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Life beyond lockdown: how the coronavirus will accelerate existing global trends

  • Aoifinn Devitt

    Head of Investment Ireland, International

  • Kunjal Gala

    Portfolio Manager

  • Steve Chiavarone

    Equity Strategist

Aoifinn Devitt, head of investment – Ireland, moderates a discussion with Kunjal Gala, co-portfolio manager on the Global Emerging Markets team, and Steve Chiavarone, portfolio manager and equity strategist.

Time Transcript
00:04 Aoifinn Devitt: How will the Coronavirus change the way we live, and therefore the business landscape?
00:09 Speaker: Hello and welcome to Hear and Now podcast, from Federated Hermes.
00:13 Aoifinn: I’m Aoifinn Devitt, Head of Investment Ireland at the firm. In these unprecedented times, I’m coming to you from my home in Dublin, not our usual studio in London, so please bear with us if there are any sound quality issues.
00:27 Aoifinn: Today, it seems, there is an element of hope coursing it’s way through equity markets. We have seen the very beginning of some reopening across some economies in Europe. It is, I would say, a very tentative reopening at this stage. There is also some early indicators that some of the data on the Coronavirus and its spread are somewhat positive. There does seem to be a flattening of the numbers of cases, as well as a flattening of the number of deaths. Markets are certainly taking this as an indicator that now is the time to be somewhat more optimistic.
00:59 Aoifinn: Joining the conversation today is Kunjal Gala, Co-Portfolio Manager on our Global Emerging Markets Team. Later on, we’ll be joined by Steve Chiavarone from Federated Hermes, Inc., as he provides his perspective from New York City. Welcome, Kunjal. Thank you for joining me here today.
01:15 Kunjal Gala: Hi, thank you very much for having me.
01:16 Aoifinn: That’s great. Well, clearly, Kunjal, you are, being engaged in emerging markets, you have probably seen the very earliest indicators of the effect of Coronavirus as it was, of course, in China where the virus first had its impact. Before we launch in, however, to the effect that you believe this will have longterm on the region, and on some of the sectors, and some of their prospects, I’d love to get a little bit of detail about your personal journey into investing. Can you just talk us through how you ended up now as co-portfolio manager of a global emerging markets team?
01:49 Kunjal: Yes, sure. I’m happy to do that. I joined back in 2012, so it’s been almost eight years working with the emerging markets fund. Prior to that, I spent several years working with Her Majesty’s Treasury here in the UK. That was an interesting time. That was during 2008 onwards, when the world was coming out of the global financial crisis. I worked the with the treasury’s investments team, focusing on a number of aspects to support the economy, and also support the austerity measures that were put in place later on.
02:30 Kunjal: Prior to that, I spent several years working on the sell side, covering the global consumer sector, initially from Mumbai, and then later on from London. This was primarily from a corporate finance, mergers and acquisitions perspective. Before that, I worked with PricewaterhouseCoopers in India, where I was part of the assurance and business advisory services team, mainly focusing on assurance and audit practices of the firm.
03:04 Kunjal: Before that, while I was pursuing my graduate degree, I interned at a boutique equity research firm in India in the late ’90s. That was my first ever experience of looking at companies, doing financial analysis, looking at markets, meeting companies, et cetera. From there on, my journey started, first, to understand how the world actually works, how companies actually work, how financial statements are engineered, how governments work, how strategies are being made.
03:42 Kunjal: Then, when I felt I was ready to take on the more direct approach to investing, I joined Hermes in 2012. Initially, I joined as an analyst, focusing on Asia. And then, subsequently, around four years ago, became the co-portfolio manager on our UCITS fund, and then subsequently on the small midcap, and also on a few of our segregated mandates. That’s my journey in a nutshell.
04:13 Aoifinn: I think it’s very interesting, because clearly, as we sit here in the middle of this crisis, you’ve had many different hats, and you sat, maybe, around the table in many different seats. It certainly seems to me that as we tackle with this crisis and look at some of the potential fallout and the solutions to it, it will require a level of cooperation between many of these different seats. We’re going to need corporate insiders; we’re going to need some government stakeholders, as well as some big companies themselves working with politicians. So you certainly seem to have seen many different angles there.
04:47 Aoifinn: What perspective do you think that brings to this particular state that we’re in right now, having seen how companies deal with crisis, as well as how, perhaps, the civil service will respond?
05:00 Kunjal: Yeah, no, it is interesting because all stakeholders will have a different way of looking at things, and for us… and it has implications for us as well, as fund managers, portfolio managers, and investment analysts, because whatever other people do, we are here to evaluate those decisions and ultimately make some forecasts as to where some of the countries and economies are going to go, how certain sectors are going to evolve, and how certain companies are going to behave.
05:30 Kunjal: Let me give you some perspectives. During the global financial crisis while I was working for Her Majesty’s Treasury in their investment’s team, that was, I would say at the time, the crisis was at its peak. A number of financial institutions and banks in the UK had to be bailed out. At the same time, private sector was also crying for help. They needed bailout themselves. Airlines, in particular, some automotive companies, in particular, needed funding. At the same time, the focus of the government was not just saying, okay, let’s relieve some of these entities from stress, but how do we promote economic activity, how do we promote job creation, where should we deploy capital so that skilled jobs are being created? At some point, the conversation shifted saying, okay, we’ve spent a lot of money now. We now end up with a large deficit, so how do we reduce deficit? And then the austerity starts. I’ve seen that journey. Now, here we are with another crisis. Although, it’s quite different from the previous ones.
06:39 Aoifinn: And we certainly will later delve into some of the longterm changes that the Coronavirus pandemic will create across industries as you see it, but before that, I’d like to just drill down a little bit into EM versus DM, or emerging markets versus developed markets. You mentioned the pace at which both the government sectors, as well as companies respond to challenges. Can we talk about how emerging markets have responded to this challenge, the speed at which they’ve done so? Has it been uniform across emerging markets?
07:08 Aoifinn: We think always of Asia as really setting the standard for how the Coronavirus reaction should’ve been, the speed and the universality of the response, and perhaps, we could say, in Asia they had kind of a dry run with this with SARS in 2003, that there society’s already conditioned, perhaps, to social distancing and to behaving in this way. I think sometimes I tend to forget anyway that your Regulation of Energy Market Integrity and Transparency (REMIT) and emerging markets also includes all of Latin America, as well as Middle East, and have those countries responded in a timely fashion, or are they behind the curve? Will they even, if they want to, be able to impose the kind of social distancing that has now become the norm in developed economies, and what are the unique challenges that they face across emerging markets? I’m thinking of Brazil, Argentina, Chile, et cetera.
07:56 Kunjal: Yeah, no, that’s a very interesting question, and it’s not just the virus, but there are a lot of other aspects in which emerging markets differ. Countries within emerging markets differ from each other, be it reforms, be it the emerging middle class, consumption, investment in infrastructure, investments in digital, and we see a pattern. Those countries who are forward-looking, like China, like Taiwan, to some extent Korea, India, those countries have been quite proactive in the virus situation as well by banning international travel, domestic travel, imposing severe lock downs.
08:47 Kunjal: Whereas, economies on the other side of the world, Latin America in particular, were a bit complacent in the beginning, and as a result, the markets have already reacted to some extent by penalizing them, because these economies are also vulnerable from the global slowdown. Some of the economies are vulnerable from a flow perspective. Some of them are vulnerable from external funding perspective. Unfortunately what has happened is the more vulnerable an economy, from an economic perspective, the reaction or the policy actions from the virus perspective has been limited. We need another way around saying if you’re more vulnerable, then your action or policy action to mitigate the virus has to be even more stronger, but unfortunately, that has not been the case so far.
09:51 Kunjal: Whereas, those economies who are stronger, have a lot of resource, can fight the current situation out have been more proactive, which is good, but we also wanted to see vulnerable economies do the same, and they haven’t really done that so far. I hope that they continue to think positively about the situation and try and curtail the impact.
10:18 Aoifinn: Can we talk then about flows into emerging markets? Because what has been notable to me has been that there has been a sort of a systematic, lackluster response, I believe, for the last number of years by investors towards emerging markets, whether that be debt or equities, and it does seem that in recent times there has been a stark fall off in foreign flows into China equity, EM equity, excluding China, as well as emerging markets debt. What do you think is the story behind these ad flows?
10:50 Kunjal: Yeah. Let’s just recap what has happened year to date and the severity of the outflows. So according to the Institute of International Finance, the emerging markets have seen a record amount of outflows this year, totaling to almost close to a little less than $100 billion. A majority of the outflow has been on the equity side and some on the debt side as well, and the severity of this outflow is significantly more than what we saw in some of the previous crisis, like the GFC or the taper tantrum during 2013.
11:36 Kunjal: For example, during GFC, the amount of outflow was approximately anywhere between $20 and $30 billion. We have seen a significant flow out of EM in just a couple of months this year because of the scare, the virus scare. That has, again, impacted countries differently, so if you think about China, in particular, it was only recently when China opened up its capital markets to foreign investors, and you have a very strong, dominant domestic institutions and retail investors in China. China did not face the issue so much as compared to, say, Indonesia or India or other parts of EM in MEA or Latin American side, where the dependency on portfolio flows is a lot higher, especially when it comes to funding the current account deficit.
12:40 Kunjal: To that extent, yes, the flows have been quite severe, and it is understandable, because we are in particularly uncharted territory right now. It’s the fear of the unknown. Nobody really knows how we get out of this situation, or whether we can get out of this situation on a more sustainable basis, or whether we’ll have these type of issues, pandemic-related issues, come in and go every few months or every few years. Nobody really has the type of expertise. Investors are not medical professionals. Even medical professionals are struggling, so we are in an unknown territory. That’s why the first thing people will do is to pull money out and then think about it later.
13:28 Kunjal: That is what has happened. But interestingly, what has happened is, if you look at, say, a place like India, domestic investors have been a lot more sanguine about the issue. They’re also worried. They’re also nervous. Don’t get me wrong. But generally, when foreign investors have been selling, domestics have been picking it up. They are looking at the opportunity as not so much as a threat, but as a means to accumulate good quality companies that are now suddenly a lot more cheaper.
14:04 Kunjal: So one has to also balance things out and think about it a little bit more realistic manner, a little bit more rational, whether the crisis is temporary or permanent, and at some point, the view should be that this is a temporary issue, and the signs and the technology will take it over and find the solution, and we’ll come out of it. We are already seeing some signs. Some you look in countries that are already talking about reducing the lock downs, getting back to work. Factories in China, some of them are now already working on double shifts. In India, 50% of districts in India are not impacted by the virus, so the government is contemplating open those districts to business.
14:56 Kunjal: I think gradually we’ll see the impact of the lock down start fading. Hopefully by then we see some sort of medical intervention breakthrough come through, in terms of either a vaccine or some treatment. Maybe the weather can also help in some way, and the portfolio flows should start reversing. Because if you think about it, what has happened, emerging markets are now trading very close to where they were during the global financial crisis, in terms of their price-to-book multiples.
15:30 Kunjal: Within that, value sectors have corrected significantly. Growth has corrected, but not so significant as value, but nevertheless, growth has also corrected. Valuations are no longer steep. And as I mentioned earlier, there are a number of very good quality companies now suddenly available at decent, reasonably lower multiples, and we believe that the longer term case for emerging markets still continue. Yes, not all markets will have a similar type of trajectory, and that is why the role of active managers is quite important, so that we can differentiate between less vulnerable and more vulnerable economies and companies who can benefit from whatever the environment comes through, or when we are through with the virus.
16:23 Aoifinn: That’s very interesting. I think, in terms of sentiment towards emerging markets, we really are dealing with quite a complex phenomenon, both as I said, countries such as South Korea and Taiwan being held up as the real standard bearers, in terms of how to cope with this crisis, and we are really looking to them for guidance, in terms of testing volume and just the very careful contact tracing. Then on the other hand, there is, of course, this fear which is stoking some, perhaps, fear of anything foreign, of anything unknown, of anything even more volatile than what we are experiencing here, and I suspect that it’ll probably be a bit of a mixed bag, in terms of the near-term implications for sentiment around emerging markets.
17:03 Aoifinn: But I’d like to take this chance to move into some of the sectors that you have focused on as four areas where there might be shifts, some longterm shifts, some of which will be accelerated by this crisis. You’ve highlighted in a piece, healthcare, enterprises, households, and technology, and I’d like to really dive into some of those in more detail, in particular healthcare.
17:23 Aoifinn: Healthcare is the obvious area where we are seeing both massive pressures right now, as well as challenges, and I, correct me if I’m wrong, but I believe in emerging markets healthcare has been a theme for some time, primarily because we did have an emerging middle class, perhaps better access to healthcare. We had seen investments in hospital chains across the region and a general improvement of the level of healthcare, which in some regions was probably starting from a fairly low base. How do you see this crisis as having an impact on healthcare in the region on some of the providers, and perhaps in accelerating some of the trends that were already in place?
18:01 Kunjal: In terms of healthcare, the way I look at it right now is back in 2008 the banks received a stressed situation. They underwent a stressful situation following the collapse of the mortgage market, and then we know what happened. Banks had to be bailed out and then regulations were changed to make banks stronger, and in fact, in many parts of the world, especially in the US, banks are a lot stronger than what they were back in 2008. Similar situation is happening now in the healthcare space. Health institutions, public health systems are undergoing an automatic stress test situation, and once we come out of the virus, governments and officials will, indeed, have a look at their shortcomings, their gaps, and try to fill them.
19:03 Kunjal: In fact, I just read over the weekend that officials in Shanghai have already worked out a set of guidelines to improve the public health system and to make Shanghai as a safe city over the next five years, from a public health perspective. They are going to deploy a lot of technology-based solutions to improve their preparedness for pandemics and just generally improve the quality of the health system. Once a major city like Shanghai decides to do that, I’m sure a number of cities in China will do that and across the world. I think politicians will be compelled to make sure that their health systems and their social security systems both kind of work during the times of crisis. I think that is a no-brainer. It is inevitable that we will see that.
19:59 Kunjal: Private sector is also likely to look at this space with much more interest, because there will be a decent amount of role for the private enterprises to play in ensuring a country’s self-sufficiency or preparedness for future health scares. It could be for developing drugs. It could be for research. It could be for making medical devices, running hospitals. It could be anything within healthcare, but I think private sector should also play an important role in delivering world class health care at affordable prices for citizens of any country. That’s been a theme that we’ve been playing even before the virus.
20:50 Aoifinn: Very interesting. Also then, moving to enterprises. Clearly, emerging markets have been the beneficiaries of much of the outsourcing that has been going on from developed markets. That’s even become quite a political theme in the US recently. Now we’re seeing some of these supply chains, perhaps, being put under pressure. We are seeing also the business continuity plans being tested in some of these outsource entities. I’d hazard to guess to say that they’re actually performing quite well under these BCP tests, but maybe you have different on the ground experience, but it does seem to me that many of these, say, call centers, for example, have actually transitioned quite smoothly to a work-from-home situation. How do you think the longterm implications on enterprises are going to pan out here? Will we revert to having more locally sourced supply chains? Is that going to be a longterm, sort of secular change we see? And how do you think some of the emerging market companies you cover have dealt with the current challenges?
21:53 Kunjal: Yeah. Supply chain, this topic has been in discussion for a while now. Even before the virus, we had a different issue that the world was facing, which was a US-China trade tensions, and because of those trade tensions and the risk of tariffs, a number of companies operating in China were looking at relocating part of their manufacturing footprint to other countries who are more favorable to the US administration. That move has already started.
22:32 Kunjal: We have seen that firsthand in some of the companies in our portfolio who have relocated their supply chains and part of the manufacturing to Vietnam, to Taiwan, and also to Mexico. Some have even gone back to the US. So we’ve seen that already, and I think with the virus, the shift from a centralized sourcing model will accelerate, and maybe there will be smaller manufacturing hubs that will get a boost, for example, Mexico, to some extent, India, Eastern Europe, Mexico.
23:15 Kunjal: I think those areas will definitely find some favor, again, provided the governments in those countries are proactive and they are able to attract those kind of investments and create an environment in which industries can flourish. I think that is where the trick is, because the reason why China is so successful is because they have created a very strong ecosystem, favorable policies, don’t have really much of bureaucratic issues when it comes to permits, large workforce, very good infrastructure, availability of water, power, et cetera, and it’s not going to be very easy for other countries to replicate that level of success that China has demonstrated.
24:12 Kunjal: But nevertheless, this is going to be a long journey, and as they say, Rome was not built in a day. Similarly, we’ll see the development of industrial economies outside of China over a period of time. We’ve already seen that recently with one company in our portfolio reacting to the virus and relocating one of their manufacturing facilities from Korea to Vietnam. I’m sure we’ll hear more of such stories in the future, but again, one has to be very careful. The moment is not going to be very smooth. It will have implications for companies, operations, their margins, because the new operation is unlikely to be profitable from day one. It will have initial issues that they will have to receive. The experience of working in China versus other parts of the world is quite different, and the most important thing is the ecosystem, right? It’s not going to be easy to replicate the entire Chinese ecosystem in the matter of a few months or a few years.
25:24 Kunjal: It will take a little bit longer, but as I say, this is going to be a journey, and we feel that getting closer to end markets should definitely help if there are future disruptions. But at least companies will have to make a start, and at least diversify away from China, let’s say, into other parts of the world to at least mitigate some of the immediate risks. But I think longer term, being closer to the end market seems more logical and rational, but provided a similar type of infrastructure and similar type of facility is available to replicate the ecosystem. So yeah, it’s going to be a long journey, but nevertheless, something that we are already working on.
26:15 Aoifinn: I think our listeners can certainly look at some of our content on our website around some of the other areas you’ve highlighted as having a real chance of notable shifts, and they would be households and technology. But I’d like to move now to a section we have every month on Fundamentals, which is we devote some time to talking about responsible asset management. This is a segment called Responsibility Works.
26:38 Aoifinn: Now, I’d say it’s fair to say that in emerging markets there has not been necessarily an easy path to responsible investing. There perhaps hasn’t been early adoption of some ESG criteria, but it seems also that the magnitude of this challenge has really meant that governments themselves simply don’t have the resources to tackle all of the challenges, that there simply are not the resources on the ground, and that the private sector does need to step up as part of a commitment to society, perhaps to show its good corporate citizenship. Can you maybe talk about some evidence you’ve seen of companies stepping up with some broader sense of responsibility now to contribution something meaningful and genuine to the current struggle against Coronavirus?
27:22 Kunjal: Yeah. So we are seeing that happening now. Initially, when the virus broke out, companies had to obviously start looking very hard at their own liquidated and survival-related issues, making sure that they have enough funds to last maybe longer than the lock down will last, just in case the lock downs had extended. I think companies probably have done that. They have been drawing their credit facilities, make sure there are enough liquid resources. They’re also looking at rationalizing their cost base, especially the fixed cost based. Some companies are going to the government for some funding requirements. I think those things have already been deal with to a large extent.
28:13 Kunjal: Then companies who do not have vulnerability, do not have liquidity issues, have enough cash, no debt to worry about, they are stepping out and saying, okay, let’s think about the wider society and let’s use some of our resource to help the public administration manage the crisis or help some of the poorer sections of the society with healthcare and medical support. So we have seen a few examples of that in our portfolio companies, where they have gone over and above their focus and their business, and are pursuing some CSR-like activities.
28:58 Kunjal: I think that’s a good thing, because it’s good for the governments, because governments are completely stretched right now. Their resources are completely stretched. They are dealing with the health crisis. They’re dealing it… Every hour there’s a different issue. So they are obviously not going to be able to focus on each and every corner of the country, and each and every society, or each and every sections of the society. I think that’s where the role of private enterprises will be quite helpful, because they are closer to certain sections of a society, and they have the rapid resource and the focus to execute well as well in these times.
29:40 Kunjal: I think it’s a good thing some companies have started the CSR… stepped up their CSR activities, and I’m sure we’ll see more of such things happening, especially larger companies who are well-resourced, have enough liquidity, go out and support, if nothing else, they can support the supply chain, their distributors. I think that itself should be a very good help.
30:04 Aoifinn: Have you seen some of the technology companies in, say, China stepping up with tools to enable, let’s say, contact tracing or even surveillance and tracing of individuals under quarantine or lock down?
30:17 Kunjal: Yeah. I mean, that has happened, so yeah, we’ve seen a number of Chinese companies develop apps to look at the COVID-19 situation. There are apps which help users understand what symptoms they have and whether it could be Coronavirus or not, all the way down to apps which can trace and track Coronavirus patients, and also help authorities understand if there is a risk in a particular community where a particular infected person has been living or has been traveling. As a result, they can then deploy some of the resources that they have on testing in those hot spots. To that extent, surveillance has been used to understand and trace the Coronavirus patients and to deploy resources accordingly.
31:28 Kunjal: I think surveillance is definitely on the rise. It was anyways on the rise even before the virus for a different reason, but now it has become a compulsion to understand where an infected person has been, and who he or she has been in touch with, and whether or not these other people who have been in touch with the infected person could possibly be infected. The reason why this has happened is very simple. It’s about testing, right? I mean, governments cannot knock on everybody’s door and test. They have to follow a targeted approach, and this is one way of targeting who could be infected and test them for the virus and then offer them some solutions.
32:12 Kunjal: So you’re right. I mean, this has happened, and we have heard similar stories in other parts of EM as well, where telecom towards and mobile frequencies are also being used to understand and know where a particular person has been, been going around, et cetera, so which communities could be infected? So governments are looking at unique and innovative methods of finding out the trouble spots and hot spots, and then making sure that appropriate testing resource is deployed in those communities, and infected people are being identified and treated.
32:54 Aoifinn: So Kunjal, it seems that much of what we’ve been discussing here actually places emerging markets in a relatively strong light. From my perspective, and I did spend some time living in Hong Kong, this is a region that is used to a certain amount of volatility. They are emerging, in a sense, so they are still in the upper halves at their peak, in terms of economic strength. In that sense, therefore, an exogenous shock such as this one, perhaps, isn’t as devastating to emerging markets as it is to developed markets, where you could say there was a certain amount of order and new world order that we’ve been enjoying for the best part of half a century. However, that said, what keeps you up at night when you look at your region? What trends do you think have been in place that are now, perhaps, completely in question, and what risks and threats do you think the region will see going forward?
33:43 Kunjal: Yeah. So that’s an interesting question. We have spent quite a bit of time thinking about this issue as an opportunity and have been diversifying our portfolio, et cetera, and we have also spent some time thinking about what can change and what are the negative implications out of this?
34:09 Kunjal: So far, whatever we have come across does not look, to me, as completely devastating for emerging markets, but there is one thing that does really bother me is how are households going to behave, are consumers going to behave after the situation normalizes and lock downs are lifted? Whether consumers think differently from how they were thinking before. Do you they change their consumption patterns? Do they change their consumption spending levels? Do they reprioritize their spending areas? I think those things are something that we really need to think very hard as fund managers, because a number of companies in our portfolio and also in everybody’s portfolio depend a lot on consumption.
35:14 Kunjal: The global economy is also kind of structured in a way where consumption expenditure is a driver for a lot of things. It’s a driver for business profits. It is a driver for investments, and it is a driver for employment, et cetera. If the consumer confidence remains subdued for a longer period of time after the virus, or the consumer changes his or her preferences, then we may be in a very different situation in maybe two or three or four quarters from now.
35:54 Kunjal: Let me give you an example. We’re thinking about global tourism and travel. So if you think about what happened last seven, eight, ten years because of internet, because of online, because of reviews, cheap air travel, et cetera, there was a real big boom in global tourism and global travel, especially long haul, and a large part of that was driven by Chinese tourists traveling to cities across Europe and US. Whether the Chinese or anybody now wishes to travel long haul, explore places in the West, I’m not sure whether that will happen in a short span of time, so people’s preferences might change over there.
36:48 Kunjal: Similarly, there could be a shift in savings pattern as well. I mean, over the last many years, here in the emerging world, we have seen the household savings rate has been declining in favor of consumption. This may change, because a lot of consumers might be feeling the heat from the shutdowns, their cash flows might be impacted, they may have lost jobs. As a result, these consumers might go into a savings mode for the next couple of quarters or maybe some time over a year as well to build up for what they have lost and also to build up a fund to help them during the next crisis. That would also have implications for consumption going forward.
37:44 Kunjal: The point I’m trying to make here is that let’s not assume that everything goes back to normal the moment lock downs are lifted. Yes, there will be some sort of recovery, because things are kind of pretty much not happening right now. Economic activity is completely dead, and things will recover. So you will definitely see sequential improvement, very strong sequential improvement, because you’re moving from zero to something, so that’s what is fine. That is fine. But then from that level, going forward, whether we continue a rapid pace of growth or a more moderate or a gradual pace of growth is something that we need to see, and I think I would be a little bit cautious on the ongoing recovery going forward, mainly on the premise that consumers will take a little bit longer to adjust to the new environment, and they may change their preferences.
38:41 Kunjal: That is something that really worries me, because if you think about the US economy, for instance, which is a major driver for the whole world, almost 70% of the GDP is consumption, and if the US consumers think differently, then we have a slightly problem. Similarly, China is looking to migrate its economy from infrastructure and property into services and consumption. Chinese consumers already have been borrowing quite a bit over the last several years. It’s not reached alarming levels, but whether the Chinese consumers continue to borrow more and spend more is something we need to really work out and test. Those things I would keep an eye on and see how they evolve.
39:32 Aoifinn: Let’s bring in another guest, Steve Chiavarone, Portfolio Manager and Equity Strategist, joined us from New York City, or technically, New Jersey, as he’s working from home these days like the rest of us. Steve, we’ve just been discussing with Kunjal some of his concerns around the future path of consumer behavior in his region, so all of emerging markets. How do you see consumers emerging from this particular crisis?
39:57 Steve Chiavarone: I think the emergence is going to be kind of reticent at first and perhaps uneven. I mean, I think there are some essential services or some basic shopping that people are going to want to do. For example, we’re all going to want to go out and get haircuts or get our nails done or things of that nature, because we’ve been kind of cooped up, we haven’t been able to access those services. I think where you’re going to see the most… We’ll go food shopping again. We’ll buy things for our homes. I think you may even see, in the initial stages, a little bit of a kind of euphoria, almost a freedom day, where you go out and you’re able to buy and engage in commerce.
40:38 Steve: I think, however, entertainment could be challenged for a while longer. While I am certainly keen on getting things for my home, maybe getting my car fixed, things of that nature, I’m probably not interested in taking my family to a very crowded sporting event any time soon. I think that that will take some time. I also think, when you think about a country like the United States, it’s a vast territory with very different kinds of communities, some that are more tightly concentrated, others that are much more spread out, so I think it’s going to be different depending on kind of what environment you’re in, how bad the virus outbreak was. There’s parts of the country here that really haven’t been all that affected by the virus, but they’ve been shut in nonetheless, so I think it’s going to be location-dependent with a preference for kind of important, essential, and then a little bit of discretionary goods, but maybe a little bit more reticence around kind of entertainment, leisure, travel, things of that nature.
41:40 Aoifinn: How accurately or correctly do you think markets are assessing the impact of this right now? At the beginning of the podcast, I discussed how today markets seem to be clinging to every bit of hope that they can, and we’ve also seen that the extraordinary Federal Reserve action announced last week that they will now be using their funds to actually purchase not only high-yield bonds but also the ETFs, high-yield bond ETFs. This seems to have shored up now the fortunes of highly levered companies. Do you think markets are properly assessing what the impact is likely to be?
42:14 Steve: I think that the markets have been more rational than they appear at first blush. When the crisis first began and you realized that you were shutting down large swaths of the economy all at once, we’d started to form more cracks in the system. You saw this through various credit markets, be it high-yield, or mortgages, or treasuries, or corporate bonds, commercial paper, and you had the ingredients left unaided for a real financial system collapse. I think that the sharp declines in the market that were occurring in the early stages had a lot to do with uncertainty over just that, so you knew there was going to be an economic impact. Okay, that’s fine. We can kind of deal with that. But when you have a risk to the financial system and the credit markets, that then becomes a crisis type scenario. That’s where you were seeing what really was one of the swiftest 35% declines in market history.
43:17 Steve: I think when you look at all of the measures that have been provided by governments worldwide really, both on the fiscal and the monetary side, they’ve removed the possibility, to a large extent, of having a financial system collapse. Now, we’re still dealing with what’s going to be a very sharp contraction in growth in the coming weeks and months. That’s still in place, but that tail risk, that financial system collapse, we think, has been taken off the table, and that’s the relief that you see in the market, because now, rather than asking yourself am I going to have a collapse and then an extended period of very subdued growth, what we’re looking at is am I going to have… is the bottom now, was it on March 23, is it coming a little bit later, and is my recovery going to be sharper or more U-shaped? We think it’s a U, but that’s a much better conversation to be having than whether or not we’re going to have the collapse of large swaths of the financial system.
44:14 Steve: While the rally has been sharper than expected and a little bit more powerful than expected, when you think about that the negative cases that we’ve taken off the table, I think it looks a little bit more logical than you would first think.
44:30 Aoifinn: Let’s talk about big structural change. Kunjal already discussed some of the big structural change that he thought would come to the healthcare sector, as well as the ongoing change to enterprises as they, I think, proved their ability to shift to a more remote working style and to respond to some of the challenges in the supply chains. Where do you think we’re going to see this, big structural change across which industries? I know we don’t have much time now to go into detail, but just if you could maybe just name the headlines.
44:59 Steve: Yeah. Look, we’ve talked about, in our past discussions, a secular bull market built, in part, on a digital revolution. We think that this crisis accelerates a lot of existing trends, so we think it accelerates the trends towards automation, robotics, AI, internet of things. We think every company’s going to do a self-audit here and ask themselves what systems do they need to upgrade, what worked, what didn’t? So we expect a big tech spend coming out of this.
45:27 Steve: We think that healthcare… countries are going to have to stockpile medical devices, pharmaceuticals, upgrade their hospital facilities. We expect to see a lot of spending there. We think this accelerates the trend of the rise of online retailers and the decline of the weaker brick and mortar retailers. Then finally, we’ve talked a lot about the middle of the United States itself emerging as an emerging market, if you will, because of a lot of open land, easy access to energy, which is plentiful, easy shipping routes, ironclad IP, et cetera.
46:04 Steve: We think that countries in general… or companies, rather, are going to ask themselves do I need to be a little less efficient? Meaning, do I need to have multiple sources for my supply chain? Do I need to have a core manufacturing inside the home country for key goods? When I think about how I use my capital, do I maybe not return as much capital and have more of a rainy day fund? Do I pay a little bit more for a domestic workforce, again, to have at least a core home-based manufacturing capability?
46:36 Steve: So I think, whereas the last 10 years have been one about maximum efficiency but not safety net, so low nominal growth, high margins, I think the next 10 years could be more about higher nominal growth, because you’re bringing more economic activity back to the home countries, but with a little bit lower margins. I think in that environment, active security selection, both on the credit side and on the equity side, is going to become more important than it was over the last 10 years.
47:08 Aoifinn: Kunjal, do you have any response to some of these points made by Steve?
47:12 Kunjal: Yeah, so I was saying that on technology, I agree with what Steve’s saying, and even in the emerging world, we are already seeing a similar trend, which is likely to accelerate going forward, be it automation, or robotics, using internet of things, machine to machine communications, as a means not just to prevent future… mitigate future disruptions, but also as a means to improve productivity and efficiency. We see technology is already embedding itself in all of the sectors that we invest in. It’s not really a standalone sector anymore now. To that extent, yes, the role of technology, the role of online is going to be quite meaningful going forward.
48:04 Aoifinn: On that note, it’s time to sound the closing bell, but before we do so, I’d like to thank Kunjal Gala, Co-Portfolio Manager in our Global Emerging Markets Team, and Steve Chiavarone from our New York office for joining me today.
48:16 Steve: Thank you so much, Aoifinn, so glad to join.
48:18 Kunjal: Thank you very much, and I hope this was a helpful session.
48:21 Aoifinn: Very helpful. In terms of the takeaways I would have from this, I’d say the first thing is clearly emerging markets are a very diverse area, and there are more or less vulnerable countries, as well as more or less vulnerable companies within these countries. The second thing is that, I think, in terms of drilling down into some of the sectors we’ve looked at, there are certain sectors, such as healthcare, where maybe they have been broken by the stress test that’s now been put upon them, but perhaps, when something is broken, something better and brighter can emerge in its place. Certainly, there seem to be already indications that the healthcare and global healthcare industry will emerge stronger from this.
48:59 Aoifinn: Finally, it seems based on our assessment of consumer behavior, that there is, just like in the case of this virus, and just like in the case of the current state of shutdown and reopening, there is an awful lot that we do not know and that we are still very uncertain about, in terms of consumer demand, how that will look going forward, whether there will be a resurgence of demand, pent-up demand, essentially, or whether consumers will now be much more risk-averse and prone to save more and spend less, as they are now have been acutely reminded of how suddenly a shock like this can take place.
49:33 Disclosure: Thank you for listening to the Federated Hermes podcast. If you found it interesting and would like to listen to more podcasts from the international business of Federated Hermes, please visit our website. Our podcasts are also available to download on Apple Music and Spotify. These podcasts are for informational purposes only and the views, information or opinions express therein are solely those of the individuals involved and do not necessarily represent those of the company and its employees. Performance should not be relied upon as a basis for investment decisions. All performance mentioned is historical. Past performance is not a reliable indicator of future results and investors may not recover the full amount invested.

These podcasts are for informational purposes only and the views, information or opinions express therein are solely those of the individuals involved and do not necessarily represent those of the company and its employees. Performance should not be relied upon as a basis for investment decisions. All performance mentioned is historical. Past performance is not a reliable indicator of future results and investors may not recover the full amount invested.

International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards.

Prices of emerging markets securities can be significantly more volatile than the prices of securities in developed countries and currency risk and political risks are accentuated in emerging markets.

There is no guarantee any specific investment approach will be successful.

MEA stands for Middle East and Africa.

CSR stands for Corporate Social Responsibility.

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