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Emerging market rally: the tech stocks to watch

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Written by: Paloma Kubiak
30/09/2016
After a rocky few years, emerging markets seem to be turning their fortunes around and one idea gathering momentum is that it is largely fuelled by a boom in technology stocks. But which have the scope to be the next Apple or Google?

The Global Emerging Markets sector has shown an increase of more than 30% to the year ending August, compared with the wider industry average of 9%, according to The Association of Investment Companies (AIC).

As a result, it’s now the second top performing AIC sector, and the shock Brexit result which fuelled the steep depreciation of sterling has bolstered the appeal and return of EMs.

But for some fund managers and investment commentators, technology stocks are leading the way when it comes to the appeal, and returns, of EMs.

American tech stocks have tended to monopolise the arena but with their higher valuations, which EM tech stocks look good and can they compete against the established giants?

EM tech stocks to watch

Carlos Hardenberg is manager of the Templeton Emerging Markets Investment Trust which has 26% invested in information technology stocks, of which the largest holding is in Samsung Electronics.

He says technology is one of the drivers of the EM rally, which is supported by recovering exports and solidifying domestic consumption.

“Companies in EMs are moving up the technology learning curve very fast, whether it is in Fintech and digital banking or more innovative manufacturing and many other areas. We are also interested in the frontier market space, which offers a strongly growing middle class and some very good companies at valuations we haven’t seen in a long time. Lastly, another area where we are also finding value is in the mid cap segment [of the market], which currently offers some very good bargains.”

He lists Sunny Optical, Hanon Systems (automotive thermal energy and climate control technology), Largan Precision (lens supplier for tablets and cameras) and Catcher Technology (light metal technology firm manufacturing smart phone and laptop casing).

Hardenberg explains his interest: “We invest in companies which have superior management teams, robust growth prospects, a conservative balance sheet, and are trading at a discount to what we think they should be worth.”

In addition to Samsung, other stocks to watch that can compete against the like of US giants such as Google, Amazon and Microsoft are Baidu (Chinese web service) and Alibaba (a Chinese e-commerce company similar to Amazon).

Omar Negyal, manager of JPMorgan Global Emerging Markets Income Trust, has over 16% in information technology and nearly 13% in telecommunications, and for him, one of the big draws is the increasing willingness of these companies to pay a dividend.

“Years ago, EMs were not considered an asset class for income but now a suitable payout ratio is 30-35%. By only focusing on those that deliver dividends, it will give good insight into the attitude to minority shareholders. Paying a dividend shows they want to reward,” he says.

As such, he favours semi-conductor companies in Taiwan as the country has a robust dividend culture with a focus, by management, on cash dividends and dividend policies which are minority investor friendly. He adds the country’s dividend payout ratio of approximately 58% is significantly above the EM average.

“Taiwan Semiconductor ADR (TSMC) has a market share of over 50%. It is as close to a monopoly as one can get in the technology sector not only in Asia, but even globally. The business has achieved double digit earnings and dividend growth over the past 10 years, average return on equity (ROE) of 23% over the past 10 years and management has recently stated they will continue to increase annual dividend payout over the next three-to-five years.”

Another company making the cut is Vanguard Semiconductor, which is majority owned by TSMC. Negyal explains: “It is a beneficiary of the semiconductor outsourcing trend in analogue and mixed signal devices. The ROE of the core business is over 50%, cash accounts for 70% of its balance sheet and fixed asset turnover is over 2 times. There is further room to grow its  top-line, while improving its ROE and management plans to return excess cash to shareholders at a rate that equates to 8% dividend yield.”

Like Hardenberg, he also lists Samsung Electronics, adding it to this portfolio for the first time in October, precisely because of its change in dividend policy.

“The company now aims to return a higher percentage of free cash flow to shareholders than before both via dividends as well as share buybacks. Crucially, shares repurchased will be cancelled which was an important development compared to previous buybacks,” he adds.

Darius McDermott, managing director of Chelsea Financial Services, describes technology as a very entrepreneurial and an exciting sector. However he believes it makes a good satellite investment opportunity, rather than being a core holding.

He explains that technology spans almost every other industry in some way, such as advances in healthcare – 3D printing of braces and virtual doctor mobile apps – through to retail.

“It touches almost everything in our lives and is very quick to evolve. Some parts of the technology sector are fair value to expensive at the moment, especially as many tech stocks are in the US. But there are still opportunities and EM tech stocks are an option. Some of the EM rally has indeed been led by companies such as Tencent (gaming apps), Alibaba and JD.com (both Amazon’esque’).”

He adds the Chinese government in particular is keen to promote the Chinese tech sector as it is a new area for job creation as it goes to a more service-led economy.

However, he cautions investors to be careful as just as many tech stocks go bust as become the next ‘Apple’. It can be a very volatile sector and investors (and the market) can get overexcited and stocks overvalued very quickly.

“You need a good fund manager who can do thorough research and stick to process and not get carried away. We like AXA Framlington Global Technology and Polar Capital Technology investment trust. For a different type of ‘play’ on this theme you could consider JOHCM Emerging Markets fund as the manager is very keen on tech stocks at the moment.”

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