Why Companies Override Countries When Building Portfolios

Investors frequently ask us for opinions on specific countries within emerging markets. Depending on what’s in the headlines, the country might be China, India, Thailand or Mexico. Conversations that start top-down and focus on country allocation include many natural questions for those considering emerging markets. However, country should not be the first question, in our view. We believe companies should come first in the security selection process.

For the Matthews Emerging Markets Equity Fund, security selection is guided by three basic questions:

1. Do we want to own this business

2. Is management working for us as shareholders, or some other party—themselves, a controlling shareholder, a family, the government—that doesn’t include us?

3. Are we getting something great for the price we’re paying?

Once we’ve answered these questions, we begin to look at country considerations. Understanding how a manager approaches the intersection between country and company, in our view, is a large part of evaluating an Emerging Markets strategy. We believe the best chances of capturing durable growth come from strategies that prioritize company selection over country allocation. A generation ago, beer, banks and cement tended to be produced and consumed locally. Today, even these highly localized businesses have elements of global competition. Global trends and local tastes are perhaps balanced in something like cosmetics whereas in semiconductors it’s really one global market.

South Korea is an interesting example of the “continuum of competition” within emerging markets. Encompassing the full spectrum, South Korea is home to companies whose competition is primarily local, as well as those whose competition is primarily global. There’s also a large category of businesses that are in-between, where competition may be a blend of local and global. Consider a local coffee shop. The coziness, banter of the barista, corner location and Wi-Fi are local elements of completion. But sourcing beans, online payment and brand recognition is often global.