‘Tencent has a superior platform’
“The company offers selective exposure to the internet sector in China. Other interesting stocks include Globalwafer, Petrobras and True Corp”
Key points
- Whilst the focus in developed markets is on the giants of the software and AI services sectors, countries such as Taiwan and South Korea dominate the hardware supply chain. How can investors capitalise on this trend without exposing themselves excessively to the risk of a tech correction?
- Where are the best opportunities geographically speaking?
- Which shares do you consider the most interesting at the moment?
Emerging markets are once again offering attractive prospects thanks to more widespread and sustainable earnings growth. According to Ernest Yeung, portfolio manager at T. Rowe Price, this shift is underpinned by improved corporate governance, valuations that remain attractive, and structural trends (artificial intelligence, the energy transition).
After years of underperformance, the outlook for earnings in emerging markets is improving. What factors make this recovery more sustainable than in the past?
A number of factors suggest that the current earnings recovery in emerging markets could be more sustained than in the past. In several regions, we are seeing better capital allocation, higher dividend payments, share buybacks and less dilutive share issues. In addition to South Korea’s ‘Value Up’ programme (an initiative to modernise corporate governance, ed.), we are also seeing similar reforms in China, with some state-owned enterprises improving dividends and returns for shareholders. The earnings recovery is not limited to any single sector. Technology and semiconductors are benefiting from AI-related capital expenditure, whilst energy, materials, industrials and financial services are being supported by structural or cyclical factors, such as green infrastructure and supply chain diversification.
Whilst the focus in developed markets is on the giants of the software and AI services sectors, countries such as Taiwan and South Korea dominate the hardware supply chain. How can investors capitalise on this trend without exposing themselves excessively to the risk of a tech correction?
We seek to capitalise on the opportunities offered by artificial intelligence-related hardware in emerging markets, but without focusing on technology beta. Whilst maintaining exposure to beneficiaries of the semiconductor and memory cycle, such as SK Hynix and Samsung – which have made a key contribution to recent performance – the strategy’s focus is on ‘forgotten’ stocks with improving fundamentals and potential for a re-rating over a three-year horizon. Following the AI-led rally, the IT sector has become the most significant underweight, whilst exposure to South Korea has been reduced. We are also underweight in Taiwan, due to our position in TSMC. Overall, exposure to tech is balanced by a broader range of opportunities in other sectors such as consumer discretionary, financial services, energy, materials and industrials.
Where are the best opportunities geographically speaking?
South Korea is of interest due to its exposure to the artificial intelligence hardware cycle, particularly with regard to memory and semiconductors. However, to avoid becoming overly reliant on a narrow AI-driven rally, we have recently actively reduced our exposure to South Korea. Brazil and Latin America continue to offer opportunities in the financial, energy, materials and cyclical industrial sectors. The key lies in valuation discipline and patience, particularly where macroeconomic or political uncertainty creates pricing anomalies. Our approach to India is selective, rather than based on a broad overweight position. Rising US interest rates are acting as a brake on the Indian economy, so we are focusing on selected areas, such as financial services and the energy transition. We remain selective in China too, where we have taken our first position in Tencent and where we favour AI beneficiaries in the internet sector, which has undergone sharp corrections.
Despite the solid data, many investors are still underweight in emerging markets. What do you think is needed to trigger a reallocation towards this asset class?
Emerging markets play a crucial role in the hardware supply chain, particularly in semiconductors, components, memory and manufacturing. If investors were to start looking beyond the most immediate winners in artificial intelligence, emerging markets would offer exposure to AI-related capital expenditure, investment in the green transition and supply chain diversification, all at more reasonable valuations. In our view, sustained earnings growth will be the key factor. Investors may need to see several quarters of earnings resilience and positive earnings revisions before significantly increasing their exposure. Furthermore, a higher interest rate environment may support the value style in emerging markets.
