BOSTON U.S. emerging market fund managers are paying less attention to where a company is located or listed than to whether it's making money, either as an advanced world company doing business in the developing world, or the other way around.
A top holding in the $710 million Ivy Emerging Markets Equity Fund, the best performing diversified emerging market fund over the last five years, is Las Vegas Sands Corp, the U.S.-based casino operator that generates most of its revenue in Macao.
The No. 2 holding in the $2.8 billion GMO Emerging Domestic Opportunities Fund is Colgate-Palmolive Co, based in New York but the maker of the best-selling toothpaste in India. And the $25 billion American Funds New World Fund is betting on a U.S. housing recovery by investing in Hong Kong-based Techtronic Industries Co Ltd, which sells power tools through Home Depot Inc, its largest customer.
"It's a new geography," said Rob Lovelace, a portfolio manager for the American Funds New World Fund, part of the No. 3 U.S. mutual fund family with $1.15 trillion in assets. "Investing based on where a company is domiciled doesn't really work. We have a better proxy because companies are disclosing more in their revenue breakdowns."
Betting on multinational companies that generate a meaningful amount of revenue from emerging markets allows fund managers to sidestep the political and currency risk that comes with investing directly in an emerging market, while also expanding their universe of potential investments.
A revenue-focused strategy allows portfolio managers to take advantage of an emerging market's strengths, such as cheaper labor costs, lower taxes and rising standards of living. Emerging market operations at multinational companies have delivered almost double the revenue and more than twice the profit growth of their parent companies, according to a Bain & Co analysis of results between 2005 and 2010.
To underscore the importance of this developing investment strategy, American Funds will provide investors with regional revenue breakdowns later this year at four funds.
Some portfolio managers using this approach are trouncing their peers, according to Morningstar Inc.
The New World Fund's three-year annual total return of 5.10 percent is beating 94 percent of rival diversified emerging market funds, according to Morningstar.
Ivy Emerging Markets Equity Fund has posted a 5-year annualized total return of 5.83 percent, the best performance among diversified emerging market funds with at least $200 million in assets during that period, according to Lipper Inc, a unit of Thomson Reuters.
The GMO Emerging Domestic Opportunities Fund's 1-year total return is 8.20 percent, beating 99 percent of peer funds, according to Morningstar.
HARD TO FIND
But the strategy has limitations, according to executives at New York-based Emerging Global Advisors LLC. Multinational companies that have measurable revenue exposure in emerging markets are hard to find.
Only 24 percent of companies disclose a specific percentage of emerging market or frontier market revenue exposure, according to an analysis of 2,025 large-cap and mid-cap companies by Emerging Global Advisors. While disclosures may be sparse for competitive reasons, fund managers say they constantly push for more specific breakdowns from company executives.
More databases and indices also are being developed to help portfolio managers identify the geographic revenue trends of publicly-traded companies. FactSet Research Systems Inc, for example, has a database that monitors more than 8,000 companies.
David Herro, who runs the $33 billion Oakmark International Fund, said if he can access a fast-growing emerging market via an indirect route, he's happy to make a big bet.
At Morningstar's annual investment conference last month, Herro pointed to German automaker BMW AG's surging revenue in China and how Milan, Italy-based Prada SpA, which is listed on the Hong Kong stock exchange, is reaping profits in China from sales of luxury handbags.
Prada generated 29 percent of net sales from China in the first quarter, while BMW sold 33 percent more BMW, Mini and Rolls-Royce cars in China (108,143) than in the U.S., according to first-quarter results. Year-over-year sales in China were up 25 percent, compared with a 3-percent rise in the United States, according to BMW.
BMW accounts for about 3 percent of the Oakmark fund's holdings, according to Thomson Reuters data. The fund's 3-year annualized return of 11.92 percent is better than 98 percent of foreign large-cap blend fund peers, according to Morningstar.
Sometimes, the best bets are in traditional emerging markets, but with a twist.
Hikma Pharmaceuticals plc, listed in London, based in Jordan and a top maker of generic drugs for markets in the Middle East and North Africa, is a darling among emerging market portfolio managers even as it says it's pursuing new markets in war-torn Iraq. Hikma is the No. 2 holding at American's New World Fund.
Hikma discloses diverse sources of geographic-based revenue, which appeals to fund managers like Lovelace. In 2013, Hikma generated 46 percent of its revenue in the U.S., according to its financial statements.
"Low labor costs and a low tax base enable Hikma to competitively price its products and gain market share,” according to stock analysts at Morningstar.
Hikma shares are up 64 percent over the past year and 125 percent over the past three years, beating the FTSE 100's advance of 3 percent and 13 percent, respectively, during those two periods.
Justin Leverenz, who runs the $43 billion Oppenheimer Developing Markets Fund, dismissed national borders altogether last month during a discussion at Morningstar’s investment conference in Chicago.
"Countries come and go," Leverenz said during a discussion about crisis-torn Ukraine.
(Reporting by Tim McLaughlin, editing by John Pickering)