Getting Active in Emerging Markets

Scott Burns: Van Eck was really a pioneer speaking of small-cap. In small-cap local country funds, [Market Vectors] Small-Cap Brazil was really kind of the vanguard of this small-cap international, especially emerging market phenomenon that really a lot of other providers have jumped on. What's your relationship? How do you interact with that fund?

David Semple: Well, for the trading purposes, for instance, we're completely separate. I mean that's we don't…

Burns: Right, right, right.

Semple: We can't – we don't trade on them. That wouldn't be appropriate. We have an active role in designing what we think the market would like. We then – at this stage, we have index providers provide the underlying index. It is interesting to construct and look at how for instance, the industry weightings and sector weightings play out at that level.

And we've had – at Van Eck, we've had a history of global investing for over 50 years. So, we've been investing in emerging markets like South Africa for an awfully long time. So we have some perspective and ability to know how these things are traded. And some of these places is not easy to trade.

Burns: Right.

Semple: And you have to have a lot of patience to trade even if it's just on rebalancing, but trading baskets sometimes as well.

Burns: Just understanding what should be in that basket from a liquidity perspective?

Semple: Understanding how the ETF's constructed and then managing that ETF and managing the pricing of the stocks underlying it and to be effective real time, real pricing as it were as opposed to stale prices.

These are specialist type of occupations and we've been doing it for a long time, so we're pretty confident about that. And, I think there are a lot of other unexplored opportunities out there. I am personally, particularly enthusiastic about the EMLC, which is the Emerging Market Local Currency Bonds. I think that's a great place to look at.

Burns: Right. And I think people, with all the money going into fixed income right now, I do think there is going to be a growing trend of – instead of people just taking aggregate bets, starting to slice and dice their fixed income exposure, much as we've been doing on the equity side for decades now.

Semple: Yeah.

Burns: It's amazing that the fixed income space, a lot of people just kind of piled into an intermediate bond fund, whether active or passive and called it a day. But I do think you know we're going to start to see that change, because what's driving the local stocks is going to drive the local bonds as well.

Semple: Absolutely. And the credit worthiness of most places within emerging markets has substantially improved. So that's why you want to carry on the local currency as well.

Burns: In 2008, I always joked, why is Brazil selling-off, it's our financial system that's in crisis, not theirs.

Semple: Yes, quite. You know, if you can accuse me of being somewhat starry-eyed about emerging markets, but I don't think that's the case. Because I think what the U.S. and U.K. and Europe have been through, will happen to emerging markets again. But my point is that's a very long cycle.

Burns: Right.

Semple: We were talking 10, 15 years from now when they've built up the leverage again, which is, they've spent the last decade deleveraging after the Asian crisis. And as they leverage up, that's where you really tend to getting the best returns.

And when they get to leverage, then watch out, but that's a long way from now, and these things will go in cycles just as the U.S. did.

Burns: I mean it kind of reminds me actually here in the U.S., I mean there is one state in particular that was really not affected by the real estate bubble, and that's Texas. And that's because, once bitten, twice bitten, shy. I mean, people in Texas couldn't take out excess leverage and the rules had changed. And I think when we look at the emerging market countries, I mean it was actually a fairly similar thing played out after the Latin American debt crisis and the Asian crisis.

Semple: Sure. For the corporates, that was like hugely cathartic experience. They are arguably too shy of debt. Their balance sheets – I mean their free cash flow for the last seven years, their balance sheets are more cashed up even than U.S., corporates. It's inefficient, the lazy balance sheets and that's – in terms of risk, it's a comfort.

Burns: Right.

Semple: As things normalize, it's a risk.

Burns: Well, I'd ask you, are you guys going to try to get a little more active, you'd be in a more active shareholder with some of these lazy balance sheets?

Semple: Oh, we do. I mean, all the time we talk to them, and if we feel that they are being overly conservative, and sometimes it's just a corporate culture of the company. We try and nudge them without being too aggressive, but nudge them into being a little bit more active on their cash management.

Burns: So, I mean it looks like – in addition, all the growth prospects of emerging markets, looks like there might be even a little corporate finance magic dust that can be sprinkled on those – some of those returns.

Semple: Well, our role is simply just to suggest what might make economic sense. The ultimate decision to do M&A is more challenging in emerging markets simply because a lot of them are entrepreneurial-driven companies, are family companies as well.

Burns: Family companies, yeah, or government companies.

Semple: ...or government companies. So, what might make economic sense looking at it from several thousand miles away, when you're on the ground, it's never going to happen.

Burns: Right, right. Well, David thanks for that enlightening conversation about how active management, ETFs work together in that emerging markets area.

Semple: You're very welcome.

Burns: I am Scott Burns with Morningstar. Thank you.