A fascinating aspect of financial markets is the interaction of momentum with fundamental analysis. George Soros calls it reflexivity, Buffett more colloquially evokes the “voting machine” vs. the “weighing machine”, they’re talking about the same thing. Nowhere is this contrast starker today than with Nvidia and Emerging Markets. 

In recent years, our fundamentally driven process has led us to overweight emerging markets in portfolios. Not only has Emerging Markets underperformed Developed Markets, but (and this will come as a surprise to many, including yours truly) Value has outperformed Growth in emerging markets. As this perfect storm unfolded over the past few weeks for our emerging manager of choice, Trinetra, we sat down with PM Tassos Stassopoulos to try and get to the bottom of it. Is it the darkest before dawn or the biggest value trap of all? 

You can’t fault fundamental researchers for trying to solve this question analytically. Tassos points to objective, numbers-based evidence that this underperformance may have created a unique opportunity for investors to access some of the world's highest-growth companies at remarkably low valuations. We can be sceptical as to whether this represents the whole answer, but it certainly deserves a listen.

One of the main reasons for Trinetra's recent underperformance is their decision to avoid investing in certain stocks/sectors, such as Taiwan Semiconductor Manufacturing Company (TSMC) and South Korean tech companies, which have seen substantial gains. While these companies are technically part of the emerging markets index, their success is primarily driven by demand from the developed world, rather than domestic consumption within emerging markets.

Instead, Trinetra focuses on investing in companies that benefit from the growth of the middle class in emerging markets, such as those in the financial inclusion, insurance, healthcare, and consumer products sectors. These companies have the potential to benefit from the substantial increase in incomes and demand for better products and services as people move from low to high productivity sectors.

Despite the significant growth potential of these companies, many of them are trading at valuations that are much lower than their developed market counterparts. This is due in part to the aforementioned outperformance of value over growth in emerging markets, leading to a 40 percentage point dispersion between the two categories. As a result, many high-quality companies with strong growth rates in emerging markets are now trading at price-to-earnings growth (PEG) ratios of less than one, indicating that they are significantly undervalued.

This presents a compelling opportunity for investors who are willing to look beyond the short-term market noise and focus on the long-term growth potential of these companies. According to Tassos, the average company in Trinetra’s portfolio is expected to generate an annualised return of 22-23% over the next five years, based solely on free cash flow generation and without any multiple expansion.

Furthermore, the risk-adjusted returns of these companies are currently at an all-time high, with the portfolio average reaching 12%, compared to the historical average of around 6%. This indicates that investors are getting a substantial amount of cash flow for a lower price, and that the markets may have overreacted to the recent underperformance of emerging markets.

While emerging markets and Trinetra's portfolio have faced challenges in recent years, this may have created a unique opportunity for investors to access some of the world's highest-growth companies at bargain prices. By focusing on companies that benefit from the growth of the middle class in emerging markets and taking a long-term view (and the last point is key), investors may be able to generate substantial returns in the coming years, even as developed markets struggle to maintain their growth momentum. Starting to sound like a broken record? Maybe, but everywhere we look, the question of how much further can Nvidia go is being asked, and Emerging Markets Growth could logically become an attractive alternative.