Seeking value in emerging markets: China

Our team joined a webinar with over 800 participants, a significant turnout that was not unexpected given the current market environment.
 
As a follow-up to the call, we’ve received numerous questions from participants, with the vast majority pertaining to China. There was also some interest in India, Mexico and Brazil, which we will address in an upcoming blog post.
 
Growing investor interest in emerging markets has been driven by China successfully flattening the COVID-19 transmission curve and being one of the first countries to see signs of a recovery.
 
Conversely, many other countries are still struggling to control the virus, with their economies continuing to deteriorate. These developments make emerging markets potentially more intriguing to investors.

We invest in businesses with a long-term vision of how to adapt to a changing Chinese supply-chain landscape.

We’ve been asked about a potential backlash against China, and whether the rest of the world may seek alternative supply chains. Regardless of a global backlash, or a continued trade war with the U.S., many production facilitates will likely migrate from China to countries with lower labour costs. We believe the virus and trade war are catalysts to accelerate this shift, one that will be incredibly important to consider when investing in Chinese stocks. None of the stocks that we own today are reliant on cheap labour to compete.

It is important to remember that unlike many other countries, China has a large and growing domestic market with a large percentage of future growth coming from internal demand. For many industries, unwinding the complex supply chain network which has been built over the past 30 years would be extremely challenging, very costly, and will take years if it is even possible.

We believe the most likely outcome will be a mixed approach based on industry. There will be a departure of production bases for some industries as we observed in apparel manufacturing. Conversely, China will likely retain production for many industries because it has highly competitive chains of production. China has some of the world’s most modern infrastructure (including digital infrastructure based on 5G technology and related applications), clusters of highly efficient supply chains, a very large well-educated workforce, and a huge domestic market. China will likely also evolve, making proactive adjustments. We focus on investing in businesses and management teams that have the vision, resources and ability to execute and adapt to this changing environment.

Export dependence

Given the concerns about trade wars and a potential backlash due to COVID-19, many call participants inquired whether it was prudent to invest in companies that are dependent on exports.

The issue for export-oriented businesses is they typically derive competitive advantages from a lower cost base stemming from cheaper labour, government subsidies, favourable policies or natural resources. These advantages are not necessarily sustainable and are susceptible to commodities price and foreign exchange volatility.

Our team conducts significant due diligence and on-the-ground research, assessing sustainable competitive advantages which we believe is key when investing in export-oriented businesses.

Chinese stimulus efforts and the reliability of domestic data

So far, stimulus announcements have included financing packages to small businesses, temporary tax cuts, subsidies on purchases of cars and home appliances and discount coupons issued to consumers by some local governments. We are encouraged by the efforts enacted thus far, and believe the government has additional resources that they can utilize to further boost economic growth.

Some investors may worry about data accuracy and transparency as they assess the efficacy of the government’s efforts. We never take any data for granted, particularly in emerging market countries. We emphasize on-the-ground investigation, collecting proprietary information and conducting independent research. We only invest in companies after developing a high conviction and can purchase the stock at a sufficient margin of safety. We believe where our team is located, and their experience and background provide a competitive advantage when evaluating businesses with less transparency or potentially inaccurate data.

Focusing on the long-term

We have taken a calm, methodical approach throughout the crisis, while ensuring our research reports, forecasts and margin of safety are all up to date. The team has been heavily engaged with management teams of both existing positions, and new opportunities and have had three or four conference calls per day. Our approach has been similar to other instances of market dislocation. We have taken advantage of volatility by adding to existing positions and/or establishing new positions.