Tim Morris:    Welcome to the Center for Investment Excellence, a production of JP Morgan Asset Management. The Center for Investment Excellence is an audio podcast that provides educational insights across the asset classes and investment themes.

Today's episode on emerging market equities has been recorded for institutional and professional investors. I'm Tim Morris, Emerging Market and Asia Pacific Equities Investment Specialist and guest host for the Center for Investment Excellence. With me today is Leon Eidelman, Portfolio Manager for the Emerging Market and Asia Pacific Equities team.

Welcome to the Center for Investment Excellence.

Leon Eidelman:     Thanks for having me.

Tim Morris:    For listeners who missed our most recent episode of the Center for Investment Excellence podcast channel, we will be focused on current market volatility, the impact on various asset classes, and how investors can best position themselves to withstand both current and future market conditions.

Today we're discussing emerging market equities -- exploring how COVID-19, the decline in oil prices, and market volatility are impacting the asset class.

First up Leon it seems like an eternity ago but can you talk a little bit about what we were seeing across the emerging market universe at the start of the year?

Leon Eidelman:    Yes. The beginning of the year was actually looking pretty reasonable. Earnings growth has started picking up. We had the trade war behind us. Economic activity across the asset class looked pretty benign. And so I think that we were really gearing up for what should have been a pretty good year for the asset class.

Clearly that's all changed now very quickly.

Tim Morris:    Some of the volatility that we've seen in markets globally so far this year is quite often a more frequent occurrence in emerging markets. As a portfolio manager in this space who's been through periods of volatility like this before, how do you and your team think about investing in the current environment?

Leon Eidelman:    Yes, I mean certainly emerging markets is more volatile than developing markets. I think the current situation is much more extreme and it's probably closer to the financial crisis in major than traditional emerging-market routes. But I think that the playbook is pretty much the same one, which is to try and identify businesses that you think have the opportunity and ability to be much larger over time by serving the consumer well. And inevitably what you find is that through the crises which will occur, these are businesses which have the ability to actually become stronger and take market share.

So from my perspective, a lot of what we would look to do is first off identify which businesses we think can fit into that category and have a very good idea of what those businesses are worth with an eye towards the long-term structural opportunity that they may have. And then look to use volatility in markets as a chance to buy into names that we don't own or a chance to lean into names that we already own.

So if you've already identified which assets are the most attractive ones, then you can use volatility to really position better than the average individual in the market who is not looking at the very long term nature of these opportunities.

Tom Morris:    Very interesting. So China is a large part of your investable universe. And it's certainly a market that's been wrestling with the impact of COVID-19 since late January. How has the situation evolved there and what are we seeing on the ground today?

Leon Eidelman:    So China does seem to have come out the other side of this situation. I think that what they did in terms of quarantining Wuhan very quickly and really moving to seize up economic activity to try and save the rest of the country seems to have worked.

And so whereas you had a pretty meaning for slow down at the beginning of the year that extended past Wuhan, what you now started to see is that most of the country is back to work. And so if you speak to large restaurant managers, for example, they would go from saying that only 10 to 20% of the outlets were open in (Jan Fed) to now saying something like 90% of the outlets are open.

Now, traffic isn't back to what it would have been at an equivalent point last year. That's still slowly coming back on stream. But certainly, the economy seems to be getting back on its feet slowly.

I think that like the rest of the world the Chinese government is also doing everything that it possibly can to try and ease the environment for businesses which have struggled from being shut down for as long as they have.

Tom Morris:    Interesting. So broadening out maybe our observations, what are some of the markets that have been wrestling with the issue and what kinds of responses have we seen?

Leon Eidelman:    Well so it's a little early really across the board for most of the markers that we look at in that at the end of the day, the response to the virus is really on the back of what infections first started. So for a lot of these countries, much like you're seeing in the US, you're only now starting to go enter the period where the shutdown will occur.

Now, the one positive side note to this is that A, I think that countries across our asset class are recognizing how serious the situation has been in places like the US and Europe and are therefore rather quick to shut economic activity down. I mean if you look at Columbia, Peru, and Chile they've been enforcing a much more aggressive quarantine than what you've seen in the states as an example. And they are being very proactive about making sure that they put up the first line of defense in not allowing the virus to spread to begin with.

Now the other thing which I think is incredibly important is that regulators globally do seem to be saying that they're going to do whatever it takes. And I think unlike the financial crisis where there was a question around whether the government would bail out actors which had gotten themselves into trouble, I think in this situation the government is imposing a slowdown on the economy as a whole.

And to a large extent the banks, which were obviously vilified the last time around, the banks are being seen as the conduit for the government to be able to assist a lot of the small and medium enterprises and a lot of the individual borrowers who are being affected by the slowdown.

So by quote-unquote doing whatever it takes, I think that what governments are looking to do is keep the economy in stasis. They recognize that we're going through an incredibly difficult period. They would like to give the economy a lifeline such that once we come out of this dark period the economy can start right back up. And so that's going to entail quite a lot of unemployment support, quite a lot of support towards the banks in terms of pushing out debt liabilities.

And again at the moment what we see is very clear intent to make this happen. And that's a global thing. We don't yet know exactly how it's going to work. And obviously every country is going to have its own nuance but I've never really seen such a concerted response from government to make sure that this is manageable for the economy.

Tim Morris:     And clearly markets are taking notice not just of the scale of the potential risk here but also of the very powerful policy responses in some cases. And that's led to a pickup in volatility in markets. What are some areas that on the back of that are starting to look a bit more attractive and what type of adjustments have we been thinking about now with portfolios?

Leon Eidelman:    So I think that I'd go back to where I started with respect to investment process. If what you are looking to do is identify businesses that are going to be very well-positioned over the long term, then ultimately you have to recognize the difficulty that we're seeing in these economies from an operational perspective today as something which will be overcome.

So no surprise you're still going to want to veer towards the stronger operators. You are seeing some parts of the academy become stronger, become more attractive to consumers. If you look at online shopping for example, you're looking at pickups in online shopping across the entire world. I mean, Amazon is slowly but surely rescuing the US consumer, but it's equivalent to across the emerging world you're doing exactly the same. You are seeing consumers who might not have been consuming virtual goods before doing so now.

So you've had a whole cohort of individuals sign on the video streaming that sort of Netflix would do in the US, or sign on to getting goods delivered and/or ordering everything online. This is the sort of thing where we believe that it's unlikely that those individuals revert back to their pre-crisis behaviors as in once you've activated those consumers it's unlikely that they go back. So it has been a boon towards businesses that are using the internet as a key pathway towards the delivery of service.

And on the brick-and-mortar side of the equation, I think that what's important to note is that clearly the businesses that have the advantage of coming at this from a very clean balance sheet are in a much better place. And if you're being forced to shut down for a prolonged period of time and you have debt liabilities up to your neck, then clearly you're going to be in a very different place than a business that can afford to shut down, can afford to make the investments necessary to adjust for this difficult period.

And that's why again those better businesses do tend to take market share during these types of environments.

Tim Morris:    One of the other impacts has been there's been quite a sharp adjustment in oil prices in recent weeks as well as in different currencies within the asset class. How do you factor that into investment decisions that you're taking?

Leon Eidelman:    Yes I mean, at the end of the day the impact from oil is more macroeconomic than anything else and it does flow through into currencies. So as a major production item for countries like Russia, like Mexico oil is going to have a huge impact in the value of their currencies. And so unsurprisingly the ruble and the Mexican peso have been hit quite hard.

You know, I would note for example that Russia's lifting costs are in rubles. So actually the ruble going down helps cushion the blow from oil prices going down. And so the impact to an economy like Russia's from the change in the oil prices is arguably less than it would be for a country like Mexico which doesn't have the benefits of those changes.

So from an investment perspective, we tend to focus on businesses. We tend to focus on businesses that cater to the consumer. So we don't have a lot of exposure as an investment team to commodities per se but obviously we would watch what impact the change on those commodity prices would have on aggregate currencies and obviously the returns that we seek to model are done in dollars. And the currency impact has been quite significant for a few countries in the asset class.

Tim Morris:     So given the drawdown that we've seen in March, what are your thoughts on aggregate valuations in the asset class and where do we go from here?

Leon Eidelman:    I think aggregate valuations are unambiguously cheap. I mean, you're about 10% from where we were during the great financial crisis. You're pretty close 10-15% from where we were during the Asian financial crisis. And historically those have been very good points in time to buy.

I think it's difficult for me to turn around and say that you can buy here and tomorrow markets will start going up. I think there is quite a lot of uncertainty as to when this bottoms. But where valuation becomes useful is if you stand back a year from now, two years from now, three years from now. I think that it would be unlikely that looking back you would think that this was a bad time to allocate to the asset class because at every point in time when valuation has been at these levels it has been very turbulent. Visibility has been minimal. That's why valuation gets to where it gets to.

But at the same token, if you're a long-term investor, you can use that to your advantage and look to position because again over time the asset class should recover, and eventually, more normal valuations should come back.

Tim Morris:    Fantastic. Well, thank you very much for joining me on the Center for Investment Excellence.

Leon Eidelman:     Thank you very much for having me.

Tim Morris:    Thank you for joining us today on the JP Morgan Center for Investment Excellence. CFA Institute members are encouraged to self-document their continuing professional development activities in their online CE tracker. If you found our insights useful, you can find more episodes anywhere you listen to podcasts or on our website. Recorded on April 2, 2020.

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