State of decay: Impact of governments on EM value

December 18, 2018

Beware of intervention in EM

In more developed markets, concern over state intervention largely centers around central bank policymaking. While that is of course highly relevant across emerging markets too, there is in fact an even larger state-led consideration when investing in these markets: the fact that around 23% of the MSCI Emerging Markets Index2 is comprised of state-owned enterprises (SOEs), as of 31 July 2018 (Source: MSCI).

The majority of these companies are not run with profit-maximizing intentions, in our view. They tend to be strategic state assets such as banks, or utility and resources companies, with heavy capital-expenditure burdens. This tends to make them poor stock investments over the long term, although a major commodity bull market can potentially change the optics temporarily. Return on equity (ROE) is usually less important than other strategic desires of the state when it comes to these companies making capital-allocation decisions.

State ownership can provide a measure of stability, but this may involve significant shareholder value dilution, since minority investors tend to be a lower priority in stressed situations or in capital-allocation decisions. Interestingly, we saw such dilution with many Western banks following the global financial crisis, and emerging-market companies are perhaps even less likely to focus on shareholder value in such situations.

As such, when looking at Emerging Market equities, we very rarely take exposure to SOEs and tend to focus on the technology, consumer and health-care sectors as they are relatively free from state control. This is where we find the most interesting investment opportunities in Emerging Market equities.

Naomi Waistell, portfolio manager Emerging and Asian equity team. Newton Investment Management – part of BNY Mellon Investment Management

Recommended for You

[2] The MSCI Emerging Markets Index (net of foreign withholding taxes) is a free float-adjusted market capitalization weighted index designed to measure the equity performance in the global emerging markets. The index consists of 23 MSCI emerging market national indices. Indices are unmanaged and do not include any expenses, fees or sales charges. It is not possible to invest directly in an index.

All investments involve risk, including the possible loss of principal. Asset allocation and diversification cannot assure a profit or protect against loss.

Return on Equity (ROE) is a measure of quality that measures how much proft a company generates with the money shareholders have invested.

Equities are subject to market, market sector, market liquidity, issuer, and investment style risks to varying degrees. Investing in foreign denominated and/or domiciled securities involves special risks, including changes in currency exchange rates, political, economic, and social instability, limited company information, differing auditing and legal standards, and less market liquidity. These risks generally are greater with emerging market countries.

BNY Mellon Investment Management is one of the world’s leading investment management organizations and one of the top U.S. wealth managers, encompassing BNY Mellon’s affiliated investment management firms, wealth management organization and global distribution companies. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation and may also be used as a generic term to reference the Corporation as a whole or its various subsidiaries generally.

“Newton” and/or the “Newton Investment Management” brand refers to the following group of affiliated companies: Newton Investment Management Limited, Newton Investment Management (North America) Limited (NIMNA Ltd) and Newton Investment Management (North America) LLC (NIMNA LLC). NIMNA LLC personnel are supervised persons of NIMNA Ltd and NIMNA LLC does not provide investment advice, all of which is conducted by NIMNA Ltd. NIMNA LLC and NIMNA Ltd are the only Newton companies to offer services in the U.S.

Views expressed are those of the authors stated and do not reflect views of other managers or the firm overall. Views are current as of the date of this publication and subject to change. This material has been distributed for informational purposes only and should not be considered advice for investments or a recommendation of any particular investment, strategy, investment manager or account arrangement. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Please consult a legal, tax or investment advisor in order to determine whether an investment product or service is appropriate for a particular situation. No part of this material may be produced in any form, or referred to in any other publication, without express written permission. BNY Mellon Investment Adviser, Inc., Newton and BNY Mellon Securities Corporation are subsidiaries of BNY Mellon.