nvesting in Small- and Mid-Cap Emerging Market Stocks
Heidi Heikenfeld, co-portfolio manager of Oppenheimer Emerging Market Innovators UCITS Fund (EMI), recently answered questions about the opportunities she sees for investors in emerging market (EM) stocks. Highlights of the Q&A include:

Q: How do you manage the unique risks associated with emerging market small and mid-caps?

Investors often think of small- and mid-cap stocks, across all geographies, as being much riskier than large caps, and treat them as such by using them as satellite allocations. What we have seen and what the statistics show, is that the risk profile for the large-cap index (MSCI EM) is higher than the mid-cap index and certainly higher than EMI. One reason for this is that we have far less exposure to cyclicality, as opposed to the large-cap index, which has about 40% of its allocation in cyclical sectors like Financials, Energy, Materials, and Real Estate. We also believe that the risk statistics for large caps are distorted because of the extremely high level of flows into and out of passive instruments. This flow is causing indiscriminate buying and selling of EM stocks. As a result, when markets dropped this quarter our strategy held up very well compared to the broader indices. But in the up markets, our low beta has not been a source of underperformance. We have protected investors well on the downside and generated meaningful excess return through stock selection on the upside.

Q: You have a focus on aspiration and investing with companies making a social impact in emerging markets. Can you share an example of this?

While our primary job is to generate high risk-adjusted returns for our investors, we don’t believe it’s necessary to invest in exploitative businesses to do that. We feel that if you align yourselves with the aspirations of EM people for the long term, then you’ll get great structural growth. I would call this a virtuous cycle in EM which ultimately leads to better lives for emerging market populations. And there are investment opportunities at each stage of this cycle.

Everything starts with improving education, which is a big theme for us via private schools and companies with tutoring services, for instance. Better education leads to higher skilled workers with better wages. A better-educated workforce also enables entrepreneurs to create new and exciting business models in more innovative sectors. This then requires additional skilled workers who will then earn higher wages. Ideally, the cycle leads to more consumption and demand for goods, including technology, and services, like better healthcare—both areas we invest in. We also pay attention to environmental practices and, of course, require very strong corporate governance practices.

To learn more about her views on investing in China and Russia, as well as the Fund’s recent performance, read the full Q&A here.