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BL-Emerging Markets is celebrating its 10th anniversary. Launched at almost the worst time possible, the fund has successfully navigated the ups and downs of emerging markets by sticking to a clear investment methodology.

Marc, how would you sum up the 10-year track record of BL-Emerging Markets in your own words?

Marc Erpelding (ME): First of all, October 2007 was a poor choice of inception date. Emerging market securities were just then peaking and would soon be dragged down by the global financial crisis. But after 10 years, I would say that I am overall rather pleased with the fund’s performance. For the time being, we have achieved our goal of outperforming a pure equity index like the MSCI Emerging Markets over the long term – and at a far less risk. However, we have had a hard time keeping up with the index over the past two years and have therefore given up some of our lead.

 

What do you attribute this recent performance to?

ME: The market is currently being driven mainly by a few large tech companies. This has been going on for some time now in America, where Internet companies such as Facebook, Amazon and Google have pushed the markets ever higher. Emerging markets are being driven by their Chinese counterparts such as Alibaba, Tencent and Baidu. While we do have some of these tech large caps in the fund, such as Tencent and TSMC, we are, on the whole, steeply underweighted in this sector, for reasons of either valuation or competition. We are also far more diversified regarding weightings of the fund’s largest positions.

 

Because of these companies’ heavy weight in the common emerging market indices, they benefit disproportionately from inflows into passive funds. Do you regard this as a risk or an opportunity?

ME: Indeed, in the past few years we have seen a clear trend of investors into passive strategies in both emerging markets and elsewhere in the world.

An actively managed fund like BL-Emerging Markets, which owns a high proportion of small and mid-caps, with almost half of those companies not being part of the MSCI Emerging Markets, has a very hard time keeping up with the index during these market phases.

The biggest danger is that investors will continue to turn away from actively managed funds and that the fundamentals of individual companies will take on secondary importance. The inclusion and weighting of a company within the most important indices would then be crucial to its market performance. Overall market volatility would then increase rather than decrease.

Conversely, this development naturally offers opportunities for stock pickers, as the relationship between fundamentals and market performance would become distorted even more.

 

The possibility of being able to control risks in your fund through the equity allocation is certainly attractive. Who is your fund meant for?

ME: When launching the fund in late 2007 we deliberately opted for more flexibility in the equity allocation. We wanted to offer a product that would allow us and our clients to counter these heavy emerging market inflows and outflows.

If equity valuations look less attractive, we will reduce the equity allocation to as low as 60 percent. On the other hand, if equity valuations are more attractive, we will raise it as high as 100 percent. After the Lehman failure in fall 2008, for example, we raised the equity allocation from 70 to 90 percent. It currently stands at 75 percent.

The flexible approach improves the portfolio’s risk-reward significantly in comparison to a pure emerging market equity fund.

So the fund is meant for clients who want to invest for the long term, over a full market cycle.

For clients who want to ride a short-term rally on the emerging equity markets, it surely makes more sense to buy an index tracker or a more cyclical fund.

 

What companies are you investing in?

ME: Our fund management company, BLI - Banque de Luxembourg Investments, uses a common methodology in picking stocks. It focuses on the quality of each company, including good market positioning, a sustainable competitive edge, low capital intensity, a solid balance sheet, high margins and return on corporate investments. Based on BLI’s fundamental research, we buy quality equities when their prices offer a margin of safety with regard to the company’s fair value that we have ascertained.

 

What are the main differences with the MSCI Emerging Markets?

ME: The portfolio is structured on the basis of individual investments and is fully independent of a benchmark index.

Because of our investment approach, we seldom hold energy, commodities and banking companies in the portfolio. On the other hand, the fund is very steeply overweighted in consumer stocks. These companies are often brands with a loyal customer base and very dense distribution networks and thereby enjoying the resulting economies of scale. We hold other investments in IT, pharma and industry. More than 80 percent of companies in BL-Emerging Markets are rather local, often with dominant market share and addressing local consumers directly.

On the country level, we have overweighted Brazil for some time now while steeply underweighting India. This positioning reflects our somewhat anti-cyclical bottom-up investment approach. While Brazil has been plagued by political scandals, India has looked like a safer haven in recent years. However, this top-down view is also reflected in the valuations of quality stocks, and we have therefore tended in recent years to raise our Brazilian exposure more than our Indian exposure.

 

How do you handle your cash and bond allocations?

ME: As I mentioned earlier, the cash and bonds allocations are the result of equity weightings. Pure cash currently amounts to about 14 percent and government bonds, 11 percent. We consider emerging market government bonds, managed by my colleague Jean-Philippe Donge, as quasi-cash for purposes of this fund. Forex risks (mainly euros and US dollars), and maturity, credit, and liquidity risk are minimised accordingly.

The fund’s cash and bond allocation is supposed to act as a buffer in the event of a sharp market correction and ultimately allows us to buy companies at more attractive prices.

Marc Erpelding, Fund Manager

Marc is fund manager at BLI. After a degree in civil engineering at the Swiss Federal Institute of Technology in Zurich (ETH Zurich), Marc worked for a short time in industry in Zurich and New York. After his Master's degree in Management from King's College, London. Marc returned to Luxembourg in 2002 to join the Asset Management department of Banque de Luxembourg. Marc obtained his Certified International Investment Analyst (CIIA) diploma in 2005 and has been in charge of emerging market equities since 2007.

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