No prizes for guessing the worst-performing sector of the fund universe over six months, one year and two years. It is global emerging markets, where on average investors have lost 16.6 per cent of their investment since March alone. So maybe there should be a prize for the tiny number of emerging markets funds that have managed to keep their heads above water and not actually lose money for the investors over the past two years, such as those from Goldman Sachs.
Goldman Sachs has something of a reputation when it comes to emerging markets, as the Brics concept was first coined by former Goldman Sachs economist Jim O’Neill back in 2001. But curiously the firm’s investors have been saved from the worst of the recent meltdown by managers whose focus is on bottom-up fundamentals rather than top-down macroeconomics.
Kathryn Koch is one of the team that runs Goldman Sachs’ Growth and Emerging Markets Broad Equity fund, ranked top quartile over both one year and three years in its sector.
“Over the last two years emerging markets has not exactly been the place to be, but we have still been able to achieve absolute positive returns. We have got there by taking a truly bottom-up approach to fund management. We don’t take huge country bets or major macro calls. If you push hard at our rivals, you will probably find that they are dominated by a macro narrative.”
So what do Goldman Sachs managers look for in a company?
“For a company to be included in the portfolio, it has to offer a significant discount to intrinsic value,” Koch says, before reeling off a number of measures she likes, such as discounted cashflow analysis and enterprise value.
Another crucial strategy is to maintain a relatively large portfolio of stocks at a time when most other managers prefer concentrated portfolios. The Goldman Sachs fund has more than 100 stocks, which not only helps diversify risk but also ensures there is sufficient liquidity at any one time.
There are 800 stocks in the MSCI Emerging Markets index, but Koch says that is too limiting for the fund. “Our investable universe is 6,000 stocks in emerging markets, as we will consider stocks with market captialisations of as little as a couple of hundred million dollars. So not only are we very bottom-up, we also have a very broad array of companies. Over half of our stocks are outside the benchmark and 40 per cent are in the small or mid-cap space.”
There are, though, a lot of themes in the funds. Consumer discretionary is perhaps not that surprising; what emerging market fund is not interested in tomorrow’s huge new army of consumers? The fund’s third largest holding is NongShim, South Korea’s largest processed food manufacturer, specialising in instant noodles and snacks. Over the past year it has jumped from 250,000 won (£137) to 382,000.
Even Tencent Holding, the Chinese internet company that is the biggest stock in the fund, hasn’t fared too badly despite the extraordinary selloff in the Far East. Over the past year it has gone from HK$123 (£10) to HK$128, although along the way it has been as high as HK$170.
Of course, that’s partly the story of the China ‘crash’. The Shanghai composite may have tumbled in recent months, but over one year it is still showing a gain of 30 per cent. Even on a year-to-date basis it is down just 1 per cent.
One of the more surprising themes in the fund is stock exchanges. Around 10 per cent of the portfolio is made up of bourses across emerging markets, even though they make up a tiny fraction of total market capitalisation.
“We hold them not just because we think they will do more and more trading, although it’s almost inevitable that over the long-term capital markets in emerging markets will deepen. What makes them interesting businesses is that they tend to be in monopolistic positions, which gives them pricing power. They are also not particularly capital intensive, and convert 100 per cent of their earnings into cashflow.”
Surely in the recent market meltdown, exchanges haven’t been the place to be? Koch disagrees; Goldman Sachs has found that stock exchange companies tend to hold up remarkably well even in market crashes. It’s a bit like buying a firm of bookies, as they make money irrespective of horses winning or losing.
What you won’t find in Koch’s portfolios is much in the way of energy or telco stocks. “Energy stocks make up around 10 per cent of emerging market capitalisation, but they are less than 1 per cent in ours. The problem is that energy companies in these countries do not see their job as maximising shareholder value.” Meanwhile, she says the problem with telcos in emerging markets is that most have lost pricing power due to intense competition.
Last week many were predicting a further outflow of funds from emerging markets if the Fed raised rates, but even though it didn’t materialise, Koch is relaxed about the day when it does finally happen. While it is likely, when it happens, to put emerging market currencies under intense pressure and reduce returns for sterling investors, she doesn’t anticipate any medium-term damage, or that emerging markets do not represent long-term value. “This is an exceptionally well-telegraphed move. For a lot of emerging markets, it is already in the price.”
While emerging markets have had a torrid time of late, returning losses on average over the past couple of years, there are some bright spots in the space. The GSAM fund has focused on bottom-up stockpicking rather than taking large macro calls, which has paid off in performance. But with a US interest rate rise on the horizon, the market sentiment is not likely to improve soon.
Kathryn Koch, is managing director of fundamental equity at Goldman Sachs Asset Management.
Katie is global head of client portfolio management and business strategy for GSAM fundamental equity. She leads the global team of client portfolio managers. She was previously head of the Global Portfolio Solutions group for EMEA and Asia Pacific ex-Japan and a member of the GPS investment committee.