December 19, 2014

We discuss volatility and opportunity in three major emerging markets. Despite the recent sell off in Russia, other oil exporting countries and emerging markets in general, the standard investment view has been that three of the BRICs – China, India and Brazil – are just too big and consequential to be ignored. This week’s guests concur. Kenneth Lowe, Portfolio Manager of the Matthews Asia Focus fund and the Matthews Asian Growth and Income fund, and David Nadel, Director of International Research for Royce & Associates and Portfolio Manager of several funds, including the Royce International Smaller-Companies fund, will discuss the opportunities they are seeing in Brazil, China and India.

The opinions expressed on Consuelo Mack WEALTHTRACK are those of the guests and do not necessarily represent the views or opinions of Consuelo Mack or MackTrack, Inc.

CONSUELO MACK: This week on WEALTHTRACK, building up your portfolio with some BRICs! As in China, India and Brazil! Kenneth Lowe of Matthews Asia funds and David Nadel of Royce Funds discuss the additions they are making to their mutual funds from markets other investors are discarding, next on Consuelo Mack WEALTHTRACK.

Hello and welcome to this edition of WEALTHTRACK, I’m Consuelo Mack. If we ever needed more proof of the volatility of emerging markets look no further than the recent financial whiplash in China. It happened even before this week’s turmoil in Russia’s stock markets.

In one day the Shanghai Composite Index experienced a nearly 5-1/2% decline, its biggest one day drop since 2009 after a regulator unexpectedly tightened credit availability.

Nonetheless the Shanghai Composite has been the year’s best performing stock market having been one of the worst for the prior five years.

And China’s recent stock advance has been rivaled by its fellow Asian BRIC, India. India’s benchmark SENSEX has been the world’s number one stock market for much of the year, boosted by the May election of Prime Minister Narendra Modi, a pro-business reform candidate who overthrew India’s ruling party of 67 years.

However the two remaining BRICs, Brazil and Russia have been losers.

Russia’s problems are profound, obvious and reflected in its plummeting stock markets. Its oil based economy is suffering mightily from crude’s dramatic decline and the country’s trade has suffered from European and U.S. reaction to its invasion of Ukraine.

Brazil’s economy has also been weighed down by its leadership. Under Workers Party, anti-business president Dilma Rousseff who recently won a second term in the closest election in Brazil’s modern electoral history, Brazil has experienced recession, inflation, rising public debt and scandals. The benchmark Bovespa Index has been one of the worst performing markets in the last five years. It only recently showed some life with the appointment of a pro-business, U.S. educated finance minister. Despite all of these problems, the standard investment view has been that three of the BRICs: China, India and Brazil are just too consequential to be completely ignored. In terms of population, consumption, economic power and potential they are significant.

This week’s guests agree wholeheartedly. They better as each is an international investor. Kenneth Lowe’s focus is on Asia. He is portfolio manager of Matthews Asia Focus fund, a concentrated fund launched in 2013 by Matthews International Capital Management, a pioneer in Asia- centric mutual funds. Lowe also co-manages the Matthews Asian Growth and Income fund, a much larger and older fund.

David Nadel is the Director of International Research for Royce & Associates, a pioneer in small company mutual funds. Nadel is Portfolio Manager of several funds including the Royce International Smaller-Companies fund.

I began the interview by asking them why Americans should look at these emerging markets now given the current hometown advantage of America’s improving economy, strong stock market and the excellent financial shape of so many American companies.

DAVID NADEL: Well, I think I would start with valuation. I think part of the answer to your question is what you’re paying for those two scenarios. So in the case of Brazil, one of the things that got us interested in this market, again, and we’ve been investing in Brazil for five or six years already, was the Buffett Indicator. The Buffett Indicator is the ratio of the aggregate market cap of the country to its GDP. And so Brazil is “trading” at about 39 percent of its GDP, versus about 100 percent at its peak in 2007.

If you compare that to the U.S., the U.S. is trading at about 130 percent of its GDP, and that’s not far from its all-time high. You’re also dealing with all-time high profit margins in the U.S., and in Brazil you have depressed profit margins. So from our perspective, we looked at that picture and said there is potential for margin expansion and multiple expansion. Brazilian small caps are trading at a five-year low, the BRIC markets have underperformed the U.S. market for five straight years. So if you’re a believer at all in some sort of reversion to the mean, and you’re looking for value, I think you’ve got a lot of upside potential in a market like Brazil, and some of the other BRICs as well.

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