December 18, 2018
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