EM vs. Developed Markets: Navigating Valuations & Future Opportunities

During their recent episode, Taylor, Carlisle, and Ardal Loh-Gronager discussed EM vs. Developed Markets: Navigating Valuations & Future Opportunities. Here’s an excerpt from the episode:

Tobias: One of the points that you made earlier, was that there is this correlation between EM and developed markets on about a rolling five-year basis. I can see how that would be the case that– I believe in mean reversion when things fall behind, they become cheaper, that sets them up for future performance and vice versa. But it seems like in the same way that value has struggled against growth in the US and anything that’s non-US has struggled in comparison with the US. I think a lot of it is– US multiples have got very, very high. Have you found that that relationship between EM and developed continues to remain true, or is that broken down a little bit as with whatever we’re experiencing now?

Ardal: Yeah. So, I think you’ve touched on a really salient point and one that I discuss with our investors and other investors on a frequent basis, which is, if you look MSCI world, so developed markets, it’s returned roughly 12% per year for the last five years, you’ve also alluded to there, Tobias, that if you own the Magnificent 7, the majority of the return is in those names. So, a lot of the performance has been driven by those.

And then, if you take the MSCI, EM, so emerging markets, it’s only compounded at 2% per year for the last five years. So, clearly there, there’s a huge dislocation between the performance of developed markets and emerging markets on the face of it. But if you delve slightly deeper, which is what you alluded to with being driven by the Magnificent 7, if you strip those out, the performances are more relative to each other. They’re more in line with historical averages. So, what you could say is the performance of the Mag 7 is a little bit of a historical aberration. What that’s done is driven the performance of developed markets to far exceed the historical average of its correlation with emerging markets performance.

The only thing that this is a humbling experience for me, because when I look at the portfolio that we’ve assembled, it’s roughly 10 stocks developed markets and 10 stocks emerging markets. Since inception, 70% of our returns have come from our emerging markets holdings. So, what you can read into that is or what I like to say is I say so, clearly, we are capable of picking highly performing undervalued stocks in emerging markets, and that they do do well despite the fact that they’re overall for emerging markets, the performance is poor. Where we seem to be under delivering for ourselves and our investors, even though it’s only a three-year basis, is developed markets.

What I think there, the insight is also really interesting, because we think we own really great businesses at undervalued prices despite the market multiples, because all of it or a large majority of it is being driven, whether it’s performance or multiple basis, by those seven stocks. And that concentration leads me to believe that there is actually more potential for outperformance in the developed market portion of our portfolio, despite developed markets performing significantly better than emerging markets over that period of time.

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