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Emerging Global Advisors' Hoekstra: EM Investment An Easy Way To Differentiate A Wealth Business

Harriet Davies

4 September 2012

Advisors may be missing a trick when it comes to differentiating their emerging markets investment offering, says Marten Hoekstra of Emerging Global Advisors.

Hoekstra, who joined EGA last year as chief executive, describes the firm as a “young, emerging markets asset manager.” While its product line combines two huge trends of recent years – emerging market investment and exchange-traded funds – he says it is “ultimately, more of an emerging markets firm than an ETF firm,” and that it will at some point expand its products beyond ETFs.

Hoekstra, a former chief executive of UBS Wealth Management Americas, has known founder Bob Holderith a long time , and went to work for him after being wooed by the idea. While the firm is young , its team is made up of people with backgrounds working for the biggest names on Wall Street. Just last month, Susan Ciccarone joined from Goldman Sachs as CFO.

The draw

While most wealth management firms claim they offer clients “something different,” when it comes to investing in emerging markets, most do not, says Hoekstra, and this is where Holderith and his team view a gap in the market.

The typical US private client is about 3 per cent invested in emerging markets, while US institutional clients invest around 5 per cent of assets, according to Hoekstra – a figure he calls remarkably low. “Americans are very underinvested in emerging markets.”

However, the firm’s target market is “the top 5 per cent of advisors in the US” – who tend to have an allocation above average. “Their perspective tends to be that there’s a shortage of active management,” he says. “They struggle with implementation.”

In a very competitive marketplace for wealth managers – with low returns, relatively low growth of wealth compared with the pre-crash days, and low confidence in the industry – firms are struggling to differentiate themselves. What’s more, as the independent movement has caught hold, an increasing number of smaller firms are trying to distinguish themselves from one another. One area where this is possible is in the breadth of investment offering – whether that’s geographical or by asset class, such as alternatives.

“What I think is underappreciated is the fact that emerging markets are one of the few places where it’s relatively easy to differentiate your practice,” says Hoekstra.

He thinks if an advisor can deliver insights on emerging market investment that go beyond benchmark hugging, if they can demonstrate to an investor what, for example, the MSCI is actually expressing in terms of country and sector preferences, that would stand out.

“In a very competitive wealth management world people want to own growth businesses in growth markets,” he says.

The mistakes

And the common mistakes people make when trying to do access this growth?

“It tends to be a misalignment of strategic intent and portfolio,” says Hoekstra.

This is best outlined via an example. “The intent of most emerging markets investors is to diversify into higher growth economies,” and when they talk about EM investment they often mean “domestic-demand themes” – the growth of the middle class, he says. However, if they default to benchmark investment they end up investing in a lot of companies and countries that don’t fall within their investment view.

For example, two countries in the MSCI EM benchmark – Taiwan and South Korea – were moved to develop status in 1997 by the IMF, yet comprise 25 per cent of the index. Furthermore, the companies that benefit when a company moves from a frontier market to an emerging market are not necessarily those that will benefit from the next stage of development, which are likely to be consumer-focused. As it is, financials, energy and materials make up 50 per cent of the MSCI EM benchmark. Emerging market-based consumer companies make up only 12 per cent of the index.

“If you look back at the last two years, the consumer theme has worked. But very few people got the benefit of that,” says Hoekstra. “By definition, a very broad, very large stock catalog is a catalog of what has already happened in a market.” It is, essentially, a backward-looking measure.

The EGShares Emerging Markets Consumer fund is down 5.05 per cent on a one-year basis but has delivered 8.69 per cent since its September 2010 inception, as of June 30.

The MSCI EM is down 6.76 per cent on a one-year basis; up 4.25 per cent on a three-year basis, and down 2.69 per cent on a five-year basis.

Other ways in

Within the investment community, various approaches have been put forward as a way of gaining emerging markets exposure. Some people suggest currency or commodity bets as a way of investing in their growth . However, one argument against this is that it throws up issues of risk and diversification.

“Our firm’s perspective is that we’re an equity shop,” says Hoekstra. It doesn’t take a view within its portfolios on currency movements, and investors can hedge that separately if they want to.

Another more-commonly cited way of investing in EMs is through multinationals headquartered in developed countries, thus avoiding the legal or political risks of having your assets in countries with different governance systems. When people discuss this they tend to cite the global brand and financial underpinnings of multinationals headquartered in developed countries, says Hoekstra.

“There’s a problem with this view: the companies on the lists tend to be companies with zero or negative growth in their home markets,” he says, so you’re essentially paying for that growth elsewhere. The second factor is that “emerging markets multinationals outgrow developed markets multinationals.”

Here he cites a McKinsey study which showed that multinational players don’t seem to be capturing growth in emerging markets as well as their emerging-market counterparts are. The May 2012 study found that EM companies grew roughly twice as fast as DM companies, and 2.5 times as fast in “neutral countries,” where neither company was headquartered. This study takes into account the base effect – that EM companies are generally growing from a smaller base and thus achieving higher rates.

Given this evidence, Hoekstra says investing in multinationals specifically to get EM exposure is inefficient.

The limitations of language

Perhaps it’s a semantic problem: our way of conceptualizing investment to “domestic” versus “international” or “developed versus emerging markets” necessarily limits the way we think about investment. It’s neat, but perhaps neater than the reality.

“It’s completely too broad. For the most part I don’t engage in the distinction…It’s an undifferentiated look at the world,” he says. It also leads to a binary approach to EM trading among Western investors, he thinks. “They’re in or they’re out.”

Hence the firm’s approach of developing products based around sectors and investment themes. Some of its products do have a geographical slant, but these have a certain logic behind them, such as its non-BRIC product which is aimed at people hoping to hit on the next “BRICs”.

Performance and costs

The proof is in the products. As a new firm many of its products do not yet have a long performance history. As an example of some that do, the total return of the Brazil Infrastructure fund is 5.78 per cent since its 2010 inception, as of end of June, with a dividend yield of 4.21 per cent. Its 12-month return is down 12 per cent approximately, but as with all funds, it depends very much on the timeframe examined.

In terms of cost, net expenses are 0.85 per cent, with gross expenses of 1.39 per cent reimbursed to keep them from exceeding 0.85 per cent of net assets.

However, according to Hoekstra’s argument, it is not necessarily that all EM sectors are going to perform well at all times, but rather that wealth managers should have the tools to express an investment view at a deeper level than “DM versus EM.” And this, certainly, Emerging Global Advisors is delivering on.