Getting Emerging Market Exposure through Developed Countries Blue Chips

As multi-national corporations (MNC) from developed countries increasingly seek to leverage growth opportunities in fast growing emerging markets, they offer investors the ability to get emerging market exposure without investing directly in emerging markets.

While there is no consensus as to whether developed markets stocks can offer sufficient emerging markets exposure, investors – especially those who see emerging markets as being too risky – can take comfort in the fact that they can benefit from the growth in these markets through indirect exposure.

Incidentally, emerging markets are on average growing significantly faster than developed markets, with 66% of the world’s growth in 2015 expected to come from emerging markets, according to the International Monetary Fund’s World Economic Outlook.

As a result, “a growing number of MNCs which have operations in emerging markets are deriving a significant portion of their revenues and profits from these markets,” says David Kunselman, senior portfolio manager with Excel Investment Counsel Inc. in Mississauga.

According to a 2013 survey of MNC executives conducted by the Boston Consulting Group, more than three-quarters of multinational companies expect to gain market share in emerging markets, although some believe they have not cracked the code to succeed against local competition.

But those that have succeeded have done well. “Some multinational companies have long-established presence in emerging markets, and these markets can make up a substantial portion – sometimes the majority – of their profits and growth,” suggests Matt Moody, vice president, investment management and portfolio manager with the Mackenzie Investments Ivy Team in Toronto.

For example, he says, Unilever NV of the Netherlands and Colgate Palmolive of the USA – both consumer goods companies – “have been in emerging markets for decades and are established leaders in their field” in Latin America and India, respectively.

“As such, an investment in these companies, or in a mutual fund that holds several of these companies, is a good way to get exposure to leading businesses in emerging markets, even though the companies may be domiciled in developed markets,” Moody contends.

^{Source: Bloomberg and company financial statements}

“How much exposure you actually get depends on the proportion of the companies’ profits that are derived from emerging markets,” he adds.

Yet Serge Pépin, global emerging markets specialist with LGM Investments, a division of BMO Global Asset Management Inc. in Toronto argues that you “never know to what extent revenues are derived from emerging markets” and “whether the amount of revenues will change from year to year” since such information is not always disclosed in the companies’ financial statements – and when it is disclosed it is often in the notes to the statements.

He also suggests that the revenues of the foreign operations of some MNCs might not be reflected in the income statements of the parent company because they are not wholly-owned or might be separate or partially-owned entities. For example, Wal-Mart de México y Centroamérica, is a Mexican-based public corporation that is partially owned by a holding company of US-Based Walmart Stores Inc.

However, that is not always the case. Kunselman says that MNCs with established operations typically disclose the percentage of revenues derived from emerging markets. He provides several examples, among them Mondelez International Inc., the American multinational confectionery, food and beverage conglomerate which derives 40% of its revenues from emerging markets; Airbus Group NV, the Netherlands-registered aerospace and defense company 50%; Henkel AG, the German manufacturing company 45%; and Nestle SA, the Swiss multinational food and beverage company 44%,

The truth is “disclosure of regional revenue and profit breakdowns varies a lot from company to company; for some it is very clear how much of their business comes from emerging markets, while for others it involves a bit of guesswork,” says Paul Musson, senior vice president, investment management and lead manager with Mackenzie InvestmentsIvy Team in Toronto.

However, “the ones with substantial operations and success in emerging markets are, of course, generally more likely to provide good disclosure,” he adds – with some companies “publishing the proportion of their revenue that comes from emerging markets, as well as the growth rates and, in some cases, the profitability.”

Consequently, “this allows investors to get a pretty clear view of how much exposure they are getting by investing in these companies,” contends Musson.

What is also important to note says Kunselman is that emerging markets are benefitting from rapid industrialization and urbanization and increasing per capita incomes, which will fuel higher demand for goods and services – contributing to the growth of MNCs operating in these markets. Colgate Palmolive, for example, is benefitting from “close to 10% revenue growth in emerging markets, compared to 2% in the US,” he says.

In addition, says Kunselman, many MNCs are also reinvesting their profits in emerging markets, leading to an increase in the size of their operations and consequently greater revenues.

The scope for investing in MNCs with emerging market exposure is also growing as more and more emerging markets relax their foreign investment restrictions, suggests Kunselman – creating more opportunities for investors. This also “puts pressure on direct competitors to follow suit,” he claims – leading to even more opportunities.

Therefore, investing in developed market MNCs with successful operations in emerging markets might make sense for some investors. But Pepin argues that taking this route “just for the sake of getting emerging markets exposure may result in missing out on opportunities offered by direct plays” in these markets. He suggests investing in a “stock picking fund” focused on emerging markets.

While a prudent strategy, the question of risk and inefficiencies which he contends are inherent in emerging markets still remain, that is, assuming that developed market MNCs are safer bets.

“We believe we are able to mitigate at least some of the higher risk inherent in emerging markets by investing in businesses domiciled in developed markets, but have a meaningful percentage of their sales in those emerging markets,” says Musson.

“These companies have geographically diversified revenue streams and are typically less risky than companies focused on a single market,” says Kunselman.

As manager the Excel Blue Chip Equity Fund which invests in MNCs from both developed and emerging markets, Kunselman uses quantitative methodology to shortlist 200 companies based on their valuations and minimum market capitalization from a universe of 400 US and foreign companies based on their fundamentals and emerging markets exposure. Using revenues and consistency and predictability of earnings, he actively follows 100 companies from which he selects 40 core positions for his portfolio.

At the end of the day, it all comes down to the unique risk profile of investors. However, it would seem that investors who want exposure to emerging market growth without the worry associated with emerging market equities may find developed market MNCs a good bet.

(A version of this article previously appeared in Investment Executive)

Dwarka Lakhan

Dwarka Lakhan is a pioneer in emerging markets journalism in Canada. His first emerging markets article, “Africa Joins Ranks of the Emerging,” appeared in Investment Executive, Canada’s leading newspaper for financial advisors, in September 1994. Since then he has written hundreds of articles on the full spectrum of emerging markets and has conducted more than two thousand interviews with emerging and frontier markets investment professionals.

More articles by Dwarka Lakhan