Invesco’s Justin Leverenz: Emerging Markets Are ‘Incredibly Attractive’

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Our guest this week is Justin Leverenz, who is the team leader and senior portfolio manager for the emerging-markets equity team at Invesco. Leverenz joined Invesco when it combined with OppenheimerFunds in 2019. He started managing the strategy now known as Invesco Developing Markets in May 2007, having joined Oppenheimer as a research analyst in 2004. Before that, he was the director of Pan-Asian technology research for Goldman Sachs. Leverenz has worked in Taiwan and Scotland. He is a fluent Mandarin speaker, and he holds bachelor’s and master’s degrees from the University of California.

Background

Bio

Invesco Developing Markets

Market View

“Mexico: A Few Reasons Why We’re Bullish on This Neglected Developing Market,” by Justin Leverenz, Invesco, March 17, 2023.

“The Case for Mexican Equities,” by Justin Leverenz, LinkedIn, April 6, 2023.

Emerging Markets

“FAQ: Our Active Approach to Emerging Markets,” by Justin Leverenz, Invesco, June 12, 2023.

“The Case for Emerging Markets,” by Justin Leverenz, LinkedIn, May 2, 2023.

“Why a Huge Emerging-Markets Fund Is Reopening to New Investors,” by Gregg Wolper, Morningstar, Feb. 16, 2023.

“What Is Going on With Chinese Equities?” by Justin Leverenz, LinkedIn, July 28, 2023.

“Why Hasn’t Fed Tightening Led to an EM Crisis?” by Justin Leverenz, LinkedIn, June 23, 2023.

“Invesco’s Justin Leverenz—Putting Emerging Markets Challenges Into Perspective,” WealthDFM, May 26, 2022.

Growth Themes

“Electric Vehicles and Renewable Power Fuel Emerging Market Investment Opportunities,” by Justin Leverenz, LinkedIn, Nov. 15, 2023.

“Western Spirits Companies Turning to China and India to Fuel Growth,” by Justin Leverenz, Invesco, May 22, 2023.

“Chinese Health Care Companies: A Growing Force for Global Innovation,” by Justin Leverenz, LinkedIn, March 16, 2021.

“Humans vs. Machines: Who Has the Edge in Emerging Markets?” by Justin Leverenz, Invesco, April 3, 2023.

Funds/Companies Mentioned

Yum China

H World

ZTO

Tencent

NetEase

Grupo Mexico

Pinduoduo

Transcript

(Please stay tuned for important disclosure information at the conclusion of this episode.)

Dan Lefkovitz: Hi, and welcome to The Long View. I’m Dan Lefkovitz, strategist for Morningstar Indexes.

Christine Benz: And I’m Christine Benz, director of personal finance and retirement planning for Morningstar.

Lefkovitz: Our guest this week is Justin Leverenz, who is team leader and senior portfolio manager for the emerging-markets equity team at Invesco. Justin joined Invesco when it combined with OppenheimerFunds in 2019. He started managing the strategy now known as Invesco Developing Markets in May 2007, having joined Oppenheimer as a research analyst in 2004. Prior to that, he was director of Pan-Asian technology research for Goldman Sachs. He has worked in Taiwan and in Scotland. He is a fluent Mandarin speaker, and he holds a BA and an MA from the University of California.

Justin, thanks so much for joining us on The Long View.

Justin Leverenz: Thank you for having me, Dan.

Lefkovitz: Absolutely. So, if I’m not mistaken, you’re dialing in today from Mexico. You’re not on vacation. You’re on a due-diligence trip. So that’s probably a good place to start. You seem to find a lot of opportunity in the Mexican equity market. You’ve got more than 4 times the benchmark exposure there. So maybe you could start by talking a little bit about why you find Mexico such a good place to allocate capital, and maybe you can give us a little flavor for the trip that you’re on?

Leverenz: Perfect. So, as you suggested, we have 12% of the fund’s assets in Mexico. It’s quite a significant investment in four particular outstanding companies. It is our single largest overweight in terms of country versus the benchmark. And why Mexico? I think there are a handful of reasons. There’s a top-down reason, which I think has proven to be quite strong over the last couple of years, which is, Mexico is perhaps alongside some of its neighbors in South America, the emblem of macroeconomic orthodoxy, which was perhaps certainly not the issue 10 or 20 years ago. But it clearly has, despite a relatively populist president—we have elections, of course, coming up in June—has maintained really durable institutions in terms of central bank independence. You now have real interest rates in excess of 600 basis points, which is, of course, frustrating growth, and maybe we’ll talk about that at some point. And you’ve also had very durable and uncontested fiscal responsibility, which has not really been the case in much of the OECD nations. So, from a top-down perspective, I think Mexico is an entirely resilient place.

Of course, there is an enormous amount of enthusiasm about where Mexico stands in this sort of geopolitical environment, increased nationalism and industrial policy, particularly in the United States, and the prospects of nearshoring. And you are seeing an increase in terms of foreign direct investment and also private investment, which has been a little bit weak, at least in the early part of the AMLO administration, coming back to take advantage of those opportunities. From a top-down perspective, Mexico is perhaps one of the more interesting places in the world.

But as you know, we fundamentally believe that the logic of investing in the developing world is not really about finding the hot growth economy or about macroeconomics. It’s about finding globally advantaged businesses with good corporate governance. And in Mexico, you have a relatively small bourse, but you have a handful, a cluster of really well-run companies. The key element tends to be a single family or promoter that is very prudential about long-term capital allocation. And we have a handful of those companies. So, companies with durable growth, really strong competitive advantages, durable moats, and a handful of really interesting real options embedded in the business. So, there’s both a bottom-up and top-down reason to have 12% of the fund in Mexico.

Benz: I just wanted to follow up, Justin, on the election in Mexico, which you referenced 2024 is an election year for Mexico, as it is in many countries around the world. Mexican politics can be tumultuous, and that has impacted markets in the past. So, can you talk about how you’re approaching the election specifically?

Leverenz: Well, I must say predicting politics is difficult at all periods of time. In fact, I would reference when AMLO was elected five-and-a-half years ago, there was widespread anxiety around the election because AMLO is a fairly uncharacteristic individual, sort of a throwback lefty, if you will. And there was a lot of agitation around markets. If you look at what he has done, albeit perhaps a handful of mistakes here with the Mexico City Airport cancellation, a couple of white elephant projects, like the railroad in the south and the refinery—nevertheless, he has actually been really quite responsible in terms of not expanding…certainly not fiscally reckless. In fact, I think Mexico was perhaps the standout economy in terms of the approach to COVID and not dipping into significant fiscal deficits. And he’s also permitted without any significant challenge, like you’re seeing in Brazil, an incredibly independent central bank to navigate defense of the currency. So, politics is very difficult to call.

I think in the Mexican circumstance, the elections seem to be favoring a continuance of the Morena movement, which is the AMLO governing coalition. And the favorite force is Claudia Sheinbaum. There’s also a very interesting candidate that’s a coalition of what used to be the PAN, the PRI, and the PRD, former ruling parties, which is a distant second. If I look at the two ladies who are both leading in the polls, I don’t think that they differ enormously in terms of economic agenda, cultural agenda. And actually, either one of them, I think, will probably be better than AMLO in terms of sentiment in both the private sector and then the investment sector overseas, because as you probably realize, AMLO has been quite flamboyant with his very long-winded morning addresses and has unsettled business from a sentiment perspective. So, from a Mexican election perspective, again, I would go back to the original comment, which is political pontification, which seems to be a career, is really difficult to do at all periods of time. I think the elections in the United States perhaps are going to be a bit more important to Mexico than who wins this contest in June.

Lefkovitz: And in terms of your current trip, Justin, are you seeing all the companies that you own? Are you looking for new opportunities?

Leverenz: Well, generally speaking, I travel a fair bit monthly, and typically 70%, 80% of the time is focused on deeper meetings with existing holdings and then leaving 20%-plus for exploration of new ideas. And so, I’m spending a very long period of time with FEMSA, which is one of the key holdings in Monterrey later in the week. I’ve got meetings with Walmex, Grupo México, and also América Móvil during these three days in Mexico City, but I’m also looking at a couple of new opportunities. Jose Cuervo, which you may know from the brand perspective, the Cuervo Group. Chedraui, which is a sort of interesting food retailer, both here in Mexico and then also in the southwest of the United States, particularly in California. And then a number of private meetings with business executives and interesting intellectuals and friends here in Mexico.

Benz: We wanted to dial out a little bit to talk about emerging markets more broadly. Let’s start by talking about the performance disparity between emerging markets and developed, especially U.S. Our U.S. equities index is up 3 times over the past 10 years. Emerging markets are up less than 1.5 times over that period. So, we all know the U.S. story, but I’m wondering if you can talk about what has gone wrong with emerging markets during that 10-year stretch?

Leverenz: Well, I would say actually it’s quite an interesting conversation that could take up our entire podcast. The first most important thing to point out is that this is very much about U.S. exceptionalism over the last 10 years. And in fact, we’ve written quite extensively about this, but every decade there’s a set of themes that tends to drive global equity markets. And so, the last 10 years, as you pointed out, the U.S. S &P, and we’re not even talking about the Nasdaq or the “Magnificent Seven,” have returned midteens U.S. dollar returns, whereas as you pointed out, EM returns have been more than 1,000 basis points underperformance during this period of time. If you go back to the decade that preceded this period of U.S. exceptionalism, it was really an emerging-markets decade. In fact, that was the last time we saw each other, as you reminded me earlier, and you saw the same sort of phenomena. U.S. equity returns were 2% compound over 10 years, and EM outperformed midteens U.S. dollar returns. And so, I think that there are long-term mean-reversion characteristics.

The last 10 years, I think there were a couple of exceptional circumstances. The first, I had a déjà vu moment about this in California a few months ago, seeing clients after a long period of time. First, when emerging markets did spectacularly well, let’s say 2002 to 2012, there were considerable excesses that got developed in terms of internal imbalances, external imbalances, and frankly, a lot of asset bubbles. And you had a period of five or six years in many of these economies where there was a significant need to repair these imbalances by growing more slowly. You also, of course, had during that period of time a significant correction in commodity prices after the rise of China-driven commodity supercycle we saw during the EM decade. And so there was a big transition actually in the large emerging-markets economies in terms of greater resiliency and slower growth.

In the emerging markets, there was another story, which of course is a more recent story, which is about significant economic challenges that have emerged in China over the last, I would say five or six years, but with increasing speed over the last few years. And in fact, the significant underperformance of Chinese equities has really obfuscated the underlying return profile of emerging-markets equities in total, because of course, the weight of China in the benchmark is so significant. If you go back two years ago, China was 40% of the benchmark weight. Today, it’s still 27%.

If you look at 2022 and 2023, I think they’re quite instructive in two dimensions. The first is EM ex-China has been incredibly resilient. You remember 2022, there was no place to hide as rates were moving up. Fixed income, equities around the world did very, very poorly. EM ex-China actually performed in line with both worldwide equities and also MSCI international equities or the EAFE index. And that’s very rare. I’ve been doing this for 30 years, and that sort of resilience is not to be expected. I think the EM ex-China has moved away from being the tail, meaning that it is fundamentally about global beta, to actually being far more resilient.

In 2023, same sort of circumstance. What you saw was the benchmark delivered approximately 10% U.S. dollar returns, so the MSCI Emerging Market benchmark. EM ex-China, however, was up 20% in U.S. dollar terms. And that was really not so far away from either MSCI World or MSCI EAFE returns. So, this lower growth but greater resiliency has manifested itself in terms of actually good equity returns for the last few years in emerging-markets ex-China. Then there’s China, which you may want to speak at more length upon, but China has really been a huge drag. Chinese equities are now down 50% in U.S. dollar terms over the last three years.

Lefkovitz: Yeah, let’s go there because China, as you said, such a big part of the universe and you have significant absolute exposure there, even if you’re underweight. Well, maybe you could talk about why you’re underweight and just how you approach a market that’s such a big percentage of the benchmark in your universe?

Leverenz: Well, I must first say that we have never been overweight China in the 27 years of this fund’s heritage. And the reason we’ve never been overweight in China really comes down to two things. The first is diversification. I don’t structurally want to have more than 20% of the fund’s capital in any particular country ever. And the second is ultimately about the fact that while China is inescapable, it’s a very large and dynamic economy even today, despite relatively tepid growth. It has historically been a very challenging place to invest from a bottom-up perspective. And I think that one of the reasons for that, the analog I often make is, it’s a bit like Silicon Valley over the last five or 10 years. If you go back to Silicon Valley’s heritage in the 1960s, the 1970s, the 1980s, it was really in terms of venture capital funded by operators with relatively small pools of capital that were incredibly disciplined about the allocation of that capital in terms of new rounds and milestones.

What you had in the last 10 years, in the world where software was everything, the software eats the world environment, which was one of the reasons for U.S. exceptionalism in the last 10 years, discipline had completely failed certainly two or three years ago, and it was no longer run by operators, it was run by former Wall Street individuals who moved to Silicon Valley with a very different approach. You think about Tiger Global or SoftBank and these sort of things. And I think the analog with China is actually quite interesting. China has been an incredibly dynamic growth environment for a long period of time. I can’t forget that when I lived in China or when I left China, it was roughly a $2 trillion GDP economy. This was in 2004. And today, it’s an $18 trillion economy. There was an enormous amount of growth and prosperity that happened in China. But like Silicon Valley, because China’s fundamental problem is it saves too much, there was an enormous amount of competition that was reckless and too much capital to fund a lot of misadventures. And so, the problem investing in China historically has been that even sensible companies with recently decent businesses have faced both reckless competition and also not particularly good capital allocation because the cost of capital is very, very low. I think that’s actually changed or is in the process of changing in a very visible fashion. And that’s one of the reasons that I think that China perhaps over the next few years could emerge as one of the best opportunities for investors around the world.

Benz: Can you talk about how U.S.-China tensions have affected your thinking, if they have?

Leverenz: Well, I am under no illusions that the global environment has become incredibly averse. In fact, I think investors, while they’re mindful of this, they don’t really think about this enough perhaps. We had a terrific period from the late 1980s, the early 1990s, where two things were happening for almost 30 years. The first thing was post the demise of the Soviet Union, we had an enormous globalization of everything—of capital flows, of trade, of ideas, of human talent, and immigration. And at the same time, we also had structurally, since the Volcker administration at the Fed, an environment of ever-declining interest rates. Both of these were phenomenal for the world in terms of human prosperity. However, the distribution of those gains was the beginning of where we have a very unsettled world in terms of the rise of nationalism and increased division across most democracies and that sort of thing. The geopolitical environment has changed dramatically in the last 10 years. It has become a much more multipolar world where you have significant regional powers in Europe, in the Middle East, in Asia, in even Latin America, although it is a relatively benign security environment. I think we’re also, as the late Dr. Kissinger suggested, we’re in the foothills of prospectively a new Cold War. And so, I’m under no illusions that the relationship between Beijing and Washington will continue to remain tense structurally.

Lefkovitz: Well, Justin, from a bottom-up perspective, maybe we can talk about where you are finding opportunity in China. You seem to have quite a bit of consumer exposure there—Yum China, H World, which is a hotel chain, some Tencent. Maybe you could talk about your seeming faith in the Chinese consumer.

Leverenz: Well, I would say, China has been a really difficult place, obviously. As I suggested earlier, the entire CSI 300, a broader group of equities in China, are down 50% in U.S. dollar terms over the last three years. It has been a very painful slide, and it’s also been a very painful circumstance for fund performance, because the winning strategy over the last three years was rather simple, which is how underweight you were in China or having no capital in China. Today, we have 17% of the fund directly invested in China, really in three clusters. We have three companies that are very consumer-facing, as you suggested. So, there’s Yum China, H World, and also ZTO, the express company. And we have approximately 5% or 6% in three technology companies: Tencent, NetEase, and Pinduoduo. And then the balance of it is spread across China’s biotech sector.

All of these companies have been lost in translation in the sense that the concerns about China’s macroeconomic circumstance, and then also some of the geopolitical issues that we just referenced, have completely overwhelmed the reality of the underlying businesses. And that always, for investors, I think represents an opportunity when the focus is on nonidiosyncratic circumstances of businesses. And when I look across the balance, and they’re all quite different companies, I think as I suggested before, one of the really interesting opportunities in China has been a wholesale strategic reorientation across private-sector China. An acknowledgement across all the companies we own that China is going to be a slower growth environment over the next many years. And these companies have resolutely focused increasingly on the core, abandoning interesting ancillary opportunities to improve underlying margins and free cash flow with the purpose of, in most cases, using that enhanced free cash flow for distribution shareholders, and particularly share buybacks. I’ve been involved with China for over 30 years, and I have never seen the level of commitment in terms of very large buybacks that are going on at present.

And so, I think, investors often—this is not just China-specific, this is also emerging-markets specific—investors often misunderstand the opportunity in emerging-markets equities, thinking that if you identify the hot growth economy, you’re inevitably going to make a lot of money. As I said earlier, China’s economy over the last 20 years has come an enormous way. It was a hot growth economy. But over those 20 years, there have been almost no absolute U.S. dollar returns across the equity markets. And in fact, if you look broadly across emerging-markets equities, some of the greatest returns have been relatively pedestrian, real economic growth economies like here in Mexico City. So, I think, eventually, since China has been almost abandoned by foreign investors over the last couple of years, investors will eventually come around to the fact that not only these companies are incredibly attractive in terms of valuations, but they’re also very promising at the idiosyncratic level of the competitiveness in their businesses, and they are distributing significant returns to shareholders. So, we’re nearly a 1,000 basis points underweight in China, which over the last couple of years seemed like not being enough. But I do hold great promise in each of the companies we have in the portfolio in China.

Benz: So earlier this decade, your fund was impacted by China’s government crackdown on the private sector. You also had some exposure to Russia going into 2022 pre-Ukraine invasion, and your investments had to be marked down after that. So, what do you say to the view that autocracies are just bad places to invest, that personal liberties and a basic respect for the rule of law are prerequisites for investing somewhere?

Leverenz: Well, I’m always wary of generalizations. I believe in pluralism and have a very liberal temperament. I think the world, it’s very hard to conceive of things as being black and white in the sense of autocracy versus democracy. And in fact, as an American citizen, I’m often concerned about these circumstances because many of our allies that presumably are Democrats don’t really seem to embrace democracy. You think about Thailand, for example. It is on paper a democracy. In fact, Russia on paper is a democracy, and it doesn’t really behave like a democracy. But the pluralist impulse, I think, is really important, which is a recognition that allowing neighbors to have their own set of values is quite important, and that many things we conceive of as universal values aren’t necessarily embraced either from historic or development perspectives or even religious perspectives.

The Russia and China circumstance, I find actually quite different. The losses, and absolutely the last three years have been incredibly painful, both being an investor in emerging markets in this period of U.S. exceptionalism and then specifically to the fund, having lost significant amounts of capital in Russia and some of the regulatory interventions that you referenced in China. But I think the two are quite different. In the first case, in the Russian case, this was not an abrogation of rule of law in the sense of the Russian state changing the regulatory environment, or even taking away our assets. In fact, after the terrible invasion a couple of years ago, we had to mark the Russian assets, which were 9% of the fund, to zero. And I reminded investors that they weren’t worth zero, that over time we would be able to realize some of the value, because that just reflected an absence of liquidity and frankly, a view among the valuation committee. And in fact, we’ve been able to unearth a few hundred basis points of the fund that we’ve recouped in the Russia circumstance. So, the Russian circumstance, it was really geopolitical issues that were the defining feature, not necessarily like in the case of China what had become unpredictable regulatory interventions, which caused a lot of stress in places like education stocks and some of the big technology companies in China. So, they are quite different.

I also think for investors that Russia and China are also quite different. And of course, for our policymakers in the United States as well, I think are mindful of this, which is, the stakes associated with Russia from a United States perspective were relatively small. There wasn’t a lot of foreign direct investment in Russia from U.S. companies. And the biggest challenge to the West associated with the war and the tit-for-tat approach to the postwar environment was really about energy and continues to be a really big issue for Europe but for the United States is actually an opportunity, particularly on the gas side. So, the connectivity between the United States’ corporate and economic sector and Russia was relatively limited. In the context of China, it’s much more connected and very difficult to untangle these 30, 40 years of heightened globalization and supply chains and integration. So, again, I find it very challenging to imagine that while Russia is almost hermetically sealed from the United States and the West, that China could be done in the same sort of fashion. I just think it would be far too damaging on all sides.

Lefkovitz: Political risk seems to be one of the factors that is suppressing valuations in emerging-markets equities. EM has been trading at a big valuation discount relative to developed markets, but the gap has persisted for some time. What do you see as some catalysts for a rerating of emerging-markets equities?

Leverenz: I think fundamentally, the two large clouds, one of which seems to at least be perceived of as fading, and the second one, which I think will over time will fade, and I just referenced. So, the first one, of course, is about the U.S. dollar and real interest rates in the United States. And there seems to be widespread sentiment if you look at the bond market post the Fed-perceived pivot in December that U.S. rates, the sovereign rate, which determines rates around the world, will actually start to move down over the course of the next 12 months. And that is where the non-China emerging-markets equity investment universe looks particularly well poised, because you have a set of circumstances that we talked about earlier where real interest rates are incredibly high across the EM landscape. Here in Mexico, they are 600 basis points; you go to Brazil, they’re even higher than that. And the environment of being able to push down nominal and real interest rates across the EM world really makes them coiled springs in the sense that incredibly high real interest rates are a detriment to investment productivity and growth. They’re also a detriment to equity multiples, because if you can get 600 basis points real rates in policy rates in cash, why would you bother with equity markets. So, the first cloud, as it dissipates, I think will be really good for EM ex-China, because that feedback loop will go in reverse. The real economy will start to pick up in terms of pent-up investments, employment, credit, GDP, and equity multiples will start to look more attractive versus fixed income. So that’s the first cloud.

The second cloud, which we talked a little bit about is fundamentally about China. And once investors become more comfortable with China growing at 3% to 4% versus historic growth rates, that stimulus is not coming. I think they will be able to treat, to actually looking thoughtfully at these companies and their idiosyncratic cases, rather than throwing the broader cloud about economic uncertainty. And I think, as I suggested earlier, that over the next two to three years, I think China will perhaps be one of the best-performing equity markets in the world.

Benz: We want to step away from China and discuss the green revolution, the energy transition that’s underway. It’s part of the Mexico story and you also see South Korean battery makers as big beneficiaries of this trend. Why is that? Maybe you can talk us through that.

Leverenz: Well, I think there are a handful of themes that tend to dominate investors’ imagination every decade. In the next 10 years, I think the energy transition is perhaps going to be one of the most prominent themes, as we try to reconcile the challenges of climate change. And one of the important areas, I think, is clearly going to be the electrification of transportation around the world, which has really taken off in China, has taken off in parts of Europe like Norway, but it’s still very underpenetrated more broadly around the world and particularly in the west, the United States and in much of Western Europe—the non-Scandinavian part of Western Europe. And that will take time because there are issues around policy, there are issues around charging infrastructure and those sorts of things. But this is going to be a very dynamic environment. This is an incredibly large industry that’s going through a big structural transformation. And to enable that, I think that there are many different threads of investment possibilities.

One thread is related to my largest holding here in Mexico, Grupo México, is really about green metals. And the fact that we in the next few years are going to have really significant supply challenges trying to deal with the energy transition, not just on the electric vehicle side, where electric vehicles consume three to four times as much copper as an internal combustion engine vehicle, but also on renewables more broadly—in terms of solar fields, wind turbines, and the infrastructure both onshore and offshore. So, I think copper is going to be one of those really interesting areas. In addition to that, we seem to be in an environment where we are going to have a dual supply chain for electric vehicles around the world. China, of course, is the big heavyweight because today 30%, 40% of the incremental sales in China are now electric or hybrid vehicles. The penetration in the United States is 5% or 6% on a run rate. But the United States and increasingly Europe, I think for energy security, for industrial policy, really are not allowing the Chinese, which are uber competitive in both electric vehicles, the product themselves, the batteries, and the battery components to compete on what they consider fair terms. And as a result of that, the default winners will likely be South Korean, because South Korea has the battery chemistry, they have the scale and they have the joint ventures increasingly, for example, LG Chemical here in the United States with a number of OEMs.

Lefkovitz: The emergence of India has been a theme of yours for some time. You’ve long found great companies in India, but now you feel that the macro backdrop, the policy backdrop, is supportive. What’s changed and also given returns there, how do you get comfortable with Indian valuations?

Leverenz: Well, we have in the 27 years of the fund always been significantly overweight India, and that has never really been shaped up until recently by the view that India is going to be an outperformer in terms of real economic growth. The overweight was always very idiosyncratic about the businesses that we own and the promoters and operators of these businesses and their governance standards. But fundamentally, things have changed dramatically in India in the last five years, which is really the combination of a series of discrete economic reforms that have really improved the capacity for India to grow. So, I do think that in the long term, meaning the next five or 10 years, there will be an Indian renaissance in terms of growth—that India will command significant attention of investors that are not just emerging-markets investors, but global international investors, because the opportunity will be quite spectacular.

In the short term, meaning the next 12 months, India has performed very well. And I do think that even great circumstances go through cycles. And I do think that there are signs today that India from a cyclical perspective is slightly overheating. And I think that there are parts of the equity market that are radically overheating. And there’s a real discrepancy. If you look, for example, last year at the performance of the Indian equity market, which was quite strong and in line with EM ex-China, that sort of obfuscated what was really going on underneath the hood. Large-cap India didn’t have a spectacular year. And most of the action was in cyclical stocks, particularly because of really aggressive infrastructure spending that’s unsustainable given the fiscal circumstance in India. And so, you had capital goods companies, engineering construction companies, cement companies that posted stunning returns and looked incredibly expensive despite the Indian Renaissance ahead. And then you had an enormous amount of enthusiasm, largely from domestic mutual funds and retail investors around mid-cap companies that tend to have relatively small market capitalizations, of course, and also very limited free floats. And those companies, by and large, are trading at, what we call, whimsical kind of valuations, completely unsustainable. So, I guess, in brief, in the long term, I have great enthusiasm that India has repaired its capacity after 70 years of independence to really grow much more aggressively without inflation in the long term. But it will go through a cycle, and I think the cycle may happen in the next 12 months.

Benz: Biotechnology is another growth theme that your portfolio is exposed to. Can you talk about how emerging-markets companies have benefited from trends in the healthcare space?

Leverenz: Well, I think biotechnology, alongside we talked about the energy transition, India is one of the big themes of the next decade. There has been enormous amount of progress over the last 20 or 30 years in science in terms of new modalities. We all know, of course, mRNA because we all had those injections during the COVID period. There are things like antibody drug conjugates, which are much more targeted and better form of chemotherapy and are going to be prospectively a $100 billion industry. There are obviously CAR T, which has gotten a lot of press because of FDA approvals. There’s gene and cell therapy. So, a lot of things that have been developed in science over the last 20 or 30 years are now in advanced stages of the clinic. It’s going to be a really promising area for global investors.

So, where do emerging markets fit in in this perspective? I would say in two dimensions. The first is much of the innovation that’s happening in biotechnology around the world is actually in biotech and not in Big Pharma. You’ve obviously seen in the last six months a big amount of business development and mergers and acquisitions associated with Big Pharma that have patent cliffs going and buying biotech. But there’s been a fragmentation of the industry where now discovery, development, manufacturing is increasingly being decoupled, particularly for biotech that doesn’t want to compound clinical risk with the risk of actually doing manufacturing even in the development phases. And so, where emerging markets fit is in China and Korea, there are huge opportunities associated with the CDMO, CMO space, so the development and manufacturing scale to be able to work with biotech and actually increasingly Big Pharma that wants to dual source for security in biologics.

The second area is actually very China-specific, which is, a large part of the talent pool around the world in the life sciences. If you go to the big life science schools, you see this at Stanford, or Johns Hopkins, or MIT is actually Chinese. And you have seen a wave over the last five years of Chinese scientists and clinicians who’ve hit a glass ceiling in the West, whether it’s in Boston or South San Francisco or Switzerland, moving back to China and building really innovative biotech companies. And so much of the M&A wave in the last six months has been associated with Big Pharma, companies like GSK or AstraZeneca, Merck going to China and in-licensing clinical assets of China biotech companies. So, there will be big opportunities in the manufacturing and development side, and then there will be significant but much more idiosyncratic opportunities associated with China biotech, which is increasingly going global.

Lefkovitz: Switching gears, Justin, wanted to get your thoughts on the idea of getting exposure to emerging markets indirectly through developed-market companies that have revenues coming from emerging markets. You do have some developed-market companies in your portfolio. So, maybe you could talk about why and how you pick and choose, but also just what you think of this concept? Some people think it’s sufficient to have developed-market exposure to emerging markets and not to have dedicated emerging-markets holdings.

Leverenz: Well, we have always taken the approach that we will have 10% to 20% of the fund at all periods of time in emerging-markets companies that happen to be domiciled outside of the emerging markets. But we’re very clear about we want truly to be involved in companies that have developing-market franchises that dominate the earnings cash flow and growth of these businesses. So, these are clearly emerging-markets-led companies. These are not Nvidia, or Microsoft, or Eli Lilly or Novo Nordisk, which are really interesting companies, but not really emerging-markets companies. So, we’re very specific about wanting to invest in, frankly, some of the best franchises across the developing world are actually just not domiciled in places like Sao Paulo, Beijing, New Delhi, that sort of thing.

As it relates to exposure to emerging markets directly versus gathering some emerging-markets exposure through investing in the developed world, I would say there are two issues with that. The first is it’s very hard to find if your objective from an asset-allocation perspective is to be involved with the 80% to 90% of the world’s population that is actually living in the developing world, it’s very hard to find critical mass of companies that clearly have that sort of exposure. That’s the first. And the second, frankly, is that I think that the emerging markets on a relative basis look incredibly attractive compared with the developed world today—after the decade of considerable underperformance that you suggested. Valuations are very attractive. We talked earlier about the coiled springs associated with U.S. dollar rates, prospectively moving down. We talked about the opportunity in China equities where there’s been an enormous amount of carnage. Everything has been on a tag sale and there are really significantly outstanding companies that have been lost in the chaos that are world class in terms of being globally advantaged kind of companies. And I’m not certain you’re going to be able to accomplish that by investing in the Nikes or Estee Lauders of the world.

Lefkovitz: Well, that seems like a good place to close. Justin, thank you so much for your time. We really enjoyed talking to you today.

Leverenz: Yes, thank you. I appreciate you hosting.

Benz: Thanks so much for being here, Justin.

Thank you for joining us on The Long View. If you could, please take a moment to subscribe to and rate the podcast on Apple, Spotify, or wherever you get your podcasts.

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Ptak: And @Syouth1, which is S-Y-O-U-T-H and the number 1.

Benz: George Castady is our engineer for the podcast and Kari Greczek produces the show notes each week.

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