Managing Risk in Emerging Markets Patricia Perez Coutts, CFA Senior - - PowerPoint PPT Presentation

Global Equity Client Name

Managing Risk in Emerging Markets

CFA Society Montreal: Emerging Markets Luncheon, Feb 4, 2015 For Professional Use Only ‐ Not for Public Distribution 181 Bay Street ● Suite 2450 ● Toronto, ON ● M5J 2T3 ● www.westwoodgroup.com

Patricia Perez‐Coutts, CFA

Senior Vice President and Portfolio Manager, Westwood International Advisors

“All countries are risky; the Emerging Markets are those where this is priced in”

‐ Dr. Jerome Booth

Investor, Economist, and Author*

“All countries are risky; the Emerging Markets are those where this is priced in”

‐ Dr. Jerome Booth

Investor, Economist, and Author*

* Emerging Markets in an Upside Down World: Challenging Perceptions in Asset Allocation and Investment (The Wiley Finance Series), 2014

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I. Defining Risk

• Categories of Risk
• Risk Exposures

II. Managing Risk through Fundamental Analysis

• Our Approach
• Alternative Measures of Risk

III. Stock Examples

WIA Client Service Agenda

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• 1. Loss of Capital – downside risk
• 2. Relative Underperformance (versus benchmark and peers)
• 3. Volatility

Defining Risk

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Market

• Liquidity
• Breadth

Economic

• Macroeconomic environment
• Inflation
• GDP

Political

• Rule of law: rights and freedoms
• System of government
• Stability

Currency

• Balance of payments
• Current account balance
• Capital mobility
• External debt financing

Categories of Risk Short‐term and Long‐term

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Risk Exposures – Endogenous and Exogenous Financial Risks

Equity Markets Interest Rates Exchange Rates Credit Markets Commodity Prices Liquidity Risk

Non-financial Risks

Regulations Legal Taxes Accounting Operations Model

Source: CFA Institute: Risk Management, 2015

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Company

How does a company manage risk for future return potential?

Assessing Risk through Fundamental Analysis

• Qualitative Analysis
• Business model
• Management track record
• Competitive landscape
• Shareholder rights
• Quantitative Analysis
• Financial statements
• Return ratios (ROE, ROIC, CFROI,

etc.)

• Drivers of return: sales growth,
• perating margins, asset turns

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As bottom‐up, fundamental investors, we attempt to incorporate all possible risks into our calculations for COE (Cost of Equity) / WACC (Weighted‐Average Cost of Capital) assumptions.

Our Approach

• Define RFR (Risk‐free rate) – 10yr
• Market Beta
• Equity Risk Premium – CDS spread
• Inflation differential
• Idiosyncratic risk

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• Standard deviation / Variance
• Tracking error
• Sharpe Ratio
• Sortino Ratio
• Downside Capture

Alternative Measures of Risk

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Stock Examples Stock Examples

5 10 15 20 25 30 COE EQRP

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Commercial International Bank of Egypt

Cost of Equity (COE) and Equity Risk Premium (EQRP)

Source: *Bloomberg, Factset, Jan 2015

5 10 15 20 25 30 35 Return on Common Equity 15 30 45 60 Price History (in local currency)

Copa Holdings (Panama)

Weighted Average Cost of Capital (WACC) and Equity Risk Premium (EQRP)

Source: *Bloomberg, Factset, Jan 2015

2 4 6 8 10 12 14 16 WACC EQRP 5 10 15 20 Return on Invested Capital

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50 100 150 200 Price History (in local currency)

Thai Union Frozen

Weighted Average Cost of Capital (WACC) and Equity Risk Premium (EQRP)

Source: *Bloomberg, Factset, Jan 2015

2 4 6 8 10 12 14 Return on Invested Capital 2 4 6 8 10 WACC EQRP

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5 10 15 20 25 Price History (in local currency)

• 1. How do we define Risk?
• 2. Managing risk as investors
• 3. Emerging Markets – past perceptions and misconceptions

Summary

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