at this EM sector from a long-term investment viewpoint,” Bhartia comments.
He explains that the EM universe comprises 26 countries, and for committed EM investors allocation is essential to ensure the optimal returns form the sector. “How, therefore, do we identify the winners and losers?” he pondered. “Well, we believe we have some of the answers to help construct portfolios that more adequately reflect risk and potential. It is incredibly important to be disciplined, we believe, especially in such an environment. We find, for example, that countries such as China, Taiwan and Korea offer far more potential resilience and reward than Latin America, where we see that Brazil is down more than 50% this year, while Chinese internet stocks are actually up for the year, following NASDAQ’s lead. In short, we see these types of divergence in performance continuing, and even exacerbating, in the foreseeable future.”
GMO has forged a reputation for asset allocation forecasting, with its frameworks used extensively by some of the biggest pension funds and universities across the world. The firm encourages investors to focus on the long-term, and not succumb to knee-jerk reactions. GMO extols the value of EM, sharing that it believes it is a good place to be based on current valuations. In fact, if you look at the firm’s seven-year asset allocation forecast, EM continues to play a core role in GMO’s strategy.
Bhartia then mines down into greater detail, remarking first that a key finding in the White Paper is that GMO believes there are various sectors or characteristics that will underperform, led by certain banks and any companies that are highly leveraged. “But those companies with robust balance sheets, that fulfil customer needs and that are sensibly valued, can perform well in the coming months and years,” he observes.
Key Takeaways from GMO’s White Paper titled ‘Risk and Resilience in the Emerging Markets’
These are the verbatim key findings from the GMO report.
“The headline results regarding EM vulnerability/ability to respond to Covid-19 derived from this new methodology, which is described more fully in the sections that follow, are:
- About 68% of the MSCI EM index comprises countries that rest in what we define as a ‘safe cluster.’
- Countries falling in the ‘high risk cluster’” represent 8% of the index.
- There is significant variability among countries in their ability to respond to a crisis.
- It is very difficult for EM countries to implement measures like ‘social distancing’ when per capita incomes are one-sixth those of Developed Markets (DM); a ‘daily’ wage sustains 20% of the ex-China EM working population.
- Unlike previous crises, when index composition was poor, we now think EM countries are better equipped to manage severe drawdowns. (Recall that drawdowns were higher than 50% during both the 1997 Asian Financial Crisis and the 1998 Russian Financial Crisis.)”
China a clear winner
Taking countries one by one, Bhartia focuses first on China, the major winner in this debacle in his view. “I am a big believer in China, where per capita income has seen phenomenal growth in the past several decades. There are regular fears that China will suddenly falter, but actually they have done a remarkably good job of managing their economy and financials. Their domestic debt might be huge, but it has been spent productively on infrastructure of all types: medical, physical and digital. Tech giants such as Alibaba, Tencent and others have been registering incredible growth of 25-30% plus in recent years, and even now continue to deliver. We like China from a top-down perspective as well as from a bottom-up viewpoint.”
Bhartia explains that while an Asian HNW investor’s portfolio might be, say, around one-third weighted to China, the GMO funds he manages are higher than that, currently at nearer 42%. “This should always be dynamic,” he adds, “so for example back in 2015, when values there were really stretched, we down-weighted to about 15%, but today there is a lot of potential, hence our elevated position there.”
Bhartia has for some time been a keen promoter of the Thai market, with a roughly 9% weighting in December, before this pandemic came out of the blue. “I have for some time believed Thailand to be an excellent play on the rising middle class in Asia, and rising consumption, similar to India and China. And Thailand’s tourism industry has been dynamic, especially with inflows from India and China. Thailand also has one of the best balance sheets in emerging markets. Although relatively slow economic growth prevailed there before Covid-19, the very low vulnerability was a great attraction.”
He concedes that the pandemic has rearranged many of the markers for the future in Thailand, but notes that the country has a strong healthcare sector, both for domestic and international patients and clients, so is well positioned to handle health-related crises. “In this regard, they are the top in the EM universe, and even sixth best in the world if you look at some of the research, for example from universities like Johns Hopkins. With a very strong currency, Thailand has done really well in terms of total return in US dollars in the past five years.”
Health & Wealth
GMO has long had a firm belief in the value of public spending on health. Looking to the firm’s 2013 paper titled ‘Health is Wealth’, Bhartia himself had argued that resilient domestic consumption is a function of effective public spending on health care, a premise the firm has stuck to over the years as a key input in GMO’s top-down ESG models. That helped the firm when creating its latest White Paper looking at Covid-19 in terms of where countries fall on the vulnerability scale, and in determining their ability to respond in a framework that determines the strength of a country’s ability to combat and recover from the virus.
“For example,” Bhartia reports, “we found that in Korea each citizen is entitled to a set of three Covid-19 tests free of charge, and the country is very disciplined. Whereas in some countries, testing is rudimentary and social distancing might also be a luxury – for example, India and Indonesia, respectively, have 24% and 15% of their labour force constituted by casual workers who effectively depend on daily wages, making extended lockdowns extremely difficult. And the heads of some governments have exhibited a very cavalier attitude toward virus mitigation recommendations.”
Bhartia then takes a few steps back to scan the EM universe, noting that over the firm’s more than 25-year history in these markets, volatility and crises have been endemic throughout those years.
“There are always some countries suffering financial, political or other type of derailing,” he comments, “but our approach is to be disciplined, to focus heavily top-down, to also analyse bottom-up, and therefore to fairly allocate exposure to well-identified risks and rewards. Add to that our rapid and dynamic agility to adjust exposures, and we believe we can accurately reflect where we believe our EM portfolio should be at any one time.”
While there are constant ups and downs in the EM world, Bhartia argues that these markets entered this crisis in a resilient state. “We see some key reasons,” he states. “The index quality has improved significantly, so risky countries, which were some one third of the universe about eight years ago are now below 10% , while less risky China has become roughly 40% of the EM spectrum, and China has immense economic, fiscal and monetary power.”
He notes, for example, that while the US is spending about 13% of its GDP as fiscal stimulus, this time China has spent less than 3% of its GDP. “In short,” he comments, “China can do far more if they need to without the impact that the US is suffering to its finances. The overall EM world will, we predict, suffer a negative -2% GDP growth this year (-4% EM x China), while China and Taiwan are doing far better than both the emerging and developed economies of the world. And we estimate that about 68% of emerging market countries today can manage a crisis such as Covid-19 significantly better than crises they faced in the past.”
Four pillars of Emerging Markets
Bhartia explains that the GMO Emerging Markets Team assesses markets based on its four pillars. These, he says, are the addressable market, long term earnings predictability, vulnerability and reliance to global trade. “We constantly revise positions based on new data,” he says, “but the pillars remain the same, as the framework allows us to understand the long-term intrinsic value of a country. “The framework is based in four pillars that helps us evaluate countries by addressable market size, earnings potential, global dependency and vulnerabilities, Therefore, what we are looking at here are countries with large pie of consumers, with stable and good quality institutions, that don’t rely too much on external factors to achieve its own growth targets and most important, where risks are not too high. We believe that changes in each of these four pillars have a direct impact in the intrinsic value of a company. It has more than 50 qualitative and quantitative indicators covering 25 countries and is updated on a quarterly basis.”
In terms of differentiation, Bhartia explains that his team puts a roughly 70% stress on its top-down analysis, while most peers are primarily bottom-up oriented. “We want to be in countries and economies that are doing the right things and not invest in countries that are exceedingly vulnerable,” he reports, “so we avoid Brazil, and even India, where we see more risk and vulnerability, while many of our peers like assets there from the bottom-up view. However, once we know where we want to concentrate from the top-down standpoint, we can find plenty of value from bottom-up analysis, so it is the best of both worlds really. For almost 10 years, this has stood us in great stead, as we have suffered less in bad times, and participated more and for longer in good times, staying committed to participate in most of the rallies, compounding returns, but at the same time limiting the impact of negative shocks.”
“One of the key areas we have been working on is understanding which economies have a good social transfer mechanism, to ensure that money can reach the hands of people who really require it,” he reports. “This is actually part of our ESG framework approach, and something that especially at this time is becoming increasingly critical, as it determines partly which economies can come out of this recession faster. This is not only about which governments have strong finances, but how they allocate and distribute. And Thailand, for example, ranks very well in this regard, as their transfer mechanisms are among the best in emerging markets; we estimate about 70% to 80% of the Thai population can directly receive state funds, if needed.”
Winners and losers…
Time will tell how the pandemic plays out, and what short- and long-term effects it has on the developed and emerging world. For now, it is probable safe to say that China’s vast fast-growth economy, immense financial resources, enormous population, and hugely centralised political control stand it in good stead to outperform not only other EM countries, but also the major developed economies. Korea and Taiwan appear to also be well set, all going well, and some of the other smaller EM countries, for example Thailand, should recover reasonably well, assuming the virus can be contained.
Getting Personal with Amit Bhartia
Born in Delhi and educated in Mumbai right through to completing his engineering degree, and then MBA, followed by obtaining his CFA charter holder qualifications, Bhartia has since then enjoyed a career spanning some 25 years with GMO.
He is therefore one of those rare people who sticks with one company throughout. “It has been a fine firm to enjoy growing with throughout the past roughly quarter of a century of remarkable expansion and excitement in Asia,” he comments.
He reports that in that time, the figure for GMO’s assets under management in Asia was just under USD25 million; today it is just above USD7 billion under the strategies he is involved in.
Bhartia is today a Portfolio Manager for GMO’s Emerging Markets Equity team and oversees fundamental research. Additionally, he serves as CEO and an executive director of GMO Singapore.
He is married with one 20-year-old son who was educated in Singapore, and who is studying computer science at University of Southern California in LA. “Actually,” Bhartia adds, “he is spending the confinement with us here right now in Singapore."
Despite his daily involvement in research, strategies and opinions, Bhartia also loves to spend his spare time on Twitter. “Maybe I spend a bit too much time on that, but if it gets too much I switch to Netflix for my other hobby,” he jokes.
His more reflective time is spent reading, for example a recent book on American history. “The past is the future,” he comments, “and without a solid perspective on what has come before, we cannot properly understand the present or imagine the future. I am also trying to read more about the history of the economies I cover in the emerging markets. That is, at least when I have time.”
Founded in 1977, GMO is a private partnership whose sole business is investment management. The firm manages global portfolios with offices and clients around the world. Investment offerings include equity, fixed income, multi-asset class, and alternative strategies. GMO is known for blended fundamental and quantitative investment research expertise and a long-term orientation toward value opportunities.
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