Discussing Emerging Markets With Ninety One's Varun Laijawalla
Varun is a co-portfolio manager for the Emerging Markets Equity and Emerging Markets ex China Equity strategies in the 4Factor team at Ninety One. Prior to joining Ninety One, he was vice president of Asia ex-Japan Equity Sales at Macquarie Capital Securities, and was based in Hong Kong for 5 years. Varun started his career in London at Corporate Value Associates, where he consulted blue-chip corporates in the Financial Services sector. Varun holds an MBA from INSEAD with a specialization in Finance. He earned a degree in Bachelor of Science in Management from the University of Warwick.
I want to thank Varun for taking the time to talk to me and also thank Laik Sweeney for organizing the Teams meeting and sending me material.
I don't generally talk to portfolio managers but it was clear from the onset this wasn't a sales pitch, I wanted to dig deep into emerging markets and Varun really knows his stuff as you'll see below.
I began by asking him to give me a background about himself and how he got to Ninety One which he did:
Sure, I've been at the firm for 10 years. I'm co-manager Emerging Markets Equity portfolios. I've only invested in emerging markets through the duration of my career. Before the joining the firm, I was based in Hong Kong where I spent four years working on the sell side, working for Macquarie Capital. There I was focused on Asia ex-Japan, so the current role is a broadening role to global emerging markets.
I'm originally from India, I was born in India, my family are from there. I grew up in Holland but with very close ties to India through my grandparents and my family. I married an Indian girl, my in-laws live in India so we go back very often.
I asked him if it was Mumbai and he said that's where he was born. I noted it's definitely a burgeoning place
I then asked him to tell me a bit about Ninety One and which asset classes it specializes in. He replied:
Ninety One is very straightforward. We manage I think close to 250 billion Canadian dollars, and roughly 60% of those assets are emerging markets related. We are one of the few asset managers that are emerging markets focused. That's emerging markets equities, emerging markets fixed income, emerging markets private markets. So if you were to put us into one category, I'd say we are an EM house and that speaks to the heritage of the business.
The business was founded in South Africa during an interesting time, in 1991 hence the name, and it was a particularly monumental time of our position because it's when apartheid ended. We were founded in a market undergoing tremendous change and that's in our DNA, operating in difficult markets where change happens sometimes for the good, sometimes for the bad.
I asked him if he broke down assets between public and private markets, are they predominantly public and he said yes.
I then shifted my focus to investments telling Varun I'm a macro person, used to allocate money to the best directional hedge funds in the world, had very few EM managers in my L/S book of managers and for me Emerging Markets were always about Risk On/ Risk Off markets meaning when rates were low and vol was low, they outperformed, when rate climbed and vol picked up, they got dinged.
But I told him this "macro top down view" isn't necessarily still binding as there has been a profound shift in emerging markets over the last ten years and you see it as Canadian pension funds shifted their focus there, and there are powerful secular trends -- urbanization, rise of a strong middle class, digitization and communications and even though these countries remain export oriented, there is a growing service economy there leading to more economic stability.
I asked him if he agreed or if it's still Risk On/ Risk Off like we thought about emerging markets in the 90s? He replied:
I think your intuition is correct. If you take a 20-year view, and you line up the best-performing asset class every calendar year all the way to the worst-performing, Emerging Markets Equities will be the very best or the very worst in roughly 75% of those calendar years over a 20 year period.
To your point, there's is absolutely Risk On/ Risk Off, a lot of volatility and inherent cyclicality.
To your point about things changing, you're absolutely right. What has changed is vol (volatility), vol has changed and if you look at vol through that lens, the vol of emerging markets has been falling precipitously over the past 15 years. So much so, over the last couple of years there have been periods where vol of EM was lower than vol of DM, and when I say DM, I mean MSCI Equity. It's quite an eye-opening thing to appreciate.
And the reason for the vol divergence or narrowing of vol, I think there are structural reasons and cyclical reasons. The structural reasons from a macro perspective, the policy has improved for EM because you used to have bad policy frameworks and that has changed. What I mean by that is you have strong central banks particularly in places like Brazil, India and Indonesia. That is leading to better policy-making.
You also have flexible exchange rates that have moved away from pegged exchange rates, therefore the sudden breaking of the currency is less common.
That is the macro side of how things have changed, the other is plumbing, the general plumbing in a lot of these emerging markets has improved. And by plumbing I mean they've become deeper markets locally or domestically.
Take India for example, it's a very deep, domestic market where the annual domestic flows have almost tripled since pre-Covid. So the Indian equity market saw roughly $12 billion of inflows pre-Covid. Post-Covid, $12 billion became $29 billion in a short amount of time.
The reason that has dampened vol is if you have foreigners running for the exits, you still have the domestic funds there to hold up the market. It's a much more genuine market rather than one governed by foreigners.
I think the final thing is we talk about US exceptionalism, if you put numbers against a narrative, equity vol has increased and it has increased because it's a concentration risk around US assets, particularly around the Mag-7.
So you have almost the DMification of EM or the EMification of DM where we are looking a lot more developed market like and developed markets are looking a lot more like emerging markets.
Things are changing.
Indeed, over the last 20 ears, things have changed drastically in emerging markets.
I noted there's definitely more diversification now in the EM markets than the US market but it's the same across the DM worlrd ex-US, meaning that Mag-7 and other tech heavyweights in the US (eg. Broadcom) are skewing the S&P 500 there.
I noted in emerging markets, you have good financial services, telecoms, materials but similar to Canada, they don't have that powerful technology sector which has led the US and world equities since 2010 frankly.
So there are diversification benefits in emerging markets but I also told Varun that countries like India worry me a bit because there are still three or four billionaires which control the main publicly listed equities there.
He responded:
Those comments are well placed but I think there's nuance if you would allow me to explain.
To your point on technology and the US being the innovation hub and the rest of the world following or being a fast follower, I'm not sure I agree with that and the reason I say that is if you think about AI, AI as it relates to the stack. You've got the apps at the very top, predominantly US based, then you've gt the GPTs in the middle, again, US based, but at the bottom of the stack, you have the infrastructure which is how to bring the whole thing to life. That is the fundamentals to how a house is built. And that is entirely emerging market based, predominantly Taiwan and Korea based. Think about Taiwan Semiconductor, Nvidia doesn't exist without the chip manufacturing and capability of TMSC nor doe sit exist without HAMNI Semiconductor which specifically provides high bandwidth memory chips that make AI possible.
The question I would pose to you, Leo, is during a gold rush, do you want to own the goldmine which is the apps, or do you want to own the guys that make the picks and shovels? the picks and shovels is in emerging markets.
I interjected to say that is very interesting because Taiwan Semiconductor is still a stock that is very cheap by my standards:
I asked him to give me a breakdown of sector exposure because I always assumed financials make up 20-30% and technology maximum 10% in emerging markets. He responded:
You'd be surprised. If we look at Technology, it's now 25% of the benchmark.Taiwan Semiconductor is the largest, then you have Samsung Electronics based in Korea, Xiami (the Apple of China), and then a long list of other businesses but those are the top three [Note: Not sure which benchmark he is referring to because in the iShares MSCI Emerging Markets ETF (EEM), Alibaba and Tencent also figure among top holdings.]
So Technology is 25% of our world, Financials is 25% of our world. Innovation is happening in our markets, it's almost a quarter of the opportunity set.
I also asked him whether it's fair to say there is more value added in emerging markets because they're not as widely covered as US markets.
He responded:
I would certainly think so. The way I evidence this and we've done a white paper on this, we try to answer the question in which asset class does it really pay to go active vs being passive?
So we lined all up all the asset classes, and the one where it consistently paid to go active was emerging markets over the last 20 years. And that speaks to your point about the inefficiency.
If you think about the reasons for this inefficiency, I'll point out a couple. Retail participation is a really big one. China is 30% of the benchmark, roughly 80% of Chinese trading is dominated by the retail investor. 80% of the biggest market in the opportunity set, that's enormous.
If you look at places like Korea, Saudi Arabia, they're dominated by the retail investor. So an active approach that is disciplined --and we'd like to think we are in that category -- has a pretty good shot of generating alpha over an extended period.
The other area of inefficiency i one of the characteristics of emerging markets is you have family owned businesses, like the point you made about India. Whats interesting about that as it related to inefficiency is you tend to have two types of families. The first is the family that wants to grow the size of the pie and therefore treat minorities well, that is a win-win type of approach.
The second is a family that wants to grow their share of the pie. That's not a win-win approach. What you tend to have in that second category of family is leakage. Leakage in related party transactions with their own side businesses, leakage sin terms of allocating capital to M&A, leakages in terms not paying out dividends or buying back shares when they should be because perhaps they own a minority stake in the business.
That leads to opportunity if you can determine which business to invest in and which business to avoid.
He gave me an example of a Russian airline they were looking at five years ago which looked remarkably good on paper but they looked at the board structure, governance structure and specifically changes to the board and one of the proposals was to add a 2-year old boy. They discovered the founder entered into a proxy battle with the board and to ridicule other board members, he proposed his 2 year old boy be a board member.
That was an extreme example but worth noting that governance and board structure matters in emerging markets.
Lastly, I asked him about Trump's tariffs and how they are impacting emerging markets.
He responded:
Tariffs are a lose lose game, there's no sugarcoating, everyone loses. That's the first thing.
Second thing, let's look at the price action, forget my opinion. Emerging markets are outperforming developed markets year-to-date. And one of the best performing markets year-to-date is China which supposedly should be hardest hit by tariffs.
So, there's a narrative and there's reality. The reality is emerging markets are outperforming developed markets and China is doing very well.
I interjected and told him last year when David Tepper came out with his big long on China, I was very skeptical because China is a communist country. So I asked him why is China outperforming?
He answered:
This is where my view comes in, if you look at why China has underperformed over the last 5 years, you'll get a lot of emotion around regulations, geopolitics, etc.
Take all that away, there's a financial reason that China has underperformed. There are five things that drive any market at any point and time: revenue growth, margin growth, currency, revaluation and fifth most important for China is net issuance.
Think about net issuance as a company issuing capital vs a company doing a buyback or paying a dividend.
That is what happened in China, net issuance has been off the charts over the past decade predominantly because you had very large companies in the late 20teens that went to IPO, the Chinese internet companies. And when they IPOed, they IPOed at a very high multiple in relation to the market multiple. They IPOed at roughly 27x P/E, the market multiple was 10 times.
That's not a problem in and of itself, the problem is you had regulations in 2021 and those high priced companies derated to the market multiple. They are very big index companies, that is a dilutive impact on the benchmark, hugely dilutive. Alibaba's weighting in the benchmark now is 2.85%, it's come down a lot since it IPOed.
That's history. If you look at what is happening now to think about the future, the net issuance in China is reducing substantially. It's reducing substantially because in 2024, the value of buybacks was almost double the value of buybacks in 2023.
So the capital allocation framework for the average Chinese company has flipped on its head, the behaviour has changed. Now Chinese companies are saying the following: "I can't control the geopolitics, I can't control policy in my own country, I can't control whether the consumer saves or spends, there's only one thing I can control as an entrepreneur, it's with what do I do with the cash that flows into my business. And with that cash I will not be empire building, buying companies willy nilly, I'm going to do a buyback because my stock is cheap, I will be paying myself a dividend."
That is why you have record high buybacks, record high dividends in China. That is leading to net issuance declining significantly.
To recap, the financial reason China underperformed is net issuance, not anything else. The financial reason China could outperform is net issuance, that drag goes away and that is happening.
We ended up with a discussion on which markets he likes in the EM world and he told me UAE because it's uncorrelated and it's becoming more open to business, reducing tariffs and in 2019, they issued a golden visa for foreigners allowing them to remain in the country if they lose their job so immigration there is enormous (Dubai is booming).
He told me he likes Aldar Properties in Abu Dhabi. He also like PopMart in China where Chinese buy small collectible toys which sit in mystery boxes so you don't know what you're buying and this business in China is booming (check out Labubu on Tik Tok). These mystery boxes are now selling all over the world and the margin overseas is significantly higher than the margin in China.
He told me they're underweight Taiwan because given tariffs are here to stay they want to be selective with businesses there that have pricing power (like Taiwan Semiconductor).
Alright it's late but this was a fantastic discussion and I wanted to post it so my readers can digest it over the weekend.
Varun Laijawalla is a really smart guy who is a real pleasure to talk to and he opened my eyes to the opportunity set in the emerging markets.
Below, a conversation with Varun Laijawalla, Portfolio Manager at Ninety One, where he manages long only EM and EM ex-China portfolios. Take the time to listen to this interview.
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