Headlines drive rally, fundamentals drive outperformance in EMs

Recent developments in talks between the US and China to develop a trade framework has boosted investor interest in emerging markets (EMs). 

However regardless of how talks progress, investors should sharpen their awareness of the broader factors which bode well for investment in this overlooked area of the market.

In early June, the United States and China agreed in principle on a framework to stabilise their trade relationship - a development that helped fuel a rally in several Asian and emerging markets. As of 10 June, the MSCI Emerging Markets Index had delivered a net total return of 12.9 per cent year-to-date in US dollar terms, including an over 4 per cent return in May. Between 3 and 10 June, the index again rose sharply gaining nearly 3.8 per cent in a week.

Several stocks within the Orbis EM portfolio participated meaningfully in this rally. Kiwoom Securities, a Korean financial services firm, gained more than 30 per cent in the month to 10 June, while Chinese tech company NetEase rose around 28 per cent over the same period.

These figures reflect renewed optimism around geopolitical dialogue and the potential easing of bilateral tension between the two nations. However, regardless of if or how further trade talks unfold, our conviction in EMs remains rooted in fundamentals — in businesses we believe are overlooked by markets, yet positioned to thrive. Markets can move on headlines, but durable returns are rooted in fundamentals.

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In our view, the value in EMs is real, and often hidden in plain sight. We believe the broader opportunity in EMs runs far deeper than any single catalyst and our conviction in EMs doesn’t depend on specific trade outcomes or diplomatic steadiness.

If people think about EMs at all, they often focus on risks linked to deglobalisation and geopolitical shifts. But deglobalisation can actually support countries with strong domestic demand and integrated regional supply chains. In our view, EMs are adapting to this shift, becoming more self-reliant and more central to global growth. 

Many have also become more fiscally disciplined, in some cases surpassing their developed market peers. This disconnect between perception and reality is where we see opportunity. Volatility and uncertainty often cloud rather than reflect intrinsic value, which is why we build our portfolios from the bottom up, stock by stock, guided by deep research and valuation discipline. 

Many EM companies today have demonstrated stronger balance sheets, more disciplined capital allocation, and better governance — yet still trade at valuations that do not reflect this progress.

Beyond company-level potential, broader macro forces may also tilt the playing field. Foreign investor positioning in the US is stretched, and any weakening in the dollar or softness in US equities could prompt a reassessment. Losses compounded by currency effects may turn US inflows into outflows. If capital begins to question long-held assumptions about US dominance, especially in a world drifting toward nationalist forms of capitalism, the US may emerge as a relative loser. 

By contrast, companies outside the US may benefit from redirect capital flows, lower starting valuations, greater policy headroom, and improving structural tailwinds. We stay mindful of the macro environment, but our focus is firmly on fundamentals - building portfolios from the bottom up, where we believe deep research and a contrarian mindset can provide a genuine edge.

Pessimism has contributed to attractive valuation opportunities in EMs

EMs have been out of favour for several years and have even been considered uninvestible by some. However, EMs relative underperformance versus developed markets over the last decade has created an attractive setup. EMs now trade at around a 13 times cyclically-adjusted price-to-earnings earnings (CAPE) ratio – a 30 per cent discount to developed markets and a whopping 55 per cent discount to the US.

This extended period of disappointment and low sentiment has seen many EM investors simply shifting investments elsewhere. Massive amounts of capital have flowed into the US, concentrating in areas like tech. If you are a passive investor in the world index today, you will most likely have around 70 per cent invested in the US alone and 20 per cent or more of your portfolio will be in just seven US tech giants. That is concentration, not diversification and this kind of crowding leads to mispricing - that's exactly what we think we're seeing in EMs today.

The last period where there was a similar discount in EMs was during the Asian Financial Crisis of the late nineties. Today there is nowhere near the financial distress or broad-based crisis in EMs that was prevalent then, making current valuations particularly appealing to us. 

A potential blind spot in portfolios

EMs make up more than half the world's population and about a third of global GDP but are only 10 per cent of the MSCI All Country World Index. EMs represent an even smaller portion - around 6 per cent - of popular global equity funds commonly used by Australian investors. This imbalance suggests many global equity funds do not provide adequate EM exposure, and this is potentially a blind spot in most investors’ portfolios. 

Even though EMs present great opportunities, they also come with risks such as corporate governance. State owned enterprises can play a significant role in EM economies which can sometimes lead to conflicts of interest between government and shareholders. If you simply opt for investing in high-growth countries, you might encounter issues like shareholder dilution. 

Not all EMs are created equal

There is also a wide range of valuations between individual EMs, lower quality businesses, overloaded balance sheets, and poor ownership structures. One should therefore be discerning regarding which countries and stocks to invest in, rather than buying everything across the EM board with little regard for valuation; active investing in EMs might be even more important than in other sectors. 

Given the unique challenges, risks, and opportunities in EMs, Orbis Investments spends its time managing a contrarian, high conviction, benchmark agnostic EM portfolio, built from the bottom- up, stock by stock, based on deep fundamental research. We prefer businesses with strong governance, sound capital allocation, and shareholder aligned owners – often owner operators with skin in the game.

An example of an EM stock in our portfolio is Jardine Matheson – one of Asia’s largest conglomerates. Some of its prominent assets include Astra, Hongkong Land, and DFI Retail Group spanning auto dealerships, retail, real estate, and a range of other trophy and well-run assets. Despite the strength of its underlying businesses, it’s treated like most EM stocks – subject to widespread pessimism.

If you add up the market value of all Jardine’s major holdings, most of which are publicly listed companies themselves, you get a total value of Jardine’s assets to be around $18bn USD. Yet, the market currently values Jardine’s itself at just $12.5bn – a 30 per cent discount to the value of its parts. We believe the real discount could be even wider because many of those parts could themselves be trading well below intrinsic value.

Potential risks include a slowdown in Asian economies that would put pressure on Jardine’s domestic focused businesses or a sharp rise in USD rates that could negatively impact some of the companies in their stable. We appreciate the uncertainty, as with all investments, but think that the low valuation reflects overly pessimistic expectations. This seems like an attractive opportunity in our book as patient, long-term, fundamental investors.

A unique diversification opportunity

At Orbis we fully accept EM investing comes with volatility, but we don't believe that's a reason to disregard them. Investors should not let sentiment and things like recency bias in the past decade blind them to long-term opportunity.

In a world where most investors are heavily skewed to US exposure and many passive portfolios are incredibly concentrated, EMs offer something fundamentally different – different cycles, different risks, and different drivers of growth. They give investors a chance to diversify away from things like the US tech narrative. Recent rallies in the MSCI EM Index remind us how quickly sentiment can turn, especially in parts of the market where expectations remain muted.

Consequently, this could potentially be one of those periods where investors look back and wish that they had invested in EMs.

Werner du Preez is investment specialist at Orbis Investments.