This outperforming fund manager is 'massively overweight' emerging-markets stocks

Alex Umansky of the Baron Global Advantage Fund says growth in China and Brazil still trumps that of the U.S.

  • By Michael Brush,
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There’s always a bear market somewhere — and that’s good news for contrarian investors.

Today there’s an angry bear on the loose in emerging markets (EM).

The iShares MSCI Emerging Markets ETF (EEM) was down over 20% this month from January highs. The standard definition of a bear is a 20% decline.

Emerging markets are slumping, in large part, because of trade-war fears. This has sent EM currencies down sharply against the dollar. Nervous investors worry that EM governments and companies might not be able to pay back debt denominated in dollars. Sellers are also worried that trade wars may spark a global slowdown and slower growth, particularly in China, which does a lot of business with other emerging economies.

In contrast, with the S&P 500 Index (.SPX) up about 9% this year, U.S. shares are trading near all-time highs and pretty richly valued. The upshot: Now’s probably a good time to trim exposure to U.S. stocks and use the funds to buy EM stocks, exchange traded funds or mutual funds.

Part of the logic here is that President Donald Trump likes to negotiate by bluster — starting off with exaggerated threats and then backing off to compromise. That’s likely to happen in the China trade negotiations.

Besides, EM stocks now look “generally cheap,” say strategists at J.P. Morgan Chase, which recently turned bullish on the space. Favorite countries to overweight include China, Brazil, Korea and Russia.

For some buy-side guidance on interesting stocks in the pullback, I recently turned to Alex Umansky because he’s got good chops in the space. His Baron Global Advantage Fund (BGAFX) looks like one good way to get EM exposure. It is up an average of 16.9% a year over the past five years, compared with 11.5% for the MSCI ACWI Growth Index. Like his fund, that index is a blend of developed markets and EM exposure. Umansky says he is “massively overweight” EM.

“I am an unabashed emerging markets bull,” says the portfolio manager. He acknowledges concerns about EM currency weakness and a possible EM growth slowdown. But he thinks growth will still be OK, and better than in most of the rest of the world. “Everyone is concerned about growth slowing,” he says. “But where else am I going to find this kind of growth?”

Any slowdown that does happen will be offset for by several mega-trends inside EM economies — for investors who position wisely. Here’s what he means, and here’s how to position wisely.

China

First, consider China. There, policy makers are succeeding in converting the economy over to one driven by domestic consumption and away from government spending. Domestic consumption accounted for 62% of GDP last year, compared with 35% in 2003. “In 15 years, they flip-flopped,” says Umansky. That’s been the plan all along. A big part of this comes from the continued growth in the middle class, a trend that still has legs.

Next, mobile phones are popular, and they are driving big growth in parts of the economy. Umansky says China has 750 million smartphone users who spend over three billion hours a day online, and that is growing at 22% a year. This helps drive e-commerce growth in China of at about 28% a year.

Inside e-commerce, the penetration of smartphones has enabled many people to start banking. This drives growth at mobile- and online-payment platforms like Alipay, a division of Alibaba (BABA) and WeChat Pay, which is part of Tencent (TCEHY). Together, those two platforms control most of the online-payments business in China. That’s a good segment to dominate, since it’s growing so rapidly, about 200% a year.

Given exposure to this kind of growth, and considering that over 90% of Alibaba sales come from inside China, it doesn’t make a lot of sense that investors are selling Alibaba shares because of worries about U.S. tariffs on Chinese goods. The company has been posting year-over-year sales growth of more than 60%, yet it trades at about 20 times earnings. “We have no idea how this trade dispute will be resolved,” says Umanksy. “We do know that three years from now Alibaba will worth considerably more than it is today.”

Besides online payments, Tencent benefits from its presence in online games, messaging apps and cloud services. Umansky likes Naspers (NPSNY) for exposure to Tencent. It holds a large chunk of Tencent shares, but the valuation of that stake is not fully reflected in Naspers’ own shares.

Like Alibaba and Tencent, the China-based after-school-tutoring-company TAL Education (TAL) now trades at or near 52-week lows. It’s down on part because of worries that China is cracking down on operators in this space with greater regulation. But this actually helps TAL because it weeds out nefarious competitors using questionable marketing tactics. Umansky doesn’t think TAL’s business will see much downside because of the crackdown. The company is still posting revenue and enrollment growth of greater than 40% and 50%.

Despite the weakness in China shares, a food-delivery company called Meituan just came public in a $4.2 billion initial public offering (IPO). The Tencent-backed company is like a combination of Groupon (GRPN), Yelp (YELP), and Grubhub (GRUB) in that it offers coupons and vouchers, user reviews and food delivery. “They are digitizing the food-delivery business in China,” says Umansky. He thinks it will be the dominant player taking most of the profits in this space. A key theme for Umansky is to go with “platform companies” that dominate a space and reap most of the rewards there.

Brazil

Outside of China, Umansky likes a Brazilian company called PagSeguro Digital (PAGS), which offers digital-payment systems. “It is enabling small merchants in Brazil to accept electronic payments,” he says. It’s a lot like PayPal (PYPL) and Square (SQ) -except that its stock has gotten hammered, even though it dominates this space in Brazil. The shares have fallen to around $28 from $40 last spring. Both PayPal and Square are trading near 52-week highs.

“PagSeguro Digital is down due to macro concerns, but their performance has been stellar. They have beaten and raised estimates since they went public,” says Umansky. The company went public in the U.S. in January. The stock trades at about 25 times 2019 earnings even though it is posting earnings growth of 40%-50%.

“This is a digital-commerce enabler in a place where maybe half the country does not have bank accounts,” says Umansky. “We are so early. This is just the beginning. They can grow for 10 years-plus.” PagSeguro Digital is his fund’s largest investment in Brazil.

At the time of publication, Michael Brush had no positions in any stocks mentioned in this column.

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