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A Different Path to Growth in Emerging Markets
Oppenheimer Emerging Markets Innovators Fund
Interview with: Heidi Heikenfeld

Author: Ticker Magazine
Last Update: Jun 25, 9:45 AM EDT
In the emerging markets universe, large-cap names attract most of the attention. However, investors should also look to small- and mid-cap companies for bigger opportunities. Heidi Heikenfeld, portfolio manager of the Oppenheimer Emerging Markets Innovators Fund, navigates the area through the lens of innovation and long-term structural growth. The fund seeks companies with not only high earnings growth but also positive impact for local populations.

ďThere is significant wealth creation in the emerging universe and the number of companies with market cap of more than $500 million has tripled over the last 10 years and doubled over the last five years.Ē
Q: What is the history of the fund?

A: Within OppenheimerFunds we have a large Emerging Markets Equity Strategy, managed by Justin Leverenz, with assets under management of approximately $48 billion. Our goal was to create a portfolio that was complementary to our flagship strategy and different from all the other 300+ actively managed EM funds.

Prior to joining the EM team, I spent 10 years as a global investor specialized in small- and mid-sized growth companies. I gained a reputation for identifying transformational growth in the Healthcare, Technology and Consumer Discretionary sectors. In 2013, I was hired to launch a small-and-mid-cap EM fund in partnership with Justin. I spent 18 months mapping the investment universeóspending at least half the time on the ground in EM countries with the goal of designing something different. We launched the Oppenheimer Emerging Markets Innovators Fund (EMI) on June 30, 2014.

What is exciting about EMI is that itís a very different portfolio, both in terms of content and style. Almost 85% of all companies in the main MSCI EM Index are large cap. There are only around 400 companies in EM with market caps above $10B, but there are over 5,000 small- and mid-sized companies in the EM universe, with market caps of $500 million to $10 billion. With EMIís focus on investing in innovative businesses, weíre also taking advantage of a big structural shift in the EM opportunity set. The number of companies within EM in the high growth, high profit sectors of Consumer, Healthcare and Technology has tripled over the last ten years and doubled over the last five. Since the fundís inception, those sectors have accounted for between 65-75% of invested assets. Given this concentration, we believe we are uniquely positioned to benefit from structural growth in emerging markets going forward.

Investors see our portfolio as a diversifier. EMIís active share is over 90%. Our overlap with the MSCI Emerging Markets Index is only 4%. As a result, weíve taken some market share from large cap portfolios and now have around $1.2B in assets.

Q: What else differentiates you from your peers?

A: We seek to invest at the intersection of strong earnings growth and positive impact. We perform exhaustive due diligence to avoid companies with exploitative labor and environmental practices. Whenever possible, we align ourselves with the aspirations of EM people. These include education, financial inclusion, affordable healthcare and environmental improvement. Thatís a unique element of our strategy.

We also offer more concentrated exposure to entrepreneurial culture in developing economies and the dynamism of these fast-changing markets. Whiles many large-cap companies sell their products globally, our small and mid-cap companies are more focused on domestic or regional growth.

Finally, we donít invest in commodities, which is almost unique among our peers.

Q: Which emerging markets do you focus on?

A: We invest in 30 countries. Our largest allocation is in China. Other major exposures are South Korea, Taiwan, India, Brazil, and South Africa. About 4% of the portfolio right now is in the frontier markets.

We have underweights in Brazil and in South Africa. We have observed an inverse correlation between natural resources and innovation, where countries with a lot of natural resources tend to spend their money on the development of those resources, while countries with no natural resources have been quicker to develop innovative industries.

In emerging markets, country allocation has been one of the biggest determinants of relative performance over the last several years. As an example, in 2016 we underperformed in part because of the big commodity rally. But we were also heavily underweight in Brazil during the impeachment and subsequent removal of President Dilma Rousseff. We did not respond quickly enough to the change in the countryís macro environment. This mistake taught us to be more responsive to significant macro/political changes and more thoughtful about our relative country weights.

Q: What core beliefs drive your investment philosophy?

A: We are growth investors looking for highly profitable companies. We believe seeking innovation allows us to identify durable competitive advantages that lead to earnings growth. We care about valuation. We use a proprietary EPS growth model with a 3- to 5-year time horizon.

Since we understand the importance of local context, we spend a lot of time on the ground in emerging markets. This has the added benefit of helping us to identify opportunities early.

We also have a lot of imagination and can see a future that looks very different from the present. This allows us to identify transformational growth companies with the ability to rapidly take market share or create new markets.

Q: How would you describe your investment process?

A: Each year we screen the entire investment universe and divide the interesting companies from those we want to avoid. We eliminate about 80% of the EM universe in that process. Our screening is both qualitative and quantitative. We use metrics like profitability, sales growth, balance sheet strength and business essence, including competitive position. We donít invest in highly-regulated businesses like commodities, telecoms or utilities.

We use structural growth themes to help identify opportunities. Some of these themes have existed since the inception of the portfolio. Other themes are new, like industrial automation and augmented or virtual reality. We analyze companies in clusters. As an example, when looking at the education theme, weíll examine education companies around the investible universe to identify the best ones. This approach provides context and better understanding of each business.

When meeting companies in their local markets, we aim to understand both advantage and opportunity set in order to determine how profitable the business could be.

In assigning a valuation, we assess for direction and magnitude, because we try to identify companies whose valuation could more than double over the next three years. We look to buy good companies at great prices.

Q: Could you give us some examples that illustrate your research process?

A: Since the fundís inception in 2014, we have been very interested in identifying biosimilar drug makers with compelling science. Biosimilars, which are replicas of biological drugs, require strong development capabilities and are difficult to manufacture. Over the next few years, a number of blockbuster biological drugs will be coming off patent. These drugs, which treat diseases like cancer and inflammatory diseases, generate over US$100B in revenue. For many diseases, Emerging Market companies are leading the way in biosimilar development. We seek to identify the companies with the best scientific capabilities in each of the countries where the biosimilar industry exists.

The search for the best science led us to invest in Biocon in India, Celltrion and Samsung Biologics in South Korea, and 3SBio in China.

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Sources: Data collected by 123jump.com and Ticker.com from company press releases, filings and corporate websites. Market data: BATS Exchange. Inc