It’s not timing the market, it’s time IN the market

Patrick Russel of Northcape Capital discusses the long-term opportunities in developing countries

It’s not timing the market, it’s time IN the market

This article was provided by Canada Life Investment Management.

Passive investing is a long-term strategy for building wealth by buying securities that mirror stock market indexes, then hold them long term. In developed countries passive investing can be a lower risk investment because you’re picking a well-known index that tracks stable investments. However, in emerging markets it can be a higher risk. This includes the MSCI Emerging Markets Index (MSCI), according to Patrick Russel, Director, Portfolio Manager and Analyst at Northcape Capital. “About 50% of the MSCI is actually high risk,” he says. “Of the 24 countries in the index, currently we only invest in nine because you have to be acutely selective about the markets you’re exposed to.”

Russel’s sensitivity to risk has been shaped by decades of experience. He joined Northcape Capital in 2008 after spending 18 years at Merrill Lynch, where he led teams in both Global Emerging Markets and Asia Pacific Telecom and Media. Investors can access Russel team’s expertise through the Canada Life Pathways Emerging Market Equity Fund. The fund seeks to achieve long-term capital growth by investing primarily in a portfolio of equity securities of  companies in emerging markets.

Northcape Capital is an Australian based boutique fund manager fully owned by its staff. They specialize in managing concentrated high quality equity portfolios. Speaking from Northcape’s office in Melbourne, Russel expanded on three guiding principles that have helped the emerging markets portfolio grow its assets under management over the last 15 years. These include demographic trends, good governance, and a search for industry leaders.

Northcape focuses on countries with young and growing populations that have markets with a growing labor force, rising wealth, and a generally positive approach to innovation and change. “We like markets where young people are beginning to work, building homes, and starting families,” he says. “These are massive economic tailwinds.” Asked which countries are benefiting most from these demographic tailwinds, Russel points to India, Indonesia and Mexico. Northcape uses a suite of sophisticated analytical tools and data to distinguish these promising markets from others, such as the number of people employed multiplied by average weekly earnings. “They are beautiful environments to trade in for any business, and they pay the best demographic dividends,” Russel says. However, Russel is less optimistic about the demographic future for China. He believes the country’s changing population profile will become a significant headwind in the years to come. “There's a whole raft of reasons not to favour China’s market, but the poor demographic outlook is a big factor,” he explains.


While Northcape is attracted to youthful demographics in places like India and Indonesia, the firm is careful to highlight the importance of good governance. Companies and their investors need assurances they will be protected by clear laws and independent courts. “We want to see governance improving,” Russel says. “And to get that, you need an independent judiciary. If the state can override the law, they can requisition private property, and that stifles innovation and growth.” Unsurprisingly, the legal landscape for emerging markets presents a wide range of opportunities and challenges, with some countries moving in the right direction toward clear governance while others are starting to relapse. India and Indonesia both continue to improve Russel says, “We've seen really significant improvements in South Korea.” But he has concerns about South Africa, where good governance is starting to fray, and Northcape has decided to avoid China due to the lack of protection for private property.

Despite this mixed bag of progress, he believes good governance is generally improving. “Some countries are eroding the important institutional pillars that support capital markets, but others are strengthening them. It's getting better.” This general improvement is partly due to the role played by investors like Northcape, which use their influence to raise corporate standards. “Substantial foreign investors like ourselves put significant pressure on companies to pull their socks up,” Russel says. “They realize better governance can create a better valuation and lower cost of financing.”

Industry leaders

We’ve seen Northcape assess demography and governance to help define their investment targets. Asked how the firm identifies individual companies within emerging markets, Russel says Northcape is very selective with their investments, focusing on no more than about 40 stocks at a time. “We look for an industry leader. We’re looking for a company with a very strong balance sheet and a defendable market position that may provide downside protection.”

This is important for companies operating in more volatile emerging markets, Russel says, because exogenous shocks can force highly geared companies into selling assets at the bottom of the market and risk permanent capital loss from which they never recover. Northcape therefore focuses on companies that generate a lot of free cash flow that provide a buffer during unpredictable market movements. “When a downturn hits asset prices, they're the ones that end up buying the beachfront property at the bottom of the market. That's the company you want your capital in.”  

Russel has some thoughts for Canadian investors who may be considering exposure to emerging markets but remain concerned about risk and short-term volatility. “It's not about timing the asset class,” Russel says. “It's about time in the asset class, particularly with an active manager who can deliver the best outcomes over the longer term.” This focus on long-term trends is a theme that seems to resonate with the people who work at Northcape. “We've been going for 15 years now, and our emerging markets team hasn’t lost an employee. Our investment analyst turnover has been zero. While other firms have a carousel of staff coming and going, I think we have a culture and focus that allows people to do what they do best.”

Want to get more insights on emerging markets?

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This interview is part of an ongoing series about Canada Life’s approach to investing with its partners around the world. Previous stories discussed value investing, fixed income and performance).


The views expressed in this commentary are those of this investment manager as at the date of publication and are subject to change without notice. This commentary is presented only as a general source of information and is not intended as a solicitation to buy or sell specific investments, nor is it intended to provide tax or legal advice.

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