In this podcast episode, Paul O'Connor, Head of Investment Management at Netwealth, and Amit Goel, Portfolio Manager at Fidelity International, explore the intricacies of emerging market equities. They discuss the diverse nature of emerging markets, highlighting the differences amongst countries, including varying demographic, social, and evolving economic conditions. They also discuss potentially attractive valuations and emphasise the importance of understanding businesses and effectively managing risks.

Transcript

Paul O'Connor:

Good morning all, and welcome to the Netwealth Portfolio Construction Podcast series. My name's Paul O'Connor and I'm the head of strategy and development of investment options for Netwealth Investments. Today we have Amit Goel from Fidelity International joining us on today's podcast to discuss emerging market equities. Amit is the portfolio manager of the Fidelity Global Emerging Markets Fund. He's based in Singapore, and has 17 years of investment experience. He joined Fidelity in 2006 as a research specialist focusing on the healthcare sector before taking on a broader analyst role in 2008, covering multiple sectors across the Indian equity market.

In 2013, he joined Fidelity's Asian portfolio management team, and in 2014 became responsible for the Asian component of Fidelity's core global emerging markets strategy, and was later appointed as co-portfolio manager. In February, 2020 Amit assumed full portfolio management responsibility of Fidelity's India fund, and then also took over portfolio management responsibilities for the Global Emerging Markets Fund in late May, 2021.
Prior to Fidelity, Amit worked as an analyst at First Global Stockbroking in India. He holds a bachelor of pharmacy from the Delhi University and an MBA from IIT Delhi in India. Given Amit's role as a portfolio manager and analyst of global emerging markets equities, today's podcast will obviously focus on emerging markets. Good morning Amit, and welcome to the Netwealth Portfolio Construction Podcast.

Amit Goel:

Good morning Paul. Great to be here.

Paul O'Connor:

Fidelity International Limited is a privately owned asset manager incorporated in 1969. It is majority owned by management and investment professionals with a balance held by members of the founding family. The manager is separate from the US-based Fidelity Management and Research, with a separate shareholder base and separate business and investment organisations.
Fidelity operates across a global network with research and investment management teams located in all major financial markets, and manages a range of funds covering all regions, industrial sectors, and asset classes. As at April, 2023, the group had US $730 billion of assets under management across all multiple asset classes.
There are 10 fidelity managed funds on the Netwealth Super and IDPS investment menus, covering Australian equities and international equities, including the Fidelity Indian and Global Emerging Markets Funds that Amit is the portfolio manager of.
Australian investors have allocated to emerging market strategies for many years. But the performance of these strategies has varied significantly, which in some part I think is due to the disparate nature of this sub-asset class. And what I mean by this comment really is that emerging markets cover many different regions around the world, including Central and Eastern Europe, Asia and South America. And active managers obviously have varying degrees of resources and skill sets across all of these regions.
Obviously in recent times, geopolitical risks have impacted on returns, and particularly after Russia's invasion of Ukraine. But I'll note that Amit's fund has strongly outperformed the MSCI Emerging Market Index over the last three to seven years. So I'll be interested in understanding what Amit believes has driven this out performance.
Chinese equities have also been a difficult market to outperform, and has been very volatile. So again, I'll be interested in understanding Amit's view on this market and how he thinks about allocating to Chinese equities in the context of the broader emerging markets fund he manages.
Disappointingly emerging markets equities have underperformed developed market equities for the best part of 10 years, but this does not really make sense in my mind given the economic growth potential of these economies versus the developed economies.

In addition, most investment professionals would agree that emerging markets present greater for opportunities for active managers, but are typically more volatile when compared to the large and mega cap equity strategies. So I'll be interested again in discussing with Amit how the Fidelity Emerging Markets Team view and manage risk.

Amit, you're in your 18th year now with Fidelity and ninth year as a portfolio manager, so can you briefly share with listeners your background and experience in emerging market equities and what really attracted you to working as an equity analyst?

Amit Goel:

That's a great question, Paul, to start. As a young kid, I grew up in a middle class family in India. My family and my extended family all were doing some sort of their own businesses, largely trading businesses. The family atmosphere and your extended family ecosystem was always very entrepreneurial. So I think that was basically the source of what you wanted to do.
When I was growing up, my background, I have a medical background in my education, I did my MBA. When I was deciding to think that what should I do now? Should I start a business? Should I join my family business? Extend it? I realised that there are two aspects of businesses. First is a business idea and the capital you need to start the business. So that's the very investment kind of an area. And the second part of the business, which is very important, is also being very important and excellent in the operations part of the business.
So you need to be a very strong person in both those parts. And I realised that there are much better people who have operational excellence than me, the ability towards investment management, and obviously you always start as a research analyst in this area, which kind of gives you experience to invest as a portfolio. So I think I always now believe that investment research, investment management, being an analyst, being a portfolio manager is actually a true form of entrepreneurship.
In this area I'm choosing the business model where I want to invest. I'm choosing the amount of capital I want to put in, but more importantly, I'm also choosing the people I want to run this business. I'm choosing every part which is required for any business where I think I don't have the skillset and I'm choosing the best person to do that part. I think I'm good at allocating capital, I'm good at identifying business idea, but I'm choosing the right people, right management team to run that business for me.
And I think that for me was the biggest kick to come into this area. As you said, I've now 17, 18 years of experience, this area presents a strong opportunity for you to learn and become a better investor, a better human being as you go along.
I joined the industry as a 25-year-old graduate. I don't see there's any other area of field where a 25-year-old graduate on day one of his job can start to learn from 20, 30, 40 year of experience of colleagues who have seen this area and managed money. Plus also learn from CEOs and CFOs of large corporations who are willing to spend time with you in the first year of your job. I think that's completely unparalleled in this area, which has given me so much opportunity to learn as an investor, as a human being.

Paul O'Connor:

No, I can certainly appreciate your comments there, Amit, because at times I've felt over my investment career fortunate to be able to, I guess intimately get under the bonnet of different businesses and very large and successful businesses, and really to understand what's driven that success. So I think at many times it's a fortunate position that we all work in.
But no, an interesting journey from you, from considering working in the family business, through to doing a pharmacy degree, and then moving into investment management. But I guess it all makes sense there.
Moving into the questions today, can you summarise the last 12 months in emerging markets, and what is your outlook over the next 12 months, thinking geopolitical risk, inflation, potential for a significant global GDP growth slowdown all appear as challenges. So how are you navigating these risks and positioning your portfolio at present?

Amit Goel:

When it comes to emerging markets it has always been looked as in higher growth, higher volatility, higher risk asset class. I think there are a few right things about that perception and few misconception about that view. If you look at last 12, 15 months, you really have to break down emerging markets into different parts. As you rightly said in your opening remark, it's a very heterogeneous asset class. If you look at last 15 months, obviously emerging markets have been more volatile than other parts of global equities, but a large source of that volatility has come from just one market, which is China.
If you start from early 2022, for the first 10 months of last year, emerging markets went down about 30% versus global markets down 20%. But China within emerging market was down 50%, and China is 35% of emerging markets. So a large part of that decline of emerging market index in the first 10 months came from China. Outside China, emerging markets were actually doing much better than even global equities.
Then you see this period of January, December, November, the three months, which is again, a period where nobody expected China to reopen, give up its zero-covid policy, sentiments were very negative after the party congress in October, and China thought this short recovery; Chinese index went up 50%, emerging market went up 15 versus global markets went up five.
On the way up, it was all driven by China. If you add over these two periods, the first 10 months of 2022 and the three, four months after that in China reopening, emerging markets in generally has been in line with global equities, with all the volatility being driven by China. So I think what you see across emerging markets over the periods that some of these single blocks or different parts of emerging markets tend to behave very differently.
And to me that's a long-term source of volatility. But for active managers that's also a long-term source of opportunity for us. It's a very heterogeneous asset class, we can pick and choose to be in the right part of that emerging market, both from a medium-term perspective and from a long-term perspective. So I think this volatility, we always embrace this volatility and that's been a very important part of my philosophy as well.
On your questions on how do we navigate this risk, I think the only way to navigate these risks are first understand what do you own. So we spend a lot of time in understanding our businesses. Every business that sits in the portfolio, it is so essential for us to understand the business model, the people behind the businesses, their long-term competitiveness, why it can sustain.
So I think the only way for any investor to protect wealth for their clients is to make sure that they understand what they're doing. So we trying to understand a lot of our businesses deep down as much possible as we can. And then just to be aware of the risk that you take if you are in parts like China, if geopolitical risk is rising, regulatory risk is rising, are you putting in the right cost of capital for the risk you are taking in assets? I gave you an example of Russia, our fund was underweight Russia, so we did not government of Russia, our fund was underweight in Russia, so we did not lose money in Russia. But it was not that because we were anticipating an invasion from Russia into UK. It was just the fact that our barriers to entry in the market like Russia were very high because we were putting a very high country risk premium. So I think the way we navigate risk is to make sure that we understand our business. And then depending on the macro risk, we put the right cost of capital and the right risk premium on any country or region or company that we invest in.

Paul O'Connor:

So the performance of the MSCI Emerging Markets index has fallen well short of the MSCI World Index over the last decade. So can you talk through the key reasons why and what provides you with confidence that the next 10 years will generate better relative returns for investors in emerging markets?

Amit Goel:

Over the last 10 years, the performance of Emerging Markets Index has been disappointing versus global equities. And given the fact that investors have this perception that emerging market is a higher growth asset class, so that should result into higher returns as well. When you buy any asset, that might be equity bonds, real estate or anything else, there are three fundamental drivers of returns for us in medium to long term. The first underlying driver is what is the underlying growth of that asset class? And I think if you see the last 10 years, the underlying economic growth of emerging markets have been roughly 2% higher than global markets. And I would tend to believe that even in the next 10, 15 years, even when China is slowing down from a high single digit growth rate to low, mid, single digit growth rate, India will continue to grow at I think mid to high single digit growth rate.
The differential growth would still remain at about two odd percent. So I think that's where things are not changing. But the second important part of any asset class returns is also do you have the right set of businesses to reflect that underlying growth? And I think that's where the index had issues in last five, 10, 15 years. If you start from 2010, a large part of global Emerging Markets Index was driven by companies like financials, especially Chinese financials or North Asian financials, utilities, materials, commodities and less technology, less consumer, which are actually multiple higher growth businesses. So you started from an index which was very heavily geared towards traditional businesses, which has continued to see a linear decline or very rapid growth versus the underlying economies. So I think that was a change. And also the fact that a good part of this underlying growth in emerging market was also captured by global companies.
If you see how global companies have done businesses in China in large part of big areas like consumer technology, the high-end industry, it was all global companies kind of taking market share. In India, what is the biggest E-commerce company? It's Amazon and Flipkart which is owned by Walmart, which is the biggest advertisement company. It's Google, Facebook, the biggest IT companies, Microsoft. So a large part of that good growth was actually captured by global companies. So I think the value was shifting there and the Emerging Markets Index was all made up of these traditional businesses which were growing slower. And that's where you see a huge differential in ROI as well where emerging market ROIs continues to be at low teens, 11, 12, 13% and continues to be weaker. So I think what I see now is a bit of positive incremental change in that part. I think now you start to see emergence of strong domestic businesses in emerging markets.
In China you have strong industrial businesses, strong technology businesses, strong consumer businesses, local brands which are gaining market share from global companies. And I see similar trend in a market like India. So I think and lastly, for the first time you have started to see global technology majors coming from Asia as well. You have TSMC which at its most competitive position in the history and the most competitive foundry business. You have Fabless chip manufacturers coming in Asia. You have semiconductor companies like Samsung, SK Hynix, which are very competitive in memory. So I think if you add technology and consumer, you started to see more competitive businesses coming out of Asia and in emerging markets. And I think that's a positive incremental driver of value which I see in the next five to 10 years.
And the last more important point is the price you pay for any asset class. If you start from 10 years back, you were buying emerging market at its highest point in terms of valuations both on absolute and relative basis. Looking today, you are buying emerging market at its lowest absolute and relative valuation versus global markets. So if you add these three things, continue differential in economic growth which is positive with better set of businesses to get the benefit of that economic growth, plus relatively better valuation framework today. So I think if you add all these three things, I'm fairly optimistic on the risk adjusted returns on emerging market over the next five, seven years.

Paul O'Connor:

I mentioned in my opening that emerging market equities is a disparate sub-asset class. And you've made reference to this already in some of your comments, Ahmed, the evidence suggests that the 24 countries comprising EM indexes are very different with most different points in their demographic, social and economic evolution. Can you share some observations on these points, including the different drivers of economic growth across these countries? And I'm assuming also that they typically, whilst the developed world and western economies are quite in sync with the economic cycle, I'm assuming that the countries in the emerging markets at varying stages help the economic cycle which provides you with opportunity. And again, you mentioned that earlier in terms of looking at companies, but also looking at the various stages of economic development growth and where those countries are at in the cycle.

Amit Goel:

That's absolutely to me the most positive case about emerging markets. It's a very heterogeneous, disparate asset class for active managers that gives an opportunity to really choose and pick the right set of businesses in the right ecosystems. If I give you examples, you have North Asia which is more like developed part of emerging markets. You have China, which is now more than $10,000 GDP per capita, you have Korea, Taiwan, even over and above that. At the same time you have South Asia, which is largely stock in a kind of mid-income, four, five, $6,000 GDP per capita economies. And then you have countries outside Asia where GDP per capita may be higher in parts like Brazil, et cetera. But the long-term trend in growth, political volatility, social volatility, inequality is very high. So the demographics, the social aspects, the political aspects are so different across emerging markets.
In my view, that's the biggest part of a population that we can have in emerging markets. So if I give you an example, if you look at China, we can all talk about the geopolitical issues or medium to long-term. We can always talk about what's happening in domestic politics on regulatory front. But it is also very clear that China is now becoming a mid to high income country with a very large population which is premiumizing. If you think about high income group or high income consumer in China, which kind of we are classifying as someone who is earning more than $25,000 disposable income every year, that number sits today at about 100 million Chinese consumers. That number in 10 years time could be somewhere between 200 and 300 million, which means that you are going to have a consumption class which is as large as US sitting within China.
I think that's the biggest change that you will see in terms of consumer markets in the world. A large part of global consumption becomes cyclical, especially on the discretionary space of how US is behaving. Chinese consumer will become as large and as important as US consumer is. So I think you have to focus on what these wealthy Chinese consumers are going to buy as product and services. What are their aspirations? What brand do they like? At the same time the country's ageing. The median age today is 37, 38 years. It's going to be in mid-40s in 10 years time. So what does this ageing mean? Different cohorts of demographics. So I think that's the most important point in a country which is premiumizing as well as ageing. So it's a very different scenario versus if you look at India now. India is a huge middle class.
If I think about kind of the mass premium segment, the upper end of the Indian middle class, we are again talking about 100 million households which are earning about $5,000 GDP per capita. That 100 million households will move into higher end of income bracket. They're from $5,000, they're going to $10,000 in next five to seven years. So we need to now focus on what this emerging middle class or upper middle class in India is going to use as product and services. What you saw in China last 20 years is probably going to repeat in the India next 10, 20 years. If you look at India now versus China, you have a huge middle class which is going to grow from roughly $5,000 GDP per capita to 10,000 GDP per capita over the next five, seven years. And they will start use products like autos, white goods, consumer credit where penetration is single digit in India.
So we have to focus on these areas because these areas are very simple to understand that for families premiumizing from $5,000 to $10,000, these are exactly the product and services they're going to use and buy. So very different dynamics in two very different countries. Similarly, if you go out of Asia, you have huge world volatility across economies in South Africa, in Brazil. But there are some very specific, very competitive businesses which are gaining market share, especially in the digital space. So we get to focus on those. So I think it's, again, very different dynamics across countries and for us that's an opportunity to invest in emerging markets.

Paul O'Connor:

So how are emerging markets and emerging market companies position should we head into a global economic downturn next year?

Amit Goel:

If you think about a potential global economic downturn... And I think in my view there are always already signs of slowing down consumption. We have seen the pressure on banking system in the US, so there are clearly obvious signs. I'm not sure whether we are heading into a deeper recession or it's a technical recession, but there's a clearly economic slowdown which we are entering into. And I believe that contrary to what emerging markets are expected to behave, they're better positioned entering into this downturn. If you always see that whenever global economies enters into downturn, especially the large Western economies, there's always a kind of risk perception around emerging markets that they will have impact on currencies. They will have impact on current accounts, given they already carry negative current accounts in most of the cases. We always worry about the fragility of the financial systems in emerging market both at a country level as well as a large financial system and company levels.
I think if you look at this time, it seems that a large part of emerging markets have learned their lessons and they're better positioned going into this downturn economically. First if you think about interest rate and inflation, it's a bigger problem outside emerging markets. Inflation again is a very different number in different parts of emerging markets. In North Asia, China, Korea, Taiwan, we are still talking about low single digit inflation. South Asia we are talking about mid-single digit inflation. Outside Asia inflation was double-digit last year. It's coming down again in Brazil, in South Africa, et cetera. But very importantly, what has happened this time is that all emerging markets have been more proactive on interest rates. Most of the emerging markets today are kept. more proactive on interest rates. Most of the emerging markets today are carrying positive real rates. So they're not anchored to a 12 month inflation number. They're carrying positive real rates. Today, they have been ahead on interest rate curve. For example, in places like Brazil where inflation has actually come down from double digit to five now, they're still carrying rates at about 14%. So emerging markets are not even trying to front run Fed on cutting rates, but given they're carrying positive real rates, inflation is, in general lower and plateauing and coming down. They have a lot of flexibility on rate cuts and monetary policies whenever Fed starts to pause and start cutting rates. So I think going into this crisis, yes you will always have this risk perception against emerging markets. You will always see some pressure on their current accounts, given the export discretionary items into developed markets. But if you think about inflation, if you think about interest rates, if you think about current account deficits, which is much better across emerging markets versus their history, I think they're better positioned going into this downturn.

Paul O'Connor:

Am I also correct in saying, Amit, that a large portion of their debt is now funded or has been issued in local currencies so they don't have that US currency risks that they may have experienced in the 1990s?

Amit Goel:

Yeah, so that's the case as well. They have learned their lessons from '97 Asian financial crisis. They were more volatile in GFC, so a large part of government liabilities and a large part of corporate liabilities are locally funded across emerging markets. So I mean, I don't have the exact number at the top of my mind, but the external liability risk is significantly lower than what you have seen in the history.

Paul O'Connor:

I think there's around 1400 companies represented in the MSCI Emerging Markets Index. So can you talk us through how you end up in your portfolio with 40 emerging market companies, how do you distil that universe down and how do you withholding 40 companies, keep the portfolio diversified by country and industry sector?

Amit Goel:

That's what the philosophy is, Paul. So if you think about our portfolio, and if you ask me to explain the portfolio philosophy in a simple line, I would say our objective is to create a focus portfolio of the best quality companies that we see in emerging markets, but more importantly companies that we understand and companies that we can own for longer duration. So when you think of quality, I think that's one level of filtration in our portfolio, which takes down our portfolio from this large fragmented benchmark of more than 1,000 companies, I would say to about 200 odd companies. And that quality lens has three very important sub-lenses or sub-layers. I mean for us, there are three important characteristics of quality. First, very important part is quality of people. If you think about emerging markets, you again, very different parts of emerging market with different management qualities.
But in general there are a lot of businesses which are still family owned, first generation, second generation. So there is a majority shareholder. The boards are not super professionals. A large part of emerging market business are also government owned, especially in the fixed asset space. In general, we put a lot of emphasis on being aligned with the right set of people who we can trust in their integrity, in their honesty, in their capital allocation, governance, operational excellence. And again, it's a journey. I mean you will never know about people in a month time or in a year time. So we tend to spend time with our businesses over 5, 10 years. And I still learn on businesses which I have been owning for 10 years and every quarter I learn more about them. So for us, quality of people, trust in people, management team, their incentive structure, how they're aligned with minority shareholder is very important. So that take us down to a lesser number of companies.
The second important part of quality for us is market leadership potential of our companies. So we really want to invest behind market leaders and potential market leaders in respective sectors and countries. These companies have very sustainable competitive advantages, whether we are talking about brand technology or scale and we spend a lot of time to understand why these companies have these sustainable competitive advantages and will that change in future? So 90% of my time is again, spend on understanding these businesses deep down along with my large analyst team, which support us. That's why this portfolio always have a very differentiated return on capital employed, return on equity profile, much, much higher than the benchmark. So that again, takes us down to a lower number of companies.
And lastly, we are not investing top down in emerging market as an asset class. We are again choosing specific parts of emerging market where we are think the underlying growth in sectors or sub-segments are faster than the underlying economies. I mean, I talked to you about Chinese upper class, wealthy Chinese consumers. I talked about the growing upper-middle class in India. So I can talk about some of the technology businesses in Taiwan and Korea, which we want to buy into. So these are very specific parts of emerging markets where we believe that the long-term structural growth is faster than the underlying economies or the overall emerging markets. So if you combine all these three, I think we get to about 200 companies and we tend to learn more and more about them.
And then the last step in our process is our valuation discipline. We are investing in quality, we are investing in growth. These companies tend to be expensive most of the time, they're tend to be momentum and we want to make sure that we pay right price for the businesses that we buy, which means that first we need to understand them, understand their long-term earning power, and then once we understand that, we should put a more reasonable expectation, reasonable multiples to them to cut to target prices, which should give us about double digit absolute return on a portfolio for our clients.
So once you combine these quality characteristics and the valuation discipline we want to have in our philosophy, we get to this 30, 40, 50 numbers. I mean it's an outcome for us. We don't design a portfolio that we only want to own 40 companies, but with all these criteria around our philosophy and we tend to be very disciplined on that, that takes us to that number.

Paul O'Connor:

So Amit, can you talk us through a company you own that's done well for the portfolio and then perhaps another company that hasn't done so well but you are still holding it? And I guess it must be hard maintaining your conviction in a company that's underperforming and the market's trying to tell you otherwise.

Amit Goel:

That's always the case. I mean, you will always have companies which are doing well in the portfolio and you still believe in them. You will always have companies which are not doing well, but you still believe in them. And then you will have companies which are not doing well and your conviction is getting lower. So I mean we tend to make sure that we have more companies in our portfolio where we believe in them and they're doing well, but even if they're not doing well, we tend to make sure that we have enough understanding knowledge so that we can still own them. And you make a lot of money in companies where market is either wrong or very short-term focus versus your own duration. So you actually make more money in companies where your conviction is high, you believe it'll work in long-term and actually market is thinking the other way around.
So I think that's always the case in the portfolio. If you ask examples, I mean we own one of the largest private sector bank in India HDFC Bank and that stock has been sitting in the portfolio since day one. It has added a lot of value to the portfolio. The company continues to be the best underwriting and the best liability franchise in a high growth economy like India. Very much consumer focused. They always think countercyclical when they're underwriting and because they have such a great liability franchise, it gives them ability to underwrite the best credit in the country as well. It's a 18% to 20% ROE bank and has been compounding at that rate. So largely self-funded. It has shown a very differentiated underwriting profile versus the rest of the country. I mean at a time when non-performing loans go up double digit as a financial system, this bank has always been in less than 1-1.5% non-performing loans.
So it's a bank with a high growth underlying economy, but very non-cyclical returns, behaves like a consumer company while it is in banks. So it has done well. But I think even at this stage when it is one of the largest financial company in emerging markets, the opportunity it set for next 10, 15 years is still very strong. I mean, you have consumer credit in India, which can keep on growing at a double digit when the nominal growth in the economy itself is about 10%. You have a self-funded institution which is driven by quality of people, quality of processes, and still trade at very reasonable prices. I mean, it's a consensus buy for everyone, but for us it's a large position in the portfolio and we don't trade around these stocks. So I think that's our differentiation to have a long duration view. So that's the one stock which we can talk about, which has done well and we continue to have high conviction to own it.
I mean the second stock, which I want to talk about, which I still have a very good conviction, but hasn't done well in last 12, 15 months though it has been okay over the last three to five years. I mean, we own a dairy company in China called China Mengniu Dairy. I mean I think dairy market is continue to premiumize as we talk about premiumizing Chinese consumer. It's also tied up to health, nutrition. And if you think about this company called China Mengniu Dairy, they have continued to gain market share in the Chinese milk space. They're selling more premium milk, they're selling more fresh milk, they're moving into areas like cheese. They're doing well on ice creams, they're talking about adult nutrition now as China is ageing.
What has happened in last 12, 15 months that because of Covid, the demand was lower than expected. So they were expected to grow 10% last year, they grew 5-6. And then on a reopening in China in 2023, market expected that the demand will bounce back to double digit. But they came out with their results in March and they said that we actually, we are going to grow high single digit in 2022 because quarter one has been weak because China was still coming out of Covid. I think market de-rated that stop from about mid 20s price to earnings to now mid teens price to earnings. For us, it now becomes one of the cheapest staple available in emerging markets. I still think that the underlying growth of the economy and the segment is high single digit to 10% with premiumization, higher margins. And this company is rightly focused on the right growth drivers within that segment. The free cashflow generation should improve and we are expecting the capital allocation also to improve in future.
I mean, this is a company which actually bought one of the Australian milk powder business called Bellamy's, which they have not been able to integrate in last two, three years during Covid. So that has been a mishap on capital allocation, but we believe that the underlying growth remains strong. The company focus on the right areas remains strong and capital allocation should improve from here. We are getting the stock at about 40% lower valuation versus it was trading two years back. So this is one stock where we continue to remain highly convinced, and actually it is now available at lower prices, so we've been buying more.

Paul O'Connor:

A key takeout of your comments here, Amit, is that to the patient, longer term investor, equity markets can be patient, longer-term investor equity markets can be rewarding, but they can be very volatile and mis-priced in the shorter term, so it's a longer term play. Australian investors typically think about Asia and China when considering emerging markets, but what about other regions that we've touched on earlier and maybe Latin America and South Africa and Poland? Do you hold stocks in any of these countries or regions?

Amit Goel:

We do own stocks outside Asia: we own companies in Brazil, we own companies in South Africa, we own companies in Mexico. So when you think about markets outside Asia, there are two, I think differentiating aspects, which I believe are important to understand. First, a lot of countries outside Asia, are generally low-trend growth countries. If you think about large economies outside Asia, we are talking about Brazil, which is one of the largest outside Asia, Mexico, South Africa, Saudi Arabia is now one of the largest countries outside Asia in emerging markets as well. The general trend growth is low single digit, versus you can still think about China at 4%, 5%, and you're at 6%, 7%, Indonesia at 4%, 5%, so you're talking about lower long-term trend growth. And also, you're talking about the higher volatility of GDPs. Brazil for example, the last five years, six or seven years would've would've negative years, positive years.
So you're having long-term time growth with higher volatility, which means that you need to put those numbers into your valuation models when you value those companies. And when you start to put higher volatility, higher country risk premium, lower growth, you need to be very selective on the businesses that you want to buy and the value you want to pay for those businesses. So that holds true for our philosophy: we are very selective in the kinds of businesses that we want to own, they need to be very competitive, and we need to get them at the right price. So, I think when you talked about how we get to 40 stocks from 1,000 stock plus benchmark, that stock selection becomes even more important outside Asia.
If I give an example, we own a company called Localiza in Brazil, which is the largest car rental business in the country. They buy about 15% of every car sold in Brazil every year. They have massive scale advantage versus mom and pop businesses and retail individual customers on both cost of financing, but as well as the cost of car. So, it's a business which is very competitive in a tough macro environment. We are buying a great business with very strong long-term growth as car ownership shifts from ownership to rental in Brazil. But we are still very selective in our valuation framework as well on this business. So, we like some of these businesses which we think are structured long-term growth businesses in different economies, but we are selective on valuations. Another example, we bought one of the airports in Mexico: air traffic in Mexico is growing 10%, they're always worried about the regulatory aspect of it, but in general it has been more stable than market perception. This is a company with a diversified set of airports, both commercial as well as leisure travel-focused.
And Mexico is one area where we continue to see this whole de-globalisation and China plus one strategy adding to more projects on the ground in Mexico, so the airport should benefit from more commercial travel as well. It trades at about 15 times earnings, gives us 5%, 6%, dividend yield growth of 10% to 15%. So, some of these businesses where we see there still can be double-digit structural growth, valuations are very reasonable: these are the opportunities for us, but there are fewer than what you will see in Asia.

Paul O'Connor:

You've mentioned about the maturing of emerging market economies, and the growth of the middle class consumer, and the growth of local domestic companies listed on the various stock markets, so is it still a fair comment or perception to think that EM equities are riskier than developed market equities? And how do you think about risk management in the context of your overall portfolio?

Amit Goel:

When it comes to risk management, the biggest risk in your portfolio is the downside risk in each and every stock that you own in the portfolio. And that downside risk comes from you buying the wrong company with the wrong fundamentals, and you buying that company at the wrong price. And that's what we focus on: for us, we don't invest into businesses where we think we don't have knowledge or differentiation. Even when we are buying, we think it's a great business, but we have only spent three, six months on that business, we start from a lower position size. And as we gain understanding knowledge and condition that business, we tend to increase our position size. So I think for us, portfolio construction, understanding of our businesses and the price we pay for our business are the biggest drivers of risk management. That's one area.
Second area, you talk about volatility as well as always issues with regulations, currencies. Even management quality, we tend to focus a lot on that, but there are some areas which are grey in nature. I think what we also make sure in our portfolio construction is that while we are running a concentrated portfolio in a more fragmented and large emerging market, we are not betting the house or the portfolio on a few stocks. The portfolio construction is very diversified while learning accounts portfolio. We tend to make sure that we don't want our portfolio returns to come from one or two companies. We want the philosophy and the process to work, so the returns that you have seen and that you mentioned on a three year, five year, seven year basis, you will see that the contribution to performance is very diversified, and across a number of names.
So it's not two, three, four, five companies which has driven all the returns: it's 15, 20 companies which have driven the returns for us. There's no single company which is more than 5% active weight or 8% absolute weight in the portfolio, there's no single company in the portfolio which is a double-digit contributor to risk in the portfolio. So while we have an unconsolidated portfolio, we are diversified risk and position sizing at a portfolio level, and I think it's a combination of our business understanding, our valuation discipline, and this diversified portfolio construction that adds a lot of risk management to our portfolio in a volatile environment.

Paul O'Connor:

Maybe just to finish with, Amit: emerging market equities at the stage where you could potentially consider managing an ESG EM equities portfolio?

Amit Goel:

When it comes to ESG, if you think about our philosophy, our process, ESG is deeply integrated to Intuit. In my view, the basic principle that we have on ESG is that our companies should be looking to make a positive impact on ES and G, all characteristics. It is not about excluding certain businesses which are carbon intensive in nature, which are labour-intensive in nature because you have ESG risk on those companies, it is about, are they improving and are they essential for the growth of those economies? If I give you an example, if you look at India, which is still at an early stage of development on infrastructure on housing, you would need materials like steel and cement, which are highly polluting building material products. They're emitting 600, 700 kilogrammes of carbon per tonne of production, but a country like India will need it. India will need power. It's a very energy-intensive development that we are going to have in the next five, 10 years.
So, we have businesses which are actually producing these building materials, but they are still benchmarking themselves on global benchmarks, on carbon intensity, and they actually have science-based targets of improvement. So for us, that is a positive impact. Do we have companies which are employing tens of thousands of people, but they care about their employees, they make sure that there's no modern slavery in their value chain? So, I think these are opportunity for us.
If I think about emerging markets, they're still behind on that ESG evolution, they're still capturing data from their supply chain on carbon intensity, they're still on early stage of auditing all their suppliers, they're still on early stage on governance, on independence of boards, but I do see positive directions and that's what we focus on. We engage with our companies very deeply on sustainability with a view that they should move into positive direction, they should add positive impact on society, on environment, and I think through that, we can have a positive impact on our portfolio as well.

Paul O'Connor:

Amit, thank you very much for joining us today on Netwealth's Portfolio Construction podcast. I always find it fascinating discussing EM equities and you always learn something and I guess the comments you had made earlier around the disparate nature of the whole asset class does make it very interesting, the different geographical regions, the different areas of economic development. But I think the one constant theme that throws up is the longer term economic growth does equate to a longer term investment opportunity within a diversified portfolio. So, I think the listeners will have got so much out of your comments, your insights, and expertise in this market. So, thank you very much for joining us again there, Amit.

Amit Goel:

Thanks, Paul. I think it was a great discussion, and I really enjoyed it as well.

Paul O'Connor:

To the listener, thank you again for joining us on the Netwealth Portfolio Construction podcast series. I hope you enjoyed the discussion with Amit as much as I have on emerging market equities, and have a great day. I'll look forward to you joining us on the next instalment of the podcast series.