EM IT sector still looks attractive

Investors might still find good investment opportunity in emerging markets (EM) software and services sector, despite a lack of sustained earnings growth, according to State Street Global Advisors (SSGA).

The firm said investors should view these opportunities as a go-to investment amid the China/US trade war as EM software and services firms in these markets were performing relatively well on a range of valuation and quality metrics.

However, investors would be required to carry out a closer examination of EM IT firms in order to fully understand where their rewards were, the firm said.

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“The IT sector within emerging markets has become extremely bifurcated at the industry level. In general, our bottom-up assessment shows that software and services (S&S) firms exhibit many positive drivers of return,” SSGA’s chief investment officer, active quantitative equity, Olivia Engel, said.

“Technology hardware and semiconductor companies, by contrast, are confronting a range of challenges.”

According to Engel, software and services firms were typically engaged in business consulting, and in application development and maintenance and a significant part of their business was focused on helping clients run more efficiently.

This meant that the cost focused spending was less impacted by economic cycles.

“As a result, unlike other IT segments, S&S firms have been able to generate consistently high returns on equity and to increase dividend payout ratios, despite a slowing global economy,” she said.

“More strikingly, a look at earnings-per-share forecasts for the three industry segments within the IT sector shows that Software companies, unlike their peers in the tech hardware and semiconductor industries, have remained immune to many of the headwinds generated by the ongoing China/US trade dispute.

“Due to their more strategic business models, S&S companies are less sensitive to trade volatility, and they’ve been able to increase profit margins in an environment that has challenged other exporters.”

At the same time,  Engel stressed that emerging markets were characterized by a lower degree of market maturity, whereas the developed software index had a higher exposure to technology payment and processing companies as well as internet stocks and these were securities that continued to be more expensive when compared to the rest of the investable equity universe and as a result score poorly on our valuation metrics.

“At present, we continue to see opportunities in the EM software and services firms, which are fairly valued and performing quite well on a range of quality and sentiment metrics — and which also offer substantial diversification benefits compared with other IT segments,” Engel said.

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