Standard Life Investments

Through the Lens

Emerging Education - GEM Equities, China and Brazil

Our stock picking approach often results in the emergence of themes. Within our global emerging market portfolios we have identified a desire to improve educational standards as the emerging market labour force seeks to improve its skillset for the future. Investing in education has long been considered a driver of economic growth and can have a genuine impact in low-income countries. When considering the inequalities and challenges for emerging markets, including income distribution, it often comes back to educational standards. If countries can successfully provide better educational standards and develop skills that will fill gaps in the economy, this will ultimately contribute to the economic progress of the country as a whole.

While many investors focus on the topical growth stories of today, there are businesses that focus on improving employability prospects and seek to fulfil the requirements of future labour market policies. Such businesses provide compelling investment opportunities, particularly as they are often economically insensitive to shorter-term market trends. New Oriental Education (NOE) is the largest provider of private educational services in China, ranging from kindergarten to adult education both in schools and through distance learning programmes. NOE has diversified into the large and fast growing after-school tuition sector and has been innovative with its online capabilities. The market currently underappreciates the opportunities for growth in NOE since the SEC instigated an investigation into Variable Interest Entities (VIE) in China. While the SEC hasn’t objected to NOE’s structure, the scrutiny undermined confidence in the company. The consensus view is for some margin recovery, while we believe there is upside to the CFO’s guidance of 18-19%, plus 25% per annum sales growth. The company has secured its position as the country’s leading education specialist and can now focus on improving profit levels rather than opening new centres. We expect margins to rebound while top line prospects remain strong for this stock.

Brazil is also increasing its expenditure on education, although as a percentage of GDP its spend on education is below the OECD average. As a consequence of the very clear links between the level of education attained and the likelihood of employment in Brazil, we have a holding in Kroton, a leading mass market tertiary education provider. Education is a well owned sector in Brazil as government policies are currently supportive of education programs. The recent history of government interference in Brazil has been to the detriment of the sector which has made the market nervous. However, we believe the government elections in 2014, at which Dilma Rousseff of the Workers Party is likely to be re-elected, will remain supportive of education programs that are dependent on companies such as Kroton. Consequently the risk/reward profile of this stock remains attractive over the short to medium term in our opinion. Over time, we expect the company will experience sustained double-digit enrolment growth rates and margin improvement that will bring the market consensus more in line with our thoughts.

Our Focus on Change investment philosophy is particularly beneficial in emerging economies where growth is often accelerated and there is underappreciated change to exploit. We continue to actively seek out differentiators from the market consensus to add insight and value to our portfolios.

For further information on our global emerging markets fund range and capabilities (insert links as appropriate).