Can this market darling finally make a recovery?

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With investors focusing on Asian markets in the Far East, are they missing out on an opportunity in South East Asia with India?

Dave and Carlos von Hardenberg, portfolio manager on the Mobius Investment Trust Ord (LSE:MMIT), discuss whether this sleeping market giant is waking up again, and is a prime opportunity for investors.

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Dave Baxter, senior fund content specialist at interactive investor: Emerging market shares are back with a bang. The returns have been really strong in the last year or so, although a lot of that has been driven by just a few shares in Taiwan and Korea associated with the artificial intelligence trade. 

What’s been really interesting though is a former market darling of this region has largely been absent from the party and even had its own struggles. Investors once not long ago clamored to have exposure to India, but some even seem to now be turning their backs. The question is: should you get involved and if so what do you need to bear in mind?

So, welcome back to On The Money, the show looking at the key issues affecting your savings and investments. I’m Dave Baxter here at ii. Today I’m joined by Carlos von Hardenberg, portfolio manager on the Mobius Investment Trust. Carlos, many thanks for joining today.

Carlos von Hardenberg, portfolio manager on the Mobius Investment Trust: Many thanks for having me.

Dave Baxter: So, cards on the table, we’re discussing this because what’s interesting is you still do have a decent chunk of exposure to India in your fund. So, I want to turn first of all to the first question on this paper here, which is two words: why India?

Carlos von Hardenberg: Why India? That’s a very good question, and India obviously is on the minds of emerging market investors. It’s a market you can’t ignore, and it’s a market that has seen immense progress over the 25-plus years since I’ve been investing in India.

It’s also a market that hasn’t performed now for a relatively long period of time. 

We take a contrarian view. We’ve had much less invested in India up until more or less one year ago. Traditionally, we had a very chunky exposure to India, and we’ve taken profits about a year and a half, two years ago, mainly in IT services and in some of the construction-related companies. We’ve had a much lighter weight up until the beginning of this year when we saw that a lot of the correction was already sort of recycled through the currency. You saw the currency having adjusted very significantly last year. You saw the market correcting substantially. 

And a couple of very specific India-related developments. Number one, which is almost strange to say, but India is not AI. This is very omnipresent in the minds of investors. And number two, many of the key industries in India, like IT consulting, are actually being disrupted by AI.

Dave Baxter: So, things like Infosys Ltd ADR (NYSE:INFY)?

Carlos von Hardenberg: Exactly. And therefore, you had this correction, this underperformance, which, for a contrarian investor, is always a good time to reconsider. We went in at the beginning of the year and...we don’t focus on the large companies. We focus on the 4,000-5,000 small and mid-caps, and that is a hunting ground which provides enormous opportunities. We rebuilt our exposure to India at the beginning of the year. It’s already helping us a lot. We’ve actually performed really well this year.

Often investors just look at the benchmark. Yes, the benchmark hasn’t done so well, but many small and mid-caps have done phenomenally well. There are a lot of structural stories. There’s a very pro-business oriented government. You have reasonable interest rates. You have inflation in check. You actually have a current account, which has improved significantly over the years.

So, a lot of initiatives, including the one by the government allowing data-centre investments to enjoy a tax-free period for 20 years, has led to a lot of FDI  [foreign direct investment] coming into the country. So, the story needs to be looked at with a little bit more attention to detail, I would say.

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Dave Baxter: There are question marks around the software services, a big part of that region, and you mentioned you’re not so interested in construction now. What kind of sectors are appealing? Often with emerging markets, people have a narrative they’re looking at, for example, a trend like favorable demographics. Are there any particular trends you’re looking to target?

Carlos von Hardenberg: Absolutely. I should say first we shouldn’t just talk about India because emerging markets is obviously providing a lot of opportunities across different geographies, especially in South East Asia. But, in India, you have a couple of well-understood trends. You have a very sizable economy, by now larger than many of the Western economies, which is growing by 7%-plus. 

That’s at least the measured organised data. I think the real data is probably above this. You have a very large population, the largest population on the planet. This is all very well known, so you have a lot of trends which relate to consumption, which relate to the fact that households over the coming decades will have more money to spend. Also, the spending itself will migrate to new areas like healthcare, technology, and modern lifestyle-related spending. So, all this is quite well understood.

One of the areas we find particularly interesting is the focus on the fast-growing, more affluent part of the Indian population. We’re moving up a little bit to the part of the population which has enjoyed enormous increases in personal wealth over the last decade or so. Therefore, one area we find particularly interesting are services that are directly geared to this part of the population, for example, wealth management.

We’ve invested in businesses, like your business actually, providing wealth management services to Indians, and it’s growing exponentially. They increasingly want their own homegrown solutions. They are leapfrogging from the Western benchmarks and offering increasingly very sophisticated products and services. So, that’s definitely growing very fast. 

There are other areas which I find very interesting. This infinite access to talented labour and low costs are constantly producing business models which are competing not just in India, but globally. We invested in a company which is one of the world’s leading providers of refurbished consumer electronics. It’s a hedge to the exponential price increase in memory in consumer electronics driven by memory prices. They are focusing on refurbished products, smartphones, laptops, desktops, and are working in the US. They’re supplying to the US, European and Asian markets, and they’re doing phenomenally well. 

I mentioned data centres. India is not totally outside the technology opportunity set. There is a lot that the government intends to do. They are looking at Korea, they’re looking at Taiwan, and they’re trying to attract these types of investments. We invested in a company providing special cable and wire solutions, for example, to data centres and servers in general, and that’s also an area which is growing very fast.

Dave Baxter: So, you’re getting some of those so-called picks and shovels plays on the AI trend?

Carlos von Hardenberg: Yes.

Dave Baxter: So, you did mention that benchmarks can be misleading, and perhaps there is some positivity in the India story that’s not really captured by those figures. But, at some point, you would think maybe India does more broadly come back into favour. What do you think it would take? I mean, is it very strongly linked to that AI trade? Do we need the air to come out of that, or are there other things to consider?

Carlos von Hardenberg: I totally agree with that idea that [you have to take] benchmarks in the emerging market world with a lot of skepticism. I mean, if you just follow the benchmark, you would load up on China. You would have had 7% in Russia. You would have lost that. The benchmark, I think, is a terrible and poor guide in emerging markets.

What is required in India? The starting point in India is always macro. The sensitivities that investors typically look at are global commodity prices, global inflation, and geopolitics in general. India is sort of at the weaker end of this. It is suffering from the current environment as a large oil and gas importer. So, that hits the Indian consumer. We talked about IT services [and] some of these industries are particularly hit right now. We also talked about flows being redirected to Taiwan. So, all these things need to normalise to some degree.

But, at the end of the day, what will lead to a renewed interest in the Indian market is going to be ultimately driven by earnings growth. And Indian companies are well prepared and working in the right environment to generate sustainable long-term and durable earnings growth.

Once the market realizes that that is actually the fact and that’s observable in India, investors will come back. Of course, there’s always the discussion about valuations, and India has typically been rather on the expensive side.

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Dave Baxter: Yeah. Has that come in now? Because at the back end of the really strong run that we had for India a few years ago, people were quite concerned that prices looked a bit high, quite rich. Has this normalised enough, or does it still need to come a bit further back?

Carlos von Hardenberg: It has normalised to some degree. It has never been an issue for us because we do not look at the crowded trades. It is a misperception. These sky-high multiples were always mainly to be found in the largest names in India, the crowded trades, which are bought by exchange-traded funds (ETFs), large mutual funds and also the domestic investors.

We’ve been steering away from this into the depths of the market. You can always find attractively valued companies. When we bought this business, which I mentioned earlier, which is refurbishing consumer electronics, we paid a very reasonable multiple. There was not a single foreign investor there yet, the same with the wealth management businesses. So, if you really look deep into the market, you’ll find undervalued opportunities even in India.

Dave Baxter: You mentioned earlier that you’re not so keen on benchmarks in this space. Say I invested in an MSCI Emerging Markets tracker. As you mentioned, I would be loading up on China. My last look at the trust suggests you are very light on China. Particularly in recent years, it’s been a country that’s quite divisive. Some people think it has recovery to come through, and, of course, some people even dubbed it ‘uninvestable’ just a few years ago. What is your current take on China? What would it take for you to get more involved?

Carlos von Hardenberg: What would it take to get more involved? A lot. Let me start by saying this: you can never ignore China per se, and you should never ignore China as long as it is an economy of such significant size, an economy that is impressing time and again, reinventing itself, moving ahead in investing in the right sectors and technology.

It is very impressive what the Chinese have achieved in many industries in many ways. To provide this environment for such a large population, [means] prices had to be paid, but still, it’s impressive. I think the structural problems that they’re facing now have not been sufficiently addressed, and you have to discount all these risks into your equation before you consider investing in China.

So, this endless discussion about the Chinese real estate sector, we have not seen a proper way out of the dilemma [given] the degree of overbuild, and the degree of exposure that private households have to real estate. The numbers indicate that between 60-70% of household wealth on average is tied to real estate, and the real estate prices keep falling quarter after quarter. So, the perceived personal wealth of households is declining. Therefore, appetite to spend is declining.

The impact this has on domestic consumption is very negative. The government has been desperately trying to steer away from the dependency on fixed-capital investment and exports to a proper domestic economy, but without success, without the desired outcome. If you look at the GDP composition, the domestic consumption is still of very little relevance. So, that’s one thing.

You have 19% youth unemployment, excluding young people in university. This is very substantial. If we had this in this country or elsewhere in the West, it would be perceived as a national crisis, and I think it is one in China. So, that’s another problem.

Plus, I have to say this, and I think it’s well understood but has been mentioned less often recently: overcapacity in every key industry, whether cement, steel, aluminium, copper, or anything else, is to a degree that’s literally scary.

Some of the government’s recent initiatives make sense. Others are going in the wrong direction, for example, limiting travel freedom for certain individuals. It’s actually not new, but it’s now suddenly discussed more intensely, which is negative.

Having said all this, and I want to wrap my answer up here, the problem is we invest in companies, in people, and in businesses that impress us, that can do really well. To find those in China is very difficult because often governance continues to be very disappointing. 

You often have a situation where minority shareholders have absolutely no chance if things get tough, and the imbalance between voting shares and economic interest is still significant.

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Dave Baxter: Government interference, though, is still quite a risk because that is what burnt investors, what, five, six years ago?

Carlos von Hardenberg: Yes. Time and again, whether it’s education, tech, or healthcare, they will continue to run it this way. We had, over the last few years, almost nothing in China. The benchmark is 25%-plus depending on the benchmark you use, and we continue to look at China with a great degree of skepticism. Having said that, we invest via Korea, via Taiwan, via other South East Asian businesses, which can succeed in China, but in a concentrated portfolio, you want to be careful in China. That’s very clear.

Dave Baxter: Turning to other parts of the emerging markets world, which countries do you think are really standing out now? Where do you think the next bit of potential is?

Carlos von Hardenberg: So now you get me talking. This is where the excitement is really. I spend a lot of time in South East Asia. We’ve talked about India, but we spend a lot of time in Korea, Taiwan, Vietnam, and across South East Asia. 

When you look at the broader situation in South East Asia, the number one observation is that people are very optimistic, which in itself is already interesting when you’re coming from Europe. Whether you speak to young people or elderly entrepreneurs, they basically see the current [global] situation to be really in their favour. This is because South East Asia, especially Korea and Taiwan, are optimally positioned to benefit from what’s going on right now.

They worked on the right education systems. They build ecosystems supported by the government and the private sector, which can compete globally. They have developed a dominance in exports and many key industries, and they also increasingly disrupt traditional industries where the West and the US and Europe have traditionally been in the lead. 

And this is no longer following the old recipe of just being cheaper. They are better, they are advanced. They invested in intellectual property. They invested in patents more than anyone else. And they now have the ability to source knowledge and skilful people from their own ecosystems. They no longer have to recruit people from US universities. So, this is the broader context. 

We’ve been incredibly excited about Taiwan despite the geopolitical discussion, which we can talk about. Without Taiwan, this recording studio would not function. The whole City of London wouldn’t function. If you look at the dependency on leading-edge processors, when you look at all the technologies which are now used in the development of data centres and corporate servers, when you look at design behind all this, it’s made in Taiwan, and dominated by Taiwanese companies. 

And this goes far beyond Taiwan Semiconductor Manufacturing Co Ltd ADR (NYSE:TSM). We have not invested in TSMC, but many of our holdings have outperformed the likes of TSMC.

We’ve got companies which test semiconductor products. We have companies which are providing, as I said, infrastructure to build data centres. One company is particularly interesting - they do [AI server slide] rail kits. With rail kits, you would think, anyone can do this. But, no, there are 2,000 patents, and the rail kits use the data centres. You can imagine that [compute] trays are worth tens of millions in some cases. They really have to work well, and they are made of special material. 

So, the technology opportunity is huge, and it’s lasting, and it will grow even bigger in the near future.

Korea is another very interesting market where, of course, everybody knows about memory, but there’s more than this. We invested in very specialised technology leaders that are catering to the memory industry, which are really doing well. But we’ve also invested in a healthcare business, one of the leading developers of medical aesthetic devices, and it is, for example, number one in Brazil and in many other markets.

Dave Baxter: And I suppose striking a more pessimistic tone, what worries you in emerging markets? What are the key risks that you are worrying about right now? I imagine one surely must just be if the air comes out of the big AI trade, maybe that drags a lot of companies and indices down with it?

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Carlos von Hardenberg: Of course that is a risk, which is largely visible right now, especially in the benchmark. If you look at the benchmark and at the ETFs and large funds, they have often 12 -15% in two or three names, and they’re all memory and TSMC.

If you then add a couple more names, you’ll have 25% in maybe four or five stocks. So, there’s a risk there. We don’t have any exposure directly to these names where you have this mega concentration of ownership, which I think in itself is not healthy.

I would rather say there is a tremendous opportunity, broadly speaking, right now. I would argue that compared to other periods, where you had maybe some sectors doing really well, broadly speaking, emerging markets are trading at a 60-70% discount to US markets, to the S&P 500 or to the Dow. So, valuations are very reasonable on average right now in emerging markets.

Number two, currencies are undervalued. You’re not in an environment where you have to overpay for currencies or where they are grossly overvalued. That has been the case very often in the last 20 years. It’s the opposite right now.

The degree of ownership in emerging markets, institutional exposure, especially from the US, is rather underweight emerging markets. So, the potential selling pressure coming from this in an event is much less than in previous phases where there has been immense overexposure to emerging markets.

So, these are insurance policies which are baked into markets right now. I think the opportunity is much larger than what is understood right now in terms of how these markets are powering ahead with their technology leadership.

As I said, over the next two or three years, I would think that there are fewer risks in emerging markets than in some of the developed markets, and there’s a lot more potential to do well because earnings will continue to do really well. 

Some of the risks relate to a strengthening US dollar and tighter rates in the US. This is diverting flows away from emerging markets into developed ones. Geopolitical risks, the meeting [in September between China’s] Xi Jinping and Donald Trump is something we need to watch. But I think that both are under so much pressure that they want good news.

And, ultimately, what’s happening in Ukraine is not just an unforgivable human tragedy, but is also causing further risks with regards to destabilisation in Europe, with a negative impact on commodity prices. So, that is always a risk one needs to watch, but I’m more concerned about developed markets than emerging markets right now.

Dave Baxter: And finally, on a different note, this year we had the passing of a kind of iconic figure in emerging market investing, Mark Mobius. You, of course, worked with him for a long time. I was interested to ask those who knew him, and who have followed emerging markets for a long time, what were any key lessons that you took from him?

Carlos von Hardenberg: There are many. As you can see, I’m not wearing a white suit.

Dave Baxter: You’ve not adopted the look?

Carlos von Hardenberg: No, I’ve not adopted the look. So, he’s not my fashion adviser, and I will not do that. But I miss the courage of someone who dressed up like this. 

I worked with Mark for 25 years, and he was a friend and a scholar and someone I spent a lot of time with. I think what impressed me - and I often think about this when I meet companies in Asia - was his relentless effort to focus on governance.

We can all understand business models. We can all do numbers. Now, especially in an age of AI, to do a proper discount cash flow analysis, a DCF, or some of the parts of it, we used to work with annual reports and manually type in all these numbers. A lot of this is now much more efficient, much faster. There’s more transparency. The operation is much easier. We work with AI agents now, we have a lot of AI agents in our process.

But what you cannot replace is what he also focused on, the quality of the people, the culture in companies, the relationship between the founder and [their] siblings or children who are in the business, how they deal with corporate culture, and how this reflects on other stakeholders, and how they deal with other stakeholders. This is something we are focusing on a lot, and this is a lesson I learned. 

It’s not just a personal observation. If you look at the numbers and study what stands behind the most successful business models in emerging markets, and the factors leading to disaster, in 99% of cases it was somewhat related to the individuals and the way they were dealing with their immediate surroundings that caused the success or the failure. So, I take that lesson from him and continue to focus on people.

Dave Baxter: Interesting. Well, that is all we have time for, but thank you for coming in.

Carlos von Hardenberg: Thank you very much.

Dave Baxter: And thank you for watching and for listening. I hope you found it useful and enjoyed it. As always, remember you can contact us directly. Do email us at: otm@ii.co.uk. Let us know what you think, and let us know ideas for future episodes. Thanks again and take care.