Investing in these economies’ stock exchanges is a way to capitalize on volatility while mitigating the effects of individual sector slumps.
Insitutional Investor
January 11, 2015
By Robert Stowe England
Emerging-markets stocks have taken a beating in recent years, depressed by the continuing slump in commodities prices and slowing growth, especially in China. But some investors see attractive value in one intriguing corner of this sector: the shares of emerging markets’ stock exchanges themselves.
It may seem counterintuitive to invest in the sites where the carnage is taking place. Emerging-markets equities have been in a bear market for five years, and the sell-off accelerated last year with the benchmark MSCI Emerging Markets index falling nearly 17 percent in 2015. Yet the exchanges offer value that many other EM stocks do not.
For starters, they are natural monopolies. Light on capital requirements, they generate lots of cash flow and often pay high dividend yields. And exchanges can perform well even in bear markets, if trading volumes remain strong. “We love stock exchanges,” says Kathryn Koch, global head of client portfolio management and business strategy, fundamental equity, at Goldman Sachs Asset Management in London. “We can’t get enough of them.”
Investors in EM stock exchanges differ in their perspectives: Some buy and hold, whereas others get in only when the valuation is compelling and leave after share prices rise to an expected target value.
Standard Life Investments takes a tactical approach. “For us, if a stock exchange is priced appropriately for the merits of its business model, then it’s not necessarily that interesting an investment,” says Mark Vincent, investment director of emerging-markets equities at the Edinburgh-based investment firm. “It becomes interesting when there is a dynamic of change that is going to drive earnings and cash flow above market expectations.”
Such dynamics may include the advent of high frequency trading, increased market volatility, growth in derivatives products and the rise of multiasset funds. “All those things bring more trading volume to an exchange,” says Vincent. “That drives up revenue.” For example, at BM&F Bovespa in Brazil, the average daily trading volume in the third quarter of 2015 was up 24 percent over the year-earlier period, even though the Brazilian economy sank deeper into recession.
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