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A focus on value can guard against the rising risk of ‘crowded trades’

Increased interest in any part of the market will be accompanied by increased prices and so it follows that a focus on valuation should help protect investors against the resurgent dangers of the crowded trade

24/09/2019

Juan Torres Rodriguez

Juan Torres Rodriguez

Research Analyst, Equity Value

One intriguing aspect of Vietnam’s burgeoning appeal to professional investors who focus on the world’s emerging markets is that, technically, it isn’t one. Look for it, say, among the 26 countries that comprise the widely followed MSCI Emerging Markets index – market capitalisation: $5.3 trillion (£4.2 trillion) – which includes the likes of China, India, Mexico, Russia, South Africa and Turkey, and you will look in vain.

You will instead find Vietnam grouped with countries such as Bahrain and Burkina Faso, Slovenia and Sri Lanka in the much smaller MSCI Frontier Markets index – market capitalisation: $104bn – which makes it all the more surprising to learn that one-fifth (19.7%) of all emerging market equity funds now hold Vietnamese stocks, according to data from Copley Fund Research, quoted in this Financial Times article.

That is three times the level of five years ago, adds the FT, before suggesting this enthusiasm stems from the view Vietnam has been a significant winner from the US-China trade war, as companies relocate there to escape “ever-deepening trade tariffs”. Other attractions cited in the piece include Vietnam’s location, young demographics, cheap workforce and “strong single-party rule that can get things done”.

These of course are all the kinds of broader economic arguments we strive to tune out, here on The Value Perspective. What does tend to attract our attention, however, is when money starts to concentrate in a particular area – which would certainly appear to be the case when a fifth of all emerging market funds can boast exposure to an economy as small as Vietnam.

To put things in perspective, the MSCI Vietnam index has just 16 constituents, with a combined market capitalisation of $19.3bn, and the largest three – a dairy company and two real estate businesses – account for well over half of that entire benchmark. As an added consideration, there are restrictions on foreign ownership of individual stocks, which means overseas investors often have to buy into them at a premium.

Most pertinently for us, here on The Value Perspective, where valuation is of course the key consideration, increased interest in any asset means increased prices and, as the following chart shows, average valuations in Vietnam, as measured by the cyclically-adjusted price/earnings ratio or ‘CAPE’, stand at 18.3x – towards the upper end of their range in the last decade. Some of the largest individual businesses are significantly higher.

CAPE.jpg

Now, some or all of those broader economic arguments mentioned above may well turn out to have some long-term foundation – and thus the current investor optimism and consequent higher valuations may, in retrospect, come to be seen as justified. Or they may not. The point of this article is not valuations – or indeed Vietnam – but the dangers of investors focusing their attention and their cash on ever more specific areas.

This trend for ‘crowded trades’ is by no means restricted to emerging markets – as our next chart, relating to large US companies, illustrates. Taken from a Bank of America Merrill Lynch study, it appeared in this Wall Street Journal article, which noted: “Investors are favoring fewer stocks, making for more ‘crowded trades’

 The overlap in the top 50 stockholdings between mutual funds and hedge funds – two types of investors whose styles typically differ – now stands at near-record levels.”

popular-picks.jpg

The history of investing is littered with examples of the risks associated with more and more money chasing fewer and fewer assets – with the technology bubble of almost 20 years ago only the most prominent. As we noted earlier, however, increased interest in any part of the market will be accompanied by increased prices and so it follows that a focus on valuation should help protect investors against the resurgent dangers of the crowded trade.

Author

Juan Torres Rodriguez

Juan Torres Rodriguez

Research Analyst, Equity Value

I joined Schroders in January 2017 as a member of the Global Value Investment team. Prior to joining Schroders I worked for the Global Emerging Markets value and income funds at Pictet Asset Management with responsibility over different sectors, among those Consumer, Telecoms and Utilities. Before joining Pictet I was a member of the Customs Solution Group at HOLT Credit Suisse.  

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