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Stephen Rudman: Good morning and good afternoon. My name is Stephen Rudman, and I'm a member of the Ashmore New York-based client team. Thank you for joining today's Ashmore webinar, the title today is: ‘The EM Comeback, More Ways Up Than You Think’. Today's speakers, who you may be familiar with, are Dhiren Shah, Lead Portfolio Manager for Ashmore's EM All Cap Equity Fund, and Gustavo Medeiros, our Global Head of Research.

Topics for today, as advertised, are going to hit many things around Emerging Markets (EM), but specifically Korea, China, Brazil, Mexico, and India. We'll also talk a little bit about artificial intelligence (AI) and the semiconductor supercycle, which may have an impact on all the countries just noted.

Before I hand it over, just a little insight, at least from the US market. Clearly so far in the first quarter, there has been a need to consider diversifying portfolios, specifically around the potential overweight to US equity. Many have noted that part of that strategy should be EM equity, and Frontier Markets, potentially, because there are some great valuations there.

As a note, if you haven't seen it, Gustavo wrote a piece towards the end of February called ‘An EM Ex-China Manufacturing Renaissance’. The piece really explores the longer-term theme of the massive impacts we're seeing with reshoring, onshoring, and manufacturing moving throughout the world with, again, significant impacts on EMs. We're going to address all those things today, so with that, we'll get the main characters involved immediately. So, Gustavo, over to you, and enjoy. Thank you.

Gustavo Medeiros: Thank you, Stephen. Well, today is really about Dhiren. It's a huge pleasure to talk to you again, Dhiren, as you always manage to pack quite a lot in a very short period of time.

Dhiren Shah: There's a lot to cover.

Gustavo Medeiros: Exactly. And I like how in the Year of the Dragon in China, you managed to find a hidden dragon in South Korea. So, tell me a little bit about how ongoing reforms in the capital markets there are trying to revalue Korean stocks, including some of the larger oligopolies. And South Korea is also going to have elections in a month, right? So the floor is yours. Where are the hidden dragons there?

Dhiren Shah:  Okay, let's start with setting the scene politically, because that’s driving the impetus for change. First of all, if you're in Korea, you've seen one of your large neighbours, such as Japan, undertake significant reform, which obviously has been very meaningful to stock market performance there. Within Korea, there's been a policy for a number of years for real estate prices not to increase due to big affordability issues. But what's happened over the last four or five years is that stock market ownership has increased significantly. The government thinks that with South Korea’s ageing population, one of the ways for retirees to achieve greater prosperity is actually for the Korean stock market to perform better. So, that's the backdrop.

The ruling party has, for the last 18 months, been pro-market. And there are local assembly elections in a month's time, where we'll have to wait and see what happens, but the expectation is that the elections will be supportive. Nonetheless, the incumbent party will likely have a number of policies supportive of the stock market. So that's the change which is happening.

In terms of trying to frame the market and the investment opportunity in Korea, most people are familiar with Korea’s globally competitive companies in healthcare, semiconductors, and automobiles. There are also domestic companies with very capable management teams, very good businesses, very good margins.

The challenge, and this has been a longstanding challenge, has been governance practices, where cash has been kept on balance sheets, and hasn't been paid out in dividends. The board structures of many Korean companies are lacking in many ways compared to what we think of as best in class. There are significant gaps.

And what's been happening in the last three to four years has been change, and it's been welcomed. It's been quite notable, but it happens in a gradual manner so that the boards are improving, and the dividend pay-outs are rising. But what we've seen in the last two months has been very surprising. A number of companies are taking aggressive actions and cancelling shares, and what the government is doing behind the scenes is actually quite meaningful. This is interesting because a lot of these companies in Korea, given the starting point, have very good margins and very good cash flows, but they're very undervalued because of these governance concerns. So the equivalent stock listed on another stock market would have twice the multiple. That's the potential, and we're seeing the change now. So this is happening, and we'd expect a lot more in the next one to two years.

Gustavo Medeiros: It's very interesting indeed. On my very high-level map, I see the price-to-earnings ratio of Korea at close to 11 and that being one Standard Deviation above the mean since 2005. It shows basically how Korea has been discounted for a long period of time compared to other EM countries.

Dhiren Shah: It has as well, and one thing to note is that a lot of the earnings, whether it's semiconductors there, are also cyclically depressed as well.

Gustavo Medeiros: Absolutely. Very good, yes. Now, let's switch gears and talk about the real dragon, China. You mentioned timing the recovery. I've been having some very interesting debates, and quite a lot of people are super bearish about China for the reasons that we all know, such as the real estate crisis, governance issues, and the regulatory framework, for example.

But when I talk to clients, and when I speak on these panels, it feels to me like it's a market that is massively oversold. And quite a lot in terms of policy developments have been improving, slowly but surely. But we mentioned timing the recovery. Where do you see the opportunities, macro and micro?

Dhiren Shah: If we look at an aggregate level, the starting point of what you've described, the negativity and so on, the market is very cheap. I think that's understood. You have a collection of high-quality stocks, amongst some of the best globally, at fair values, offering 50% to 100% upside for very good, very quality companies. One year on from China’s  economic reopening, which faded, today we are very much in a normal cycle of greed and fear of markets. This happens, and China's no different to that.

If you look back to early 2021, it was a very greedy market, and the market had done very well. Currently, it's very fearful, and that potentially provides what we think is an excellent opportunity. We have seen lots of signposts of buying opportunities. 

What’s going on with the Chinese economy? First of all, the economy's clearly slowing, and that's also well understood. I think 12 months ago, there was a lot of excitement and hope of a strong recovery, and that's faded because of the government's policies on real estate. They've been reluctant to reflate. But what's happened since then has been lots of supply-side measures from the government, which we always like to see, trying to support the private sector, and long-term planning, which has all been great.

The challenge has been this lack of consumer confidence and lack of demand. So the excess savings that are very clear to see in all the macro data, are there, and savings have actually gotten bigger over the last 12 months. The middle classes have got cash, but they're not willing to spend because their largest asset, which is real estate, has gone down in value. So, stability in consumer confidence can unleash that significant spending power. That story is still very much there; it's just a question of when that re-emerges. 

Then you look at what companies are doing. We shouldn't forget these companies are world-class companies, so they're still growing their top line. It's not growing at 15% or 20%, but maybe 10% to 12%. They still have attractive growth profiles. They're cutting costs. And what's also very interesting and very important when companies are cheap is what they are doing with that cash. Do you get stuck in a value trap or not? So companies are raising shareholder returns. They're doing buybacks. Dividends are rising very, very meaningfully, which is very, very important. That essentially provides a floor for valuations, which is something seen in the last few months. And the economy is still growing at 4%-plus. 

So, the Chinese economy is growing, companies are growing their earnings, and returns are rising. This presents a very strong opportunity, although it's not clear when that turn will happen. Companies delivering positive earnings and growth in itself is a positive trigger. For the patient investor, there are significant opportunities to be had, and when the market turns, we think it turns quite meaningfully.

Gustavo Medeiros:  It’s been turning already, right? Since mid-January, we had the snowball structured products being triggered, with high-net worth individuals in China and other Southeast Asian countries essentially sold puts on the CSI 300 and 500. Then those puts got triggered. The 'national team' came and announced they'll start doing stock buybacks, which is in line with what we've been hearing from the private sector already, with high-profile companies announcing to buy 20% to 35% of their free floats.

Obviously, that in itself could provide a backstop. And a sentiment rebound in the equity market could, in itself, be self-reinforcing. But you're right. A lot of people highlight how sentiment has been negative, but if the real estate market and the equity market are coming down at the same time, that is a double whammy. If the equity market rebounds, that could bring a little bit of a relief. 

Dhiren Shah One thing to mention is with the benefit of hindsight, we'll potentially look back and point to the government stepping in to buy the market as the catalyst or the trigger. The Chinese government has been supportive of the stock market, which is a structural tailwind when you have that on your side. And when markets got very depressed because of forced selling, it stepped in to buy significant amounts. That in itself is very meaningful, and provides confidence to local investors.

Gustavo Medeiros: This is also how Japan started on its journey three years ago, perhaps. Now, let's talk about the other theme, which is somewhat relevant to China as well, but much more for South Korea and Taiwan. Namely, AI and the supercycle in semiconductors, and how investors can play that via EM.

Dhiren Shah: It's an amazing opportunity. Here you get differentiated AI exposure at very discounted valuations. We've done significant research on the AI value chain and a collection of chip manufacturers, chip designers, Nvidia, AMD. You've also got a collection of other A6 providers, Meta, Google, and so on. They're all making chips. And the question is, where are these chips made? The manufacturing value chain of these chips primarily resides in Taiwan, and there are elements in South Korea. What you have is a very, very good industry structure where, over time, industry's being consolidated. The technology requirements have increased, and so that means there are a number of these particular areas with limited competitors and just two to three players.

Also, what we see with AI is the complexity of the hardware of semi chips is much higher. That means their selling price, is much higher, their margins are much higher, and not many companies can do this. So, when we fast-forward into the future, and we're seeing this obviously today already, this has a positive impact on companies' revenue growth, and on companies' margins. Having an environment where you have multiple companies and multiple potential customers who need your help, puts the Taiwan supply chain in a very, very advantageous situation. So, you have AI rising initially from 5%, 10%, 15%, and 20%, and over time, it will become the majority of sales. As of yet, these companies' valuations do not reflect that, so we see this as a multi-year opportunity.

There's clearly a lot of AI excitement, but it's very important to remain selective. There are parts of the value chain where more competitors will emerge over time. So it's very important to focus on the areas where the barriers to entry are very high. That's what our team spends their time doing.

Gustavo Medeiros: That's great. Valuations in that space are much less demanding than quite a few of the big, high-profile names, so you get, to Stephen's point, diversification. This is a place where you can find some nice companies with good margins and nice moats, as you pointed out, in an industry that has been specialising for a while now. Taiwan is obviously the place where you can find many more opportunities.

Dhiren Shah: I'd add to that, that the market today is thinking about AI clearly because that's been the source of demand, the source of excitement.

If we step back and think about broader impacts within tech hardware rather than software, the proliferation of AI will impact broader corporates and consumers by expanding into other parts of PCs, handsets and so on. That's how AI adoption will increase over time, and that will then drive a wider demand cycle within semiconductors. It's a bit early for that just now, but entering the second half of this year into early 2025, I imagine this will gain a lot more traction within markets. It's very interesting because that part of the market has faced a difficult two years. It obviously had a strong cycle post-COVID, but has been a down cycle since then. And that's a very good setup, and expectations are low.

There's a special type of memory chip, HVM, which you need in AI. The consequence of that is there's not much spare capacity left of the commodity grade. So, by the end of this year, there will be a shortage, and companies are not investing because they got burned last year. Those are the ingredients of the supercycle when companies don't invest, and demand will surpass expectations for a meaningful period of time. So AI’s direct impact, but also indirect impact will, we think, be very meaningful.

Gustavo Medeiros: A supercycle kicking in within a super-cyclical industry.

Dhiren Shah: Correct.

Gustavo Medeiros: Very good. Now enough of Asia. Let's talk about Brazil.

Dhiren Shah: Brazil's a very interesting market. Like many other EM markets, it's heavily discounted. What's interesting is there have been a number of structural changes and reforms in the Brazilian economy, which I don't think are very well understood or reflected.

First of all, we all know Brazil's a commodity superpower, from agriculture to mining. There's been a more significant transformation in the last two to three years on the oil side. Now, Brazil is a much more significant energy exporter, and that number will continue to increase.

The consequence of that is the trade account, the current account, is much stronger. So you have an economy where the wealth from commodities is spreading over the countryside, spreading up elsewhere, and is very strong. You've got a very cheap currency because a lot of dollars have been kept overseas. So the setup there is very good. We've also had tax reforms, including a VAT tax reform. Brazil has one of the most complicated tax systems globally, and this reform will result in a huge productivity improvement as it's implemented in the next four to five years. That's a strong gross domestic product (GDP) tailwind. India did a similar thing a few years back, and it's seeing the benefits of that now.

There has also been a big macro improvement. Interest rates are very high, as we all know. Inflation's been low. Brazil’s central bank has been cutting rates, but gradually and cautiously. That will then provide the impetus for flows – for fixed income flows to go into equities as the opportunity cost changes. Brazil’s economy is obviously growing, and we think it will accelerate as rates come down. Valuations are one Standard Deviation below history and its absolute multiples are very cheap. Companies are generating lots of cash flow, and are growing. So, we find a collection of interesting opportunities there, and we think this story plays out over quite a few years.

Gustavo Medeiros:  Locals are still worried about local politics, and there's quite a lot of noise in there, but I think you're right. I think that not only the tax reform but the pension reform that came earlier, plus a lot of administrative reforms from the previous government as well, are actually starting to show up. Also, Brazil’s energy and agricultural sector has the best external accounts in the history of the country. So it's very, very powerful, and it's forecast to keep on improving.

What about Mexico? You mentioned a Mexican stand-off, which is interesting. Are you referring to the Mexican elections, or the US elections?

Dhiren Shah: Or both.

Gustavo Medeiros: Or both. Where do you see the risks and opportunities?

Dhiren Shah: We've historically been quite constructive on Mexico. It boasts some great companies, discounted valuations, and the economy doing reasonably well. What we had last year was the start of the nearshoring boom. It's still at a very early stage, but it has the potential to accelerate Mexican GDP growth from 1% to 2% to 4 to 5% over a prolonged period of time. So, the setup is very interesting.

The market has done well, but it still remains quite cheap, and the starting point was very attractive. However, into this year, there are obviously local elections in Mexico, and there are US elections. First of all, with local elections, it's early days, but the market expectation is for a continuation of the Morena Party. We'll have to wait and see, what the policy objectives are in more detail. There's an expectation of continuity, but we'll have to wait and see if there is a super majority in Congress or not.

The second issue is obviously the US elections and, depending on who wins, the outcome there for Mexico. Trade matters a lot with Mexico, given its historical NAFTA relationships. So for that reason, we've tempered our enthusiasm. We like Mexico, but not to the same extent because we see quite a bit of uncertainty ahead, and that's starting to be reflected in the markets, with Mexican assets underperforming in the last month or so. We think it will remain a difficult market, and that potentially can make for a nice opportunity at some point, but we'll have to wait and see where we end up on the political side.

Gustavo Medeiros: Down the road. Yes, I think it makes a lot of sense. For what it's worth, my view of the Mexican election is that there is only upside. The President of Mexico, Andrés Manuel López Obrador (known as AMLO) is not running and most likely Claudia Sheinbaum would be much more pragmatic than he would be. And if the opposition wins, all the better.

But I agree. Once Trump realises he might be able to renegotiate USMCA, a deal that he negotiated, it could add a little bit of pressure. There would also be noise on the immigration front, which would impact Mexico. So, it's an interesting one.

The last topic you mentioned is India’s equity market bubble. We've talked about it in the Investment Committee for a few weeks now, but my favourite fact is that there is quite a lot of churn in the local markets, with domestic retail investors trading options in Indian stocks. This is happening in large numbers and is a little bit scary. Tell us how you see that. 

Dhiren Shah: Yes, in the same way we were talking about China earlier and the signposts of negativity, you've got the polar opposite in India. So, what are the things you'd look for in terms of equity market bubbles? I think there are some decent valuations in some of the large-cap stocks. But in some pockets of the small and mid-cap market, there’s evidence of excessive speculation. We're big believers in valuation discipline – that you pay for your future returns upfront. It doesn't matter in the near term, but valuations always matter in the long term. Having that discipline is very important. So, for those reasons, having formally been quite constructive on India, we've gone to a more relevant underweight given those valuations.

Retail participation is off the charts, with huge domestic inflows, and a lot of it's been expressed by futures. That is quasi-hidden leverage, being done by options, and so on. The valuations of a lot of these stocks no longer make sense. The interesting thing is that the Indian market has been expensive for a while, but they've become more expensive.

But we've seen a change recently, and that change is what we discussed at the Investment Committee, is regulations. And so the market regulator Sebi has been talking about capping fund flows and so on. This is potentially one of those catalysts for some of that speculation to be taken out of the market.

We think the long-term investment case for India is great, with the potential for multiple years of 6%-plus GDP growth based on historical reforms, foreign direct investment (FDI), manufacturing, liberalisation, and all the other long-term stories everyone knows about. But there are tailwinds in terms of India’s demographics and consumption. These were true also four or five years ago and will remain in place. The challenge is obviously just valuations where we can find much, much better opportunities elsewhere, plus you've got scope for more downside there. So, those are the reasons. Whilst everyone is very euphoric, it makes sense to be more prudent.

Gustavo Medeiros: It makes a lot of sense to me. It rhymes with some of the things that we've been seeing and discussing as well in other parts of the asset class. So, how do you see the opportunities in the EMEA markets since we talked a lot about Latin and Asia? Anything in the middle?

Dhiren Shah: Opportunities, yes, but they're more limited. Selectively, there are some very interesting stock opportunities from places such as Kazakhstan, where there are dominant platforms trading at single-digit P/Es growing 30%. We bought up more industrials in parts of Eastern Europe recently, because of significant market dislocations. Poland is a market we've had significant exposure to in the past, although we have more moderate exposure  today. But there's been political change there, and there are a collection of interesting companies there. So it's been more selective. We had invested in Greece, a country where there was obviously significant reform. Greece has now returned to investment grade, so it has seen a very significant improvement in its economy, which the market did not appreciate but has worked out now. So there are selective opportunities, but, in general, it is a much smaller part of our allocations compared to some of the other markets.

Gustavo Medeiros:  Fair enough. And South Africa, with elections in the middle of the year, Do you also want to be selective there as well, or cautious?

Dhiren Shah: We've been quite cautious for some time, and that view remains, yes.

Gustavo Medeiros: Fair point. I think those were the main topics we had scheduled. Stephen, do we have any questions from the audience?

Stephen Rudman: I think you addressed a question on pricing in India pretty well, where we're obviously very cautious. One other question which I think you covered was asking your opinion on Mexico. So I think the two major ones you covered. Gus, I mentioned your ‘Emerging View’ piece on ex-China’s manufacturing renaissance. If you want to spend a couple of minutes discussing that piece, because that covers the overall theme around all the markets we touched on in some real detail today.

Gustavo Medeiros: Sure. We decided to write a piece based on anecdotal evidence that we'd been collecting. We see a lot of investment in renewable energy on the ground as well, like solar panels, etc. I decided to look into the data to see how much is actually out there. 

So there are a couple of interesting points. The first is that, despite the fact that everybody's talking about the slowdown of globalisation since the Great Financial Crisis, when you break down between south-south trade, overall trade, north-north trade, and intra-south-north trade, you see that south-south trade actually kept on expanding. China became a much bigger trading partner to the rest of the world. 

The energy transition is a big topic that is going to be with us for many years. And when people think about the energy transition, there is a lot of excitement for investment, but some corners of the planet, like the US and Europe, are putting in place a lot of protectionist policies. In macro terms, these are the wrong set of policies to think about. If you are very unproductive in producing solar panels and wind turbines, and you try to put protectionist policies in terms of trade in place, you are likely to end up with suboptimal industries developing in the US and Europe. It's exactly what we're seeing in terms of some of the nascent industries in these places really struggling to survive. 

Then again, we go back to the south-south trade, and for a lot of Latin American countries and African countries, South Africa, for example, importing cheap solar panels and cheap wind turbines from China could be a long term solution for them.

It made me think that the irony is that for 25 years, there was no alternative to China for manufacturing. It was impossible to get any investment in a factory if you were a Brazilian company trying to compete with a Chinese company in terms of, for example, assembling iPhones, or you need a factory for car manufacturing, etc. 

But today, the basis of manufacturing is cheap thanks to relatively competitive labour, cheap energy, and the structural reforms in terms of infrastructure obviously. But there is also a more competitive environment in terms of regulations for the industry. And in many countries, we actually had structural reforms. We talked about India. We talked about Brazil. Indonesia, we had a number of structural reforms as well. More recently, Turkey and Argentina, which are more on the Frontier Markets side, are trying to go towards the direction, Saudi Arabia as well . So, the structural reforms are there. The currencies are relatively cheap, so labour is competitive. 

Then when you look into the data, several countries are importing so many solar panels that the percentage of renewables as a portion of total energy produced is rising, and it's likely to keep on expanding in the next few years. These countries – Brazil, for example, and others in Latin America are importing between 5 and 7% of their energy capacity generation on an annual basis of equivalent solar panels. Those are aggregate numbers that are making it hard to quantify precisely, but they're growing, and they're growing at a very large scale.

So I think that all the conditions for these heavily populated countries that have been doing structural reforms and are getting more and more cheap energy would leave them able to rebuild and try to get some manufacturing back. It’s not only the likes of Mexico and India that will benefit from friendly shoring. 

Energy transition is a very interesting theme for investment, but also hard to find good bottom-up opportunities, because of the commoditisation of that. The playing on buying copper and buying the electric vehicles really didn't work, right? So you have to find companies within the value chain as well, many of them potentially in China, that could actually benefit from that. Maybe you can share one or two thoughts on that space as well.

Dhiren Shah: I'd agree with that. I think from a high level, the simple economics of it is that if you can buy something after it's gone down 70% you make a good internal rate of return (IRR). That's what a lot of these countries are doing. They're buying cheap solar panels, and solar from a levelized cost of energy (LCOE) perspective is very economical versus other forms of energy. So it makes a lot of macro sense to be importing these panels. 

In terms of the investment opportunities, and as we've said in the past, you need to be very selective. China is extremely competitive from a manufacturing standpoint. There are multiple companies often doing the same thing, and they might start out as the sole supplier, but after four years, there are 20 other companies doing the same thing. This has meant, in general, we've had very modest exposure. We aim to find intelligent, indirect ways, of finding sub-niches, components, where companies are more complex and there isn't the same competition, as these companies benefit more. 

Some of them could be in Taiwan and also directly in parts of China. So, we've been adding selectively to parts of this as we see these companies have got great moats, and this will be many years ahead of strong demand. Interesting as well for electricity demand, it ties into AI. AI is very power-hungry despite chips becoming more efficient. It's driving a global electricity demand, especially when there are data centres associated. It's actually increasing very meaningfully. So indirectly investing in grid networks as well as just investing in companies that benefit from it, such as solar, are other ways to effectively play the same theme but in a less obvious way.

Gustavo Medeiros: Just finding the right companies with the right moats, as you said.

Dhiren Shah: Correct.

Gustavo Medeiros: I think that's it in a nutshell. Well, the wrap-up of the Emerging View piece is that if this all plays out, it would lead to much stronger structural growth in EM ex-China, which is a theme that a lot of investors and individuals are questioning, namely, what is going to be the next three, five, ten-year macro picture in Emerging Markets?

One of them could very simply, be more south-south trade, where China things where they have excess capacity, and they're getting more and more competitive. And in EM, the right answer is to absorb the subsidies, absorb this cheap cost of energy that is coming. In several countries, electricity prices are down 30 to 50% from some of these solar farms. That's a competitive advantage that the rest of EM is going to have compared to the US or Europe, which is trying to compete by putting subsidies on China, which is, quite frankly, given the scale and the magnitude of how China does things, a losing proposition almost for certain. That goes back to your first point, Stephen, on diversification, on thinking outside of the box and how this space is evolving. There is a lot of potential structural growth opportunities that investors are really missing if they're not looking through the asset class and really looking into Emerging Markets.

Stephen Rudman: That's a great spot to end on an optimistic note. Both Dhiren and Gustavo, thank you so much for your time today, very helpful. As always, if anybody has any follow-up questions looking for information, please contact your local market Ashmore client-facing team I will finish by saying thank you. We appreciate your time, your trust, and for joining us today. Have a great rest of the day in London, and we'll do this again soon. Thanks so much.

Gustavo Medeiros: Thank you very much.

Dhiren Shah: Thank you.