Venturing Beyond Borders: 5 Tips for Value Investing in Emerging Economies

Remember the iconic moment in “The Chronicles of Narnia” when Lucy first ventures through the wardrobe?

If you’re unfamiliar, this classic story begins in 1940 during World War II when Lucy Pevensie and her four siblings are evacuated from London to escape the Blitz. They’re sent to live with Professor Kirke in the English countryside.

The children explore the professor’s house on a rainy day, and Lucy, the youngest, finds an enormous wardrobe. She steps inside, and behind the fur coats, she suddenly enters another realm — the strange, snowy forest of Narnia.

The global economy has its own ‘Narnia’ in emerging markets, brimming with possibilities and unforeseen dangers.

For value investors willing to push past the known boundaries of developed economies, emerging markets present new opportunities along with unique challenges and potential risks.

In this article, we’ll step through the ‘wardrobe’ of value investing into the intriguing realm of emerging markets.

Value Investing Recap

First, a quick recap of value investing for newcomers.

Value investing is a time-tested investment approach prioritizing intrinsic worth and long-term potential. As Charlie Munger said, “It’s always wanting to get more value than you pay for when you buy a stock.”

Value investors search for assets that appear undervalued by the market and sell at a discount. They believe the market will eventually recognize the inherent value and correct the undervaluation.

Key Principles

Margin of Safety: This principle emphasizes purchasing securities at a price significantly below their calculated intrinsic value, offering a cushion against potential downturns or unforeseen market volatilities.
Intrinsic Value: Instead of being swayed by market prices and short-term trends, value investors focus on determining the inherent worth of a security based on thorough analysis and forecasts of future cash flows.
Long-term Perspective: Value investing is not for the impatient. It requires a long-term horizon, understanding that it might take time for an asset’s true value to be recognized by the market.

Characteristics of Emerging Markets

Emerging markets are seen as the frontiers of the global economic landscape, providing a backdrop of rapid growth, vibrant demographics, and evolving opportunities. They are nations in rapid industrialization and experiencing higher-than-average growth rates.

Emerging markets often boast youthful populations, urbanization trends, and growing middle classes. This demographic dividend can lead to increased consumption, a burgeoning workforce, and potential shifts in economic power.

Why Emerging Markets are Considered Lucrative

Untapped Potential: Unlike saturated developed markets, emerging markets may have sectors and industries that are nascent or underpenetrated, offering room for significant growth.
Higher Returns: Due to the risks associated with political instability, less established regulatory environments, and market volatility, many investors expect and often receive higher returns as compensation.
Diversification: Investing in emerging markets can provide a chance to diversify portfolios, especially for those who predominantly hold assets in developed markets. This can mitigate risks and offer varied growth drivers.

Emerging markets should be approached with curiosity and caution. Investors have to balance the allure of potential returns with the inherent risks in these dynamic markets.

Opportunities in Emerging Markets for Value Investors

The fairly uncharted terrain can be intimidating, but emerging markets can hold a treasure trove of opportunities.

Here are some of the captivating propositions for long-term value seekers:

Undervalued Assets

For various reasons, from lack of awareness to temporary economic setbacks, emerging markets have companies and assets that trade below their intrinsic value. For the discerning eye, this presents a chance to invest in undervalued stocks poised for future growth.

Economic Growth

Emerging markets can experience more robust economic growth rates than their developed counterparts. With burgeoning middle classes and increasing consumption levels, these markets offer a fertile ground for businesses to flourish and, consequently, for investments to appreciate.

Diversification

Emerging economies operate on different economic dynamics than the more established ones. Investing in these markets may help investors to spread their risks, potentially offsetting downturns in other parts of their portfolios.

Reform and Regulatory Shifts

As emerging markets mature, many undergo significant regulatory and economic reforms to attract foreign investment and boost domestic growth. Such shifts can create new avenues for investment and value generation.

Challenges for Value Investors in Emerging Markets

While opportunities abound, value investing in emerging markets has known hurdles.

Lack of Transparency

One of the primary concerns in emerging markets is the limited availability of transparent and comprehensive financial data. Companies might not always adhere to international accounting standards, making it challenging to assess their true value.

Political and Economic Instability

Emerging markets can be volatile due to sudden changes in government policies, political unrest, or economic upheavals. Such instabilities can significantly impact an investor’s holdings.

Currency Risks

Fluctuations in exchange rates can considerably influence the returns of foreign investors. An appreciating home currency relative to the currency of the emerging market can erode potential gains.

Limited Liquidity

Certain assets in emerging markets might not be readily tradable, leading to potential liquidity risks. An investor might be unable to quickly sell off an asset without incurring significant costs.

Cultural and Business Practice Differences

Navigating unfamiliar cultural norms and business practices can be daunting. These differences can affect negotiations, partnerships, and understanding a market’s potential.

Investors who approach these markets need a comprehensive understanding of the complexities and a strategy for mitigating the inherent risks.

Risks and Challenges

Emerging markets present multifaceted uncertainties. Investors often grapple with regulatory unpredictability and the nuances of diverse cultural and socio-economic landscapes. It’s crucial to prepare for these intricacies in order to make informed decisions and effectively navigate the path to potential returns.

Regulatory Hurdles

While reforms can offer investment opportunities, they also underscore the fluid regulatory environment of many emerging markets. Inconsistent policies, sudden regulatory changes, or barriers to foreign investment can pose challenges.

Geopolitical Concerns

Emerging markets hold a higher degree of political instability. Issues like civil unrest, changes in leadership, or geopolitical tensions can impact the market sentiment and the business environment.

Corporate Governance

Companies in emerging markets may only sometimes adhere to the corporate governance standards expected in more developed markets. Issues such as minority shareholder rights, transparency in decision-making, and management quality can be concerns.

Market Volatility

Emerging markets tend to be more susceptible to market volatility. They are influenced by factors ranging from global economic shifts to domestic policy changes. For investors, this can lead to more significant short-term fluctuations in portfolio value.

Infrastructure and Technological Challenges

Despite rapid advancements, certain sectors in emerging markets might still be grappling with outdated infrastructure or technological limitations, potentially impacting the growth prospects of companies operating within them.

Strategies for Mitigating Risks

Emerging markets pose challenges, but astute investors can use strategies to navigate and capitalize on specific situations.

Diversified Portfolio Approach

By diversifying investments across different emerging markets and sectors, investors can reduce the impact of a downturn in any specific market or industry.

On-ground Research

Building partnerships with local experts or investing in on-ground research can provide a more accurate picture of the market dynamics, potential red flags, and hidden opportunities.

Hedging Against Currency Fluctuations

Currency risk, or exchange rate risk, arises when an investment’s value is affected by exchange rate changes. Investors can use various financial instruments such as futures contracts, options, and specific ETF’s to hedge against currency risk.

Regular Monitoring and Dynamic Adjustments

With the volatile nature of emerging markets, adopting a proactive approach by regularly monitoring investments and being ready to make dynamic adjustments can be beneficial.

Prioritize Liquidity

Given the potential liquidity concerns in certain emerging markets, prioritizing investments in more liquid assets or sectors can offer an exit strategy if needed.

Value investing in emerging markets can be tricky and demands astute research, patience, and calculated decision-making. With the right approach and a solid understanding of the landscape, the potential for success awaits.

Success Stories

Emerging markets have presented numerous challenges for value investors. However, the success stories are equally compelling and highlight the immense potential of these markets when navigated with diligence and insight.

Infosys, India

Founded in 1981 with a mere $250 by seven engineers in Pune, India, Infosys transformed from a small IT venture to a global behemoth in information technology services. With its strategic focus on IT consulting and software services for global clients, the company witnessed exponential growth, earning recognition on the global stage. By the late 1990s and early 2000s, Infosys became one of the crown jewels of the Indian stock market, rewarding early investors with stellar returns.

MercadoLibre, Argentina

Often dubbed the “eBay of Latin America,” MercadoLibre was founded in 1999 in Argentina. Starting as an online marketplace, it quickly expanded its services to include a payment platform, MercadoPago, which became one of the key drivers of its growth. With its presence now across multiple Latin American countries, it has provided investors with impressive returns, especially those who believed in its potential during its early days.

Tencent, China

South African media group Naspers strategically decided in 2001 to invest $32 million in Tencent, a then-little-known Chinese tech company. This investment is now worth over $200 billion, making it one of the most successful bets in the history of venture capital.

Success lies in thorough research, patience, and, sometimes, a bit of foresight.

5 Tips for Value Investing in Emerging Markets

Here are some critical guidelines for navigating the emerging market investment journey:

Research Depth

Going beyond surface-level data is essential in understanding an emerging market’s true potential and risks.

Local Insights: Appreciating the local culture, socio-economic factors, and political landscape is vital. These insights can provide clues about consumer behavior, regulatory risks, etc.
Industry Analysis: Understand the dominant industries in the market and their growth drivers. Identify sectors with the most promising outlooks.
Historical Context: Analyzing past economic cycles, market responses to geopolitical events, and historical company performance can offer patterns and lessons.

Diversification

It’s essential to diversify investments across multiple emerging markets and within sectors and asset classes of a single market. This approach helps in spreading risks.

Geographic Spread: Investing across regions can protect against downturns tied to local events in a given country.
Sectoral Balance: Different sectors may react differently to global and domestic events, so a balance across industries can provide stability.

Partner with Local Expertise

Local analysts or advisors often hold a nuanced understanding of their home market that outsiders might overlook.

Local Partnerships: Collaborate with local investment firms or consultancies that can offer real-time insights and on-ground perspectives.
Cultural Understanding: Partnering with locals can also aid in understanding cultural nuances that can heavily influence business and consumer behavior.

Stay Updated

Emerging markets can be dynamic and ever-evolving.

Regular Monitoring: Regularly track economic indicators, political events, and market trends to anticipate shifts.
Stay Connected: Engage with local news sources, financial reports, and join investor communities or forums specific to the market of interest.

Long-term Perspective

Given the inherent volatility and developmental nature of emerging markets, having a longer investment horizon is beneficial.

Resist Impulsive Decisions: View short-term market fluctuations in the context of long-term growth potential.
Periodic Review: While keeping a long-term perspective, regularly review and adjust the portfolio based on changes in market fundamentals or investment goals.

Conclusion

As emerging markets evolve, mature, and integrate further into the global economy, the potential for uncovering hidden gems becomes more pronounced. Investing in emerging markets requires diligence, a deep commitment to research, and patience to weather short-term uncertainties. With the right preparation and mindset, the rewards can be both fulfilling and significant.

As we move further into the 21st century, emerging markets will undoubtedly play an ever-increasing role in the global financial narrative, making now a crucial time for investors to familiarize themselves with these dynamic economies.

Discussion Questions

If you had to choose one emerging market to invest in for the next decade, which would it be and why?
Have you encountered any unexpected challenges or pleasant surprises while investing in emerging markets?
What cultural nuances or local behaviors in emerging markets influenced your investment outcomes?

Let us know in the comments below!

Oliva Partners Can Help

Feeling overwhelmed by the prospect of searching for undervalued stocks on your own? Or perhaps you simply don’t have the time to sift through the market’s haystack in search of that golden needle?

That’s where we come in. At Oliva Partners, we’ve made it our business to find and invest in undervalued stocks, just like Warren Buffett did back in 1959. We’ll navigate the complexities of the market with the goal of delivering superior results.

Our experienced team of value investors will do the ‘hunting’ for you by applying the same principles — careful analysis, patience, and a focus on value — that have stood the test of time.

So, if you’re an qualified investor looking for a partner in your investment journey, we’d love to hear from you. Contact Oliva Partners today, and let’s start making your money work harder for you.

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