Leveraging Growth and Managing Risk in Emerging Markets

Investing in emerging markets requires a disciplined investment process and rigorous risk management. And the two are interconnected. The past few years have given us plenty of illustrations of why both supports are needed.

Geopolitical risk has been one of the most talked about risks with regard to investing in China. As U.S.-China relations have deteriorated, sentiment toward Chinese equities has been impacted, on a general level and at certain pressure points, notably technology. On the general level, there have been concerns over China’s role in the Russia/Ukraine conflict and speculation over China’s strategic interest in Taiwan. There have also been tariffs, bans and limits imposed on trade with China over technology, particularly regarding semi-conductors and intellectual property. The Hong Kong offshore market has suffered the most given its high exposure to international investors and international sentiment.

“ It’s an interconnected world. We have to have perspective and have a view on how we see regions and individual markets over the medium and long term.”

There are other risks to contend with in emerging markets, of course, be it economic, macro, sectoral, debt-related, or in terms of valuations of markets and stocks. In recent years, inflation and the rapid rise of interest rates have been the perhaps the biggest risk that emerging markets as a whole have had to contend with. For the most part they have controlled rising prices well, and in some case have been ahead of the U.S. Federal Reserve in raising interest rates, but investors have needed to stay vigilant.

The impact of these challenges often cannot be completely mitigated by asset managers but nor can they be ignored. What these challenges and others like it require from asset managers is perspective. For us, that means watching and listening to the world in which we invest, at the global level, at the regional level and at the country level–and, just as importantly, analyzing how these perspectives interact with each other.

Investment philosophy

We have to have perspective and we have to have a view on how we see regions and individual markets over the medium and long term. That guides geographical allocation within the portfolios of our strategies. For example, if we think China’s challenges are going to be onerous in the near term, we may trim our allocation. If we think the macro-outlook for Latin America is particularly bright, we may increase our exposure. This is our perspective, and it is infused in our investment process and our risk management.

Investment process

Emerging markets present excellent long-term growth opportunities, in our view, but they are inherently volatile and idiosyncratic. We believe in an unconstrained, flexible approach to portfolio management, that leans to the portfolio manager’s experience, expertise and flair, is bedded in a robust risk-management culture, and can adapt underlying exposures to evolving market conditions. We adjust our portfolio exposure to growth or defensive orientations driven by a clear framework based on EPS growth and P/E analysis.

Our fundamental, bottom-up analysis drives stock selection while portfolio construction incorporates a macroeconomic framework. Over the long-term, we aim to participate, grow and preserve: participating and growing in up markets and preserving capital during downturns and times of market stress, in order to generate compelling risk-adjusted returns.

Risk management

Our risk management infrastructure is embedded with the day-to-day running of our portfolios. Our risk management and portfolio strategy teams work together with one objective in mind, to serve our clients. This means putting our best ideas and stock-picking strategies into practice within a framework of robust risk management processes that ensure our portfolios adhere to the rules of the road and stay true to their mandates.

Risk is managed on four fronts: at the security level; the portfolio level, the oversight level and with compliance. At the security level, risk is managed through fundamental research. Essential attributes like free cash flow, return-on-equity, leverage and liquidity are monitored and engagement with companies and management teams is another crucial tool. At the portfolio level, we monitor macro risk in order to try and capture the best risk/reward opportunities by market; we monitor country, sector, and industry diversification and we place high priority on portfolio level liquidity. Regional risk control is a crucial tool for sizing our positions and our risk.

At the oversight level, an independent risk analytics team reviews areas including style risk, active weight limits, liquidity, tail, sustainability and governance risk, and sets thresholds for acceptable ranges of risk. At the compliance level, we monitor portfolio adherence with client investment guidelines and track regulatory changes that might impact trading, purchase and sales of securities.

Positioning for the long term

It’s an interconnected world. India, for example, is not only being supported by its domestic infrastructure program but also by global trade and international demand for its goods, and also by geopolitical considerations such as some companies shifting their manufacturing operations there instead of China.

With over 30-years of experience investing in higher risk markets, we take a dynamic approach to risk that encompasses macro, geopolitical and fundamental considerations. Our portfolios only invest in companies that we believe possess strong governance and business sustainability.

This approach equips us well to navigate today's evolving economies, changing consumer patterns, and regulatory environments. The world today—characterized by a robust U.S. economy, high interest rates and geopolitical tensions, and sweetened with pockets of exuberance like artificial intelligence (AI) —can be challenging to decipher. But the lessons of experience tell us that a disciplined active approach with perspective can navigate emerging markets and their gyrations.

The success of any investment strategy hinges on weighing up the opportunity with the associated risk. At Matthews, we focus on our investment process and risk management to potentially generate better outcomes and with a strong partnership culture our interests are always firmly aligned to that of our clients. As fundamental bottom-up stock pickers with a regional and global perspective, we believe we have a robust approach for navigating the opportunities and challenges of today’s emerging markets. We aim to capture growth opportunities while accounting for the risk and protecting capital over the long term.

Definitions: Leverage is the ratio of a company's loan capital (debt) to the value of its ordinary shares (equity).