Emerging Markets   |   Feb 6, 2020

Coronavirus Outbreak: Positioning the portfolio for the economic recovery

The beginning of 2020 saw the most optimistic forecasts of Emerging Markets corporate earnings growth for some years, the highest valuation discount of Emerging to Developed Markets since at least the GFC and certainly the biggest underweight by Global Equity Funds of Emerging Markets probably in the history of the asset class. In addition, 92% of Emerging Market GDP was in easing mode and 2019 had already shown us the impact that this could have on domestic investors’ actions in Brazil where the reduction in real interest rates caused a mass migration from fixed income into equities, pushing the market up strongly despite net negative foreign investor flows.

Dominic Bokor-Ingram
Senior Portfolio Manager, Frontier Markets

What could possibly go wrong? News started to filter out of China on the outbreak of the Coronavirus. We have no view on the virus itself – the spread of the virus; how long it will take for cases to peak and for the equity market to again start pricing in normality. Clearly, there is an economic price to pay in terms of absent spending, delays to projects and supply chain disruptions. However, none of this is quantifiable based on currently available information. What we can and do assume is that, like every other outbreak in recent history, it will be brought under control and the economic landscape will then quickly return to normal.

We believe our role as portfolio managers is to assess the likely scenario – an undefined period of uncertainty followed by a swift recovery – and make sure that the portfolios are in a position to benefit from the recovery when it comes. The key to achieving this is to invest in companies with low leverage.

To try and illustrate the thesis, consider two airline companies, both severely impacted by a 75% fall in passenger numbers due to flying restrictions and passenger unwillingness to fly. One of the airline companies has no debt and the other has a very leveraged balance sheet with a heavy debt servicing burden. Both airlines will suffer a severe drop in revenues but the unleveraged airline can stay in business by covering its variable costs and can avoid big losses by mothballing many of its routes. The leveraged airline needs to generate positive cash flow to service its debts. If the passenger reduction lasts for one month, it is likely that both airlines will survive, however a nine month shutdown is likely to result in the leveraged airline going bankrupt before the return to normal conditions.

Therefore, our first and most important task is to make sure the portfolio does not suffer from any situations that would cause a permanent reduction in capital.

The natural characteristics of companies that we like to own are those with strong top- and bottom-line growth generating high returns on capital and a strong balance sheet. We have focused a lot of attention on the debt profiles of our companies over the last few weeks as we address both the short-term revenue and profit impact on the companies, but much more importantly the sustainability of the business through the current crisis and the impact on our long-term fair valuation of the company.

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Strategy Descriptions
Fiera Capital’s Emerging Markets (EM) Income & Growth Strategy invests in high dividend paying companies across emerging markets without restriction, aiming to provide a combination of income and long-term capital growth. This strategy was created in 2010 and has been the responsibility of Ian Simmons since 2018, with the backing of the entire investment team at Fiera Capital in London. Fiera Capital’s Global Emerging Markets (GEM) Core Growth Strategy, our flagship global product, invests across emerging markets without restriction. This strategy was created in 2003 and has been the responsibility of Ian Simmons since 2018, with the backing of the entire investment team at Fiera Capital in London.

Indices
The MSCI Emerging Markets Index is a free float-adjusted market capitalization weighted index that is designed to measure the performance of large and mid-cap companies across emerging market countries, as defined by MSCI. Index results assume the re-investment of all dividends, after the deduction of withholding taxes, and capital gains. It is not possible to invest directly in an index. Investors pursuing a strategy similar to an index may experience higher or lower returns and will bear the cost of fees and expenses, which are not reflected in index returns.