The emerging economies of Asia-Pacific represent a "sweet spot" for investors seeking to build a portfolio, a US firm argues.

Here is a Q&A with the New York-headquartered investment firm City National Rochdale, about its City National Rochdale Emerging Markets Fund (RIMIX), which at launch had $4 million and is now at $615 million in AuM with a Hong Kong office. The fund's primary investors are high net worth individuals, which CNR connects with through its RIA network, and it is managed by Anindya Chatterjee, whose answers are below. This article originally appeared in Family Wealth Report, sister publication to this news service, and given the Asia focus of the item the editors hope that WBA readers find it of value.

What was the genesis of the City National Rochdale Emerging Markets Fund and how does it relate to the US?
Fundamentally, emerging Asia looks most attractive over a long-term horizon. Within emerging markets, emerging Asia is in a sweet spot with its (a) attractive demography, (b) rapid urbanisation, productivity and income growth, (c) per capita income band of $2,000-$10,000 (where nations experience nonlinear demand expansion), (d) robust savings and investment rates lending to growth sustainability and (e) low market correlation with developed equity markets, and (f) finally, global equity benchmark indices currently under-represent emerging Asia and it is fair to expect continued benchmark rebalancing going in favour of the region. With that, I expect emerging Asia equities to outperform global emerging markets over the long-term horizon. That is the focus of RIMIX.

EM benchmarks are cheap in terms of P/E, P/B, P/S valuation measures, at this point. However, we do not invest in a benchmark-hugging strategy. Investments focused on domestic demand themes, in EM Asia in particular, provide significantly attractive growth opportunities over the medium and long term. From automobile to instant noodles, the macro backdrop of per capita sweet spot, demography, urbanisation and productivity and wage growth provide non-linear growth prospects.

For example, despite the continued slowdown in investments and GDP growth, China’s retail sales are still growing - 12 per cent YoY. We see enough investible opportunities with visible >17-18 per cent EPS growth and reasonable valuations. However, we should also not forget that the asset diversification argument, in favour of its due allocation towards EM equities for US investors, remains an equally important reason for EM exposure.    

What is the fund's overall investment strategy and how – if at all – has this changed in time?
RIMIX is a bottom-up investment strategy. We have a very disciplined investment process; we build detailed financial models and get our own understanding and conviction of the true intrinsic value of companies, which lends itself to a very long-term approach.

This investment strategy has remained consistent and has not changed since the fund’s inception. Our fund’s turnover is low and the top 15 holdings have hardly changed since inception. We invest in companies with a combination of reasonable valuations and reasonable growth, and do not invest in companies without meeting the management and checking facilities and assets on the ground. We have a bias on mid-caps that are emerging leaders, but which are not often widely followed by market analysts. Our proprietary analytical and screening framework assesses the quality and integrity of management and we generally avoid companies that are dependent on government policy nuances. We focus on domestic demand themes.  

What factors have driven its success?
There are a few factors that, merged together, have really contributed to the success of RIMIX. Firstly, the investment approach that we’ve taken is a very disciplined one. But just as the approach is important, it would be invalid without the deep knowledge that our portfolio managers bring to the table. They, along with the experienced market analysts on the ground, are very focused and hyper-aware of market trends and strategy. As I mentioned, the approach is a thorough one and it’s their knowledge that allows its execution to be successful. And lastly, it is our long-term investment horizon that really allows us to understand the market’s growth opportunities.

What challenges have you encountered along the way and how did you combat these?
Emerging markets have issues on data quality, lack of transparency and management quality issues. Also, there are idiosyncratic policy and geopolitical risks that often impact emerging market equities. Our investment decisions are supported by our feet-on-the-ground research, which includes detailed financial modelling, proprietary channel checks and continuous meetings with senior management and industry specialists. We try to avoid investing in sectors and companies that have direct bearings from government policy measures.      

What is your approach to risk management?
Management risk and liquidity risk are two very important, company-specific risk parameters that we take cognisance of, in addition to monitoring the systematic market risks and country risk factors. We typically do not invest in companies with less than $800 million market cap and our investible universe must ideally have at least $1.5 million/day average daily trading volumes.

Liquidity risks are very important for emerging markets. We also closely monitor and assess management disclosure levels and the overall quality of management in our investible universe. Our country and sector allocations are a function of our broader risk assessments and outlook and we maintain strict downside flagging-out and stop loss initiatives on price declines on our existing holdings.         

What have the volatility characteristics of the markets you cover been like? Is the fund looking to profit from down as well as upward market movements (possibly through the use of derivatives)?

RIMIX is a long-only strategy, thus far. Our investments have fared well through market downswings as well as market upswings – as highlighted by the fund’s performance data on upcapture/downcapture ratios etc. Our objective is to outperform our benchmarks over the medium and long terms.

Is the fund keeping any cash reserves to take advantage of emerging opportunities in the region?

The fund is currently holding around 11 per cent cash. Historically the fund has moved its cash holdings from 6 per cent to 16 per cent based on outlook and market volatility, as part of its active management strategy, and has aptly taken advantage of price swings in stocks, thereof.

What do you see as hot investment themes in the region or in particular markets?

The sharp fall in crude prices have divergent impacts on emerging markets – from Venezuela/Russia to China/India. China imports more than 60 per cent of its crude requirement and India is as much as 75 per cent import dependent for its crude requirement. A decline in crude prices will reduce import bill, improve government budget balances and also bolster corporate profitability and contain imported inflation in most of emerging Asia.

A $40/barrel sustained crude price decline, over 2014 average price levels, can add 1.5-2.8 per cent to GDP growth across emerging Asian economies – from India, China to the Philippines. Overall, with China/India being the largest of the emerging markets – a decline in oil prices is good news.

We are positive on these markets in 2015. Within this domain, we are positive on consumer discretionary and some of the rate-sensitive sectors in pockets, such as engineering and real estate, which would gain from a decline in raw material prices and interest rates.

The bulk of the incremental global growth will continue to come from EM – particularly EM Asia, in our view. Emerging economies’ GDP growth levels are still expected to be around 6 per cent YoY in the coming years, with right-tail risks because of declines in oil prices.