In emerging markets, look at the companies, not the headlines

Often when people speak about emerging markets investing, they take you on a tour of the world to discuss macro issues: “Will there be a soft or hard landing in China? Will Brazil emerge from recession in the second half of next year? Will sanctions on Russia be lifted or not?” My response is that this might make for extremely interesting conversation, but it's totally irrelevant to managing an emerging markets equity strategy.

It can even be counterproductive. For instance, look at China. The economy grew by nearly 10% per year over the past 15 years, but the markets returned -7% on average. By comparison, in South Africa the economy averaged 3% growth per year, but the market returned 86%. So the correlation between economic growth and market returns is just not there. Had you invested on this basis, you would have underperformed massively.

Even when people agree that gross domestic product growth doesn't matter, they continue to believe that simply being in a particular market does. That just isn't true. If you look at a market-leading retailer in Russia, it has outperformed not only the Russian market, which is a serial disappointer, but emerging markets more broadly.

Successful investing is all about investing in companies.

Forget the macrotourism and forget the markets. Our analysis shows that after three years, the performance of a stock is closely related to the performance of a company's earnings. So provided you didn't overpay first, you should see investment growth commensurate with the company's net earnings growth, independently of the country, independently of the market.

In fact, if we decompose returns by sector, country and company specifics, the research we have undertaken shows that around 50% to 70% of returns come from the company itself. So when we speak about the strategy of emerging markets investing, we do not talk about where we are invested in terms of geography or industry, but instead which companies we have invested in and why.

Conceptually, we see companies in two main ways. First, there are the “traditional but still relevant” companies. These are typically more oriented toward the development of the middle classes and the enhancement of infrastructure. These are quality companies that have strong and visible growth prospects.

The other type includes what we call “new and accelerating” companies. Often, these companies are not just dominant in their local market, but also are expanding beyond their home borders. This includes south-south traders, those companies that have been extremely successful in their home markets and are now selling their products in other emerging markets.

Within the new companies category we also include the world leaders. These are the companies producing goods and services that are performing well because they are among the best at what they do worldwide. An optical lens manufacturer is a prime example. The company is a global leader in the vehicle lens market, producing high-quality sensors that are used in a number of ways, such as in providing detection, warning and viewing systems for drivers. The company's growth is supported by favorable U.S. regulatory policy, which should underpin robust demand for vehicle lenses. But it is not an American, Japanese or even European company, it is Chinese.

At a time when there are investors who are more cautious toward emerging markets, we are extremely optimistic. This is not because we think that China will have a soft landing, or that Brazil will see an economic rebound in the second half of next year or that sanctions in Russia will be lifted.

We are optimistic because of the many quality growth franchises that we believe have the potential to continue delivering growth even when emerging market economies witness slower rates of economic expansion. In addition, we are excited about the future because of the shift we have observed among growing numbers of emerging market companies over the past five years from basic business models to highly sophisticated, world-leading companies.

Jean-Louis Scandella is the London-based head of equities and co-portfolio manager on the global emerging markets strategy at Baring International Investment Ltd.