Matt Williams is back on the podcast with Nick Robinson to talk all things income investing in EM. Discussing his recent trip to South America, biggest learnings over the last 10 years and optimism in this investment landscape.
Nick: Hello, everybody. This is Nick Robinson from abrdn, and you're listening to the Emerging Markets Equity podcast, the show that explores the factors that underpin our thinking on emerging markets. We ask our expert guests the big questions from key individuals to evolving trends, all with the goal to identify and profit from opportunities in the region. So today, it's great to be joined again by my colleague, Matt Williams, it's his third time on the podcast. As a reminder, Matt has been running our emerging market equity income products for over a decade, and has generated top quartile performance over 1, 3, 5 and 10 years. Matt has just got back from a trip to see clients in both North and South America. So, I thought it'd be great to have him on to give us an update on emerging markets, what he's hearing from clients, and also talk a little bit about his investment philosophy. Matt, thanks for joining today. Welcome back. It's great to have you on.

Matt: Great to be here, Nick. Thank you for inviting me.

Nick: Brilliant. Well, let's get started. So you've been on the road in Latin America last week, having conversations with clients, in, Andean region, you know, looking at stock market performance, Chile and Colombia have been a little bit overshadowed by Brazil and Mexico the last couple of years. And certainly the excitement of nearshoring hasn't really spread to those smaller markets, from talking to clients there what's your sense of the business environment there and what's been going on? 

Matt: Yeah, you're right, Nick. Those markets have had their own constraints over the last several years, I think in common, they've both had a difficult political backdrop. But also especially for Peru, there's been an under investments and that has been structural, over a number of years where they've over promised and under delivered, and, and also where, unfortunately, they've been affected by a series of weather effects, namely, El Nino. The main observation from the trip and speaking to clients was that whilst I'd say optimism is still very low, the prospects seem to be progressively improving. And actually, that resonated with one of the research meetings that I conducted with a stock that's held across strategies. They're the largest commercial bank and financial conglomerate in the country. And they were able to cite evidence that we're starting to see a pickup in infrastructure project spending, which, as I mentioned, has long been a missing part of that growth piece. They also felt that there were pockets of improvement that they could cite, in the consumer environment looking forward. And what do we like about that company, is that even though it's been a difficult operating environment for them over the last five years, they've been able to improve their competitive position through the downturn, and have shown a willingness to invest to create what is today's leading digital platform in the country. So, we're quite excited about their prospects. So that was nice to do that research meeting. But I think if I was to categorise, overall, then I'd say optimism is still low, but it's gradually improving. 

Nick: So that's encouraging. I suppose one other thing about that region is, you know, there is some benefits from the rallying and commodity prices and particularly copper, and I think Chile has about half of its exports as copper. So one would assume that we should start seeing some trickle down effect from that over time.

Matt: I agree with that, Nick, and I think that is yet to come through. But certainly for some metals, like copper, which is really important from a conductivity perspective, we think that the outlook for that metal as our economies invest more in electrification is going to see a rise in demand. And that's interesting because there's been a lack of investment into new mines. So yeah, we think that a rise in copper prices is plausible, as a secular trend and that will come to the benefit of commodity rich countries like Peru.

Nick: Okay, that's great. If we look more broadly at emerging markets, and from the conversations you were having, in the last couple of weeks. What are the main concerns that clients have at the moment both kind of north and south of the equator? And do you think there's been any sentiment shift towards emerging markets over the last couple of quarters? 

Matt: Yeah, I think investors are turning a bit more constructive, as they sense that the interest rate cycle is peaking. But the one country that comes up in every conversation as a source of concern is China. And you know, we would sympathise with some of the overarching points. So China does have a very large debt burden. And their income prospects, particularly on the trade fronts, are increasingly facing challenge as a consequence of the trade war and the geopolitical war we're in. But tactically, we're more optimistic on China. And the key reason for that is that the country are now stimulating and addressing their two key bottlenecks that were inhibiting economic growth and those link in to providing enough funding into local government funding vehicles to ensure that they can pay companies who can then have the confidence to make investments into the country, and secondly, into the housing market, where we've seen a destabilisation and then now making efforts to stabilise the credit outlook in the country. The other thing to say about, perhaps about China is, so we're not taking a large active position in the strategy because we have those concerns about the balance sheet in the income prospects at a country level. But we are quite differentiated when it comes to the underlying positions that we hold. Most investors are crowding around state owned enterprises and financial institutions that pay a high yield. And we actually think that's the wrong thing to do today, we think there's a lot more credit risk and, you know, lower returns from those businesses, which make them quite uncompelling. In contrast, if China is going to be successful, at reengineering and modernising their economy, then they need to invest into the more productive areas of the economy like services, and consumption. And that's where the strategy has its position sizes today. 

Nick: Okay, so that's interesting. So even though your strategy would steer you perhaps towards the higher dividend paying stocks to generate the income, you're shying away from those slightly because of the environment?

Matt: Yes, that's exactly right. So we select companies based on our follow the cash flow analysis, and really, that's to make sure that companies are investing enough money to sustain and exploit their investment opportunities, and have enough cash flow left over to reward shareholders. And we think that the two main pitfalls that investors get into are investing in early stage businesses where their customers, by definition are not secure, and late stage companies where they're not investing enough to support business growth. And we think a lot of these notionally high dividend companies in China are quite late stage and shouldn't be paying out the level of shareholder returns because they're not investing enough to support the business growth. So we don't like them based on our income lens. 

Nick: Okay, it’s nice to hear a slightly contrarian view given where the markets been crowding lately. Thinking about, I suppose emerging markets, even outside of China, it's been a fairly tough decade for EM, particularly for US investors against the backdrop of very strong returns within the US. You know, what gives you optimism that ex-China part of emerging markets should perform better going forward?

Matt: Yeah, the interesting observation last year and through the interest rate tightening was that capital flowed into a number of emerging market countries away from developed market countries. And that was because the balance sheets are far healthier in a number of these emerging market countries and investors were being discerning in trying to allocate their capital. I think that's a structural trend. I think we're seeing Western governments of the view that debt levels are too high and risk being destabilising. And as a consequence, we have a policy of full public sector employment and creating large investment programs in order to bring down that debt burden and grow the size of economies. And that's actually really interesting for emerging markets because if you look at the last time emerging markets performed well, it was when we saw a large investment cycle that enabled emerging market companies earnings to grow at a greater rate than their developed market peers. And that led to consistent outperformance. Now, I think the investment expenditure is going to be different in its nature to the last time we had an investment cycle. But I do think that emerging market companies have a very important role to play, in for example, areas like technology, hardware, and in green infrastructure and resource provision. So in that way, I think emerging markets are set for a bright future. And the interesting point that is really around valuations, where valuations are really quite appealing in emerging markets, because they've been so unloved. And we had that last decade previously, where earnings growth, you know, struggled to rise to a meaningful level. So you've got a combination of attractive earnings prospects, and good valuations. And those are the hallmarks of making a good investment. 

Nick: Yeah, when you talk about those opportunities, where we're seeing increased investment in emerging markets, so green commodities, the transition, AI, yeah, have you been able to find enough exciting opportunities on a bottom-up basis, which are still trading at decent valuations? Because I suppose a lot of these, particularly things like the tech companies, they are, in a way they're competing for capital in the markets with some of the US companies where valuations have run up a bit.

Matt: Yeah, last year, we went through a downturn in technology earnings as a consequence of the work from home spending falling out of consumer and corporate budgets. And that led to a sales and an inventory correction. But then from mid last year, we started to come through that. And it was quite a rewarding period for share prices, where they were actually on very attractive valuations. And even today, we see plenty of opportunity to pick up companies that will have a very bright growth outlook ahead of them, that generate strong cash flow streams that are on reasonable valuation. So very much we see lots of opportunity to benefit as we see more investments into our technology infrastructure across the globe.

Nick: Okay, and thinking about the macro environment, you were, I was lucky enough to have you on the podcast about a year ago. And it feels like that time is gone pretty quickly. But in that last year, we've seen quite significant change in the macro environment for emerging markets, you've started to see central banks in Brazil and Chile cut rates and I think in the next few months, we're likely to see the Federal Reserve in the US also lower rates. Yeah, how does that change the environment for your style of income investing, if at all?

Matt: Yeah, our strategy processes to filter from the team's great alpha generating ideas using our follow the cash flow lens, and then prioritise growing and mature businesses that see the merits of, of paying a dividend. And we refer to that as our dividend discipline, which we think drives good capital allocation decisions and, and strong competitive moats in businesses. So that's not really dependent upon the interest rate environments, or sector or market leadership, our philosophy is that healthy businesses will find opportunity in any market environment. Now, I would say incidentally, today, I think investors are probably being a bit too sanguine on the prospects for interest rates we’re expecting cuts going forward. But I think it's becoming increasingly clear that economies, particularly the US economy, are in a more robust position. And as a consequence, the prospect of deep interest rate cuts is probably pretty low.

Nick: Thinking about emerging markets, there's the political environment concern you at all, both through with regards to the US and also the other series of elections that we're having all over region this year, in places like South Africa or India, and the like, are there any that particularly concern you?

Matt: You’re right to highlight this is quite a big year for elections. And so there's always the risk that we see a change in government mandate. But, and perhaps the biggest change will come in the US which we need to which we need to monitor for, but in a number of other markets. So we've had elections in Indonesia, which have come and gone with consistency of leadership, we've got the Indian election coming up, and we think that Modi will secure a third term in power. So, consistency for the system there. And similarly, in Mexico, we don't expect any change to the policy direction as AMLO government and his successor are the favourite to win power. So there are a lot of elections, and we need to be mindful of the risk of change. But so far, the elections that have come up and based on polling for the ones that are due to come up in emerging markets have actually pointed to consistency of approach. 

Nick: Okay, thanks. And thinking back over the last decade or so that you've been running the funds, what have been some of the big learning experiences that you've had in terms of mistakes made and some of the greatest investment successes?

Matt: Well, one thing about this industry is that, you know, you always making mistakes, as much as we're driving alpha. If you've got a portfolio of, say, 80 stocks, as we do in the strategy, then to outperform by three percentage points, it's just a natural consequence that some stocks in the strategy aren't going right at the same time. So we always have to look inward and reflect on, on what's working, and what's not. And I think there's a process of continuous improvement to try and to try and get that right. And typically, mistakes are centered around misjudging the fundamentals of a business. So where perhaps, you thought that the business foundations were one thing, but as a consequence of changing dynamics of competition, or, indeed the macro environment, that actually you get something quite different. Having said that, there are plenty of success stories. And the success typically stems from our deep research and evidence based investing that we do as a team. And a great example of that has been the analysis that we did into the changes that we were likely to see in our energy mix in terms of generation sources with more renewables going into the energy grid, and also in terms of output from the grid with new demand drivers like electric vehicles. And what our analysis pointed towards was that we were going to see a crunch in terms of grid networks that were not fit for purpose and required major investment to bring them up to the relevant standard. And last year, this, you know, really resonated, we invested in India's largest transmission provider to the state grid, and the company were able to perform extremely well, as investors realised that we were going to see higher for longer growth prospects for what had once been a mature business as a consequence of this major investment cycle that was starting to happen. 

Nick: I think perhaps on that positive note, I’ll draw the podcast to a conclusion. So thanks very much, Matt, for coming on today. And giving us for time it's been really fascinating to have you. 

Matt: Yeah, great to speak. Thanks so much, Nick.

Nick: And thanks to everyone today who took the time to listen in. If you enjoyed it, then please download our other podcasts from our website, or wherever you normally get your podcasts. Watch out for the next episode and tune in.
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