Thursday, June 20, 2013

Oppenheimer Developing Markets Fund

On May 29, we spoke with a portfolio specialist at Oppenheimer Funds about their Developing Markets Fund (ODMAX). 

Oppenheimer as a firm, and the management team of the Developing Markets Fund, are research driven and fundamentally focused. Instead of starting with a broad based macro view about countries and sectors currently that seem most attractive and then looking for investments in those areas, the fund’s weightings are the result of their individual stock analysis.  The managers seek companies with significant competitive advantages and the ability to dictate their own strategies. And they typically avoid capital intensive industries like energy, companies that are heavily reliant on government, such as Chinese banks and most companies in Russian (which represents only 5% of the portfolio). 

Geographically, Asia comprises the bulk of the portfolio at around 45%, with China carrying increasing weight. China is going through many changes, and the country is shifting from an exporter to a more consumer driven economy, which greatly impacts neighboring countries. The fund believes that as China focuses on building consumer base and investing in infrastructure, more attractive companies will arise.  

Within Asia, the fund believes that Taiwan and Korea will suffer from Japan’s quantitative easing and yen weakening policies, therefore, the fund maintains only a 4-5% weight in those countries. This is well below the index, which has Korea at a 25% weight. 

The fund can invest up to 20% outside of the Emerging Markets, and currently has 15% in developed Europe. The focus is primarily on companies that are selling heavily into the emerging markets, such as Prada, Ferragamo, Richemont, Burrberry, and SAB Miller. For example, Prada, a company which the fund bought two years ago, earns 40% of its revenue from emerging markets, mostly from China and its neighboring countries. The fund expects more growth from luxury consumer brands in these regions as the middle and upper classes continue their rapid growth. 

Latin America accounts for 20% of the portfolio, most in Brazil, but the fund finds Latin America and Brazil have poor macro outlooks and stretched valuations.  However, true to their research-driven approach, they found opportunities in Embraer and Petrobras despite their dim macro view.  

The Middle East and Africa represent 4.5% of the portfolio, with 1% in so-called frontier markets. Management likes the frontier space, in part due to lower company valuations, but has limited the fund’s exposure due to liquidity concerns, heavy state ownership and lack of investor protections.
Finally, the fund maintains 5% in cash (it has ranged from 3-6%). The cash is less of a valuation call, but more reflective of the need for liquidity in case of fund redemptions. 

Emerging markets have been underperforming developing markets – down 1% vs. up 10% in the past year, and management would not be surprised to see that continue in the near term. Going forward, the fund expects China to do well but may see volatility due to the nation’s reforms. The fund thinks India has the potential to become the fastest growing large market in the region, and will look to focus more of the portfolio in the region. 

We have used this fund for a couple of years. We remain very comfortable with management’s investment approach and we like that they are more focused on picking stocks than managing to an index. Of course, this approach can lead to period of relative underperformance. We were also pleased that Oppenheimer decided to close the fund to new investors. This is a sign that they are more focused on providing attractive returns for existing shareholders than trying to make as much money for the fund company.
Assistance on this post was provided by Ethan Xu 
(Harvest Financial Partners owns this fund in client portfolios. The principals of Harvest Financial Partners own this fund in their personal portfolios.  Positions may change at any time)