Investors have long recognised the compelling opportunity offered by emerging markets equities. Yet while returns from the asset class have considerably outperformed developed markets equities over previous market cycles, they have tended to be more volatile, severely testing investors’ resolve. Rather than attempting to time market allocations, or select regions or specific countries to over- or underweight, we believe that our proprietary emerging markets macro growth indicators and skill in identifying industry performance relative to them may offer investors a differentiated source of returns.

1. Lazard
Perspectives
Lazard
Perspectives
An Alternative
Perspective on
EM Investing:
The Case for
an Industry
Allocation
Approach
Investors have long recognised the compelling
opportunity offered by emerging markets
equities. Yet while returns from the asset class
have considerably outperformed developed
markets equities over previous market
cycles, they have tended to be more volatile,
severely testing investors’ resolve. Rather
than attempting to time market allocations, or
select regions or specific countries to over- or
underweight, we believe that our proprietary
emerging markets macro growth indicators
and skill in identifying industry performance
relative to them may offer investors a
differentiated source of returns.

2. 2
While country selection plays an important role for some
investors when allocating to emerging markets, the case for an
alternative approach is warranted, in our view. Emerging markets
constitute a highly heterogeneous asset class. Their disparate
and entangled economic drivers can give rise to unexpected and
pointed macroeconomic and political shocks at the country level,
raising the importance of managing country and currency risk in
the portfolio. By contrast, industry trends tend to be influenced
by clearer, more distinct drivers, such as competitive advantages,
and industry supply and demand dynamics.
We operate at the industry level as we believe this degree of
granularity amplifies the benefits associated with a sector versus
country approach to allocating capital in emerging markets.
However, to illustrate our points in this paper, we will use
sector-level classifications as we believe it is a good starting
point to understand the investment dynamics across different
business models. Sectors comprise industries with broadly similar
investment, economic, and productivity profiles.
We believe that by applying an industry-based allocation approach
to portfolio construction in emerging markets, while controlling
for country and currency exposures, investors may be able to target
significantly less volatile sources of returns (Exhibit 1) that have
been shown to be less correlated to traditional equities and fixed
income investments. This could lead to a material improvement
to the overall investor experience, by significantly reducing the
impact of uncertain macro factors and instead focusing on the
more visible drivers of industry returns. While an industry-based
approach can be applied globally, it is expected to be more
rewarding when investing in emerging markets, given that the
equity risk premium offered by the asset class is often significantly
greater compared to developed markets owing to the higher degree
of inefficiency.
The Importance of the Emerging
Markets Growth Cycle
A deep understanding of industry dynamics and the factors
that are likely to influence them are essential to exploiting
opportunities presented at the industry level, both long and
short, in our view. Industries have different economic sensitivities
to commodity prices, interest rates, and inflation. In addition
to top-down drivers, distinct fundamentals also have important
implications for industry-level performance, including:
• Competitive and regulatory landscape
• Innovation and disruption
• Inventory cycle
• Capital expenditure
• Credit availability
• Leverage
In order to guide asset allocation decisions and allocate to
industries at the optimal time, we believe the emerging markets
growth cycle plays an important role. We combine top-down
insights and expert bottom-up fundamental analysis to
understand the dynamics and drivers that determine industry
performance within the cycle.
Traditional growth cycle models tend to assume a linear
progression through four discrete phases within the growth cycle:
recovery, expansion, slowdown, and contraction. In addition,
the duration of a traditional growth cycle is considered in terms
of years and is often referenced in relation to the progression of
credit growth and capital expenditure in a particular economy.
We believe in an alternative construct, where a growth cycle
consists of six phases and progresses in a non-linear fashion, with
each phase playing out over approximately four-to-six months.
A six-phase model can, in our view, better explain the growth
narrative as well as offer a consistent framework to understanding
industry returns across emerging markets equities (Exhibit 2).
Our six-phase growth model—constructed using a large set
of high frequency macroeconomic indicators from different
emerging economies—tracks the transition across the stages
of the cycle in a more consistent manner when compared
to traditional models, in our view. For example, our growth
model can depict the transition from the recovery phase to
the expansion phase of the cycle, while also accounting for the
alternative scenario that can occur when a recovery fails to take
hold—as it repeatedly did in emerging markets between 2011
and 2015. Similarly, a slowdown phase does not always transition
into a contraction phase per the traditional model. Our growth
model accounts for periods when a slowdown is followed by
a re-acceleration in growth before slowing again, as emerging
markets experienced between 2004 and 2007.
Exhibit 1
Sector Returns Tend to Be Less Volatile than Country
Returns
0.0
0.1
0.2
0.3
0.4
0.5
0.6
20192013200720011995
Dispersion
Country
Sector
As at 31 May 2019
Shows the dispersion of monthly returns between the best-performing sectors
and worst-performing sectors and the monthly dispersion of returns between the
best-performing countries and worst-performing countries of the MSCI Emerging
Markets Index between 31 January 1994 and 31 May 2019.
Source: Lazard, MSCI

3. 3
Sector Performance at Different Stages
of the Growth Cycle
Our empirical analysis, which spans more than 20 years,
suggests that certain industries exhibit consistency in their
return rankings relative to the overall market at different
phases of the growth cycle. A thorough understanding of
industry dynamics, alongside comprehensive knowledge of
cycle characteristics, is required to fully appreciate the interplay
between these two factors. Our expert knowledge allows us
to deploy capital in those industries that we believe are most
closely tied to any given phase of the cycle.
For example, during the recovery phase of the growth cycle,
the information technology and consumer discretionary sectors
have consistently ranked in the top two sectors (Exhibit 3).
Conversely, the health care and communication services sectors
have consistently ranked in the bottom three during periods of
recovery, while utilities have also tended to score poorly.
Our empirical evidence shows that within this, at the industry
level, autos, consumer durables and apparel, and technology
hardware have consistently performed strongly during recovery
phases, as measured by our proprietary growth expectations
cycle indicator, while food retail, health care equipment and
services, have tended to perform weakly.
During a slowdown phase, sector leadership shifts dramatically
(Exhibit 3). For example, information technology switches
from being a top-ranking sector during the recovery phase of
the cycle to the lowest ranked during a slowdown. Conversely,
utilities and health care shift from the bottom ranks during the
recovery phase to the top ranks during the slowdown phase.
We believe fundamental drivers underpin these trends.
Technology hardware and semiconductors—the main industry
groups of the information technology sector and companies
that lack any meaningful pricing power—tend to be volume
driven. The high capital intensity of this sector translates into
a high degree of operating leverage such that in a recovery
volumes are expected to pick up significantly, causing an
increase in revenues and a disproportionate rise in profitability
when compared to any other point in the growth cycle.
Exhibit 2
Six-Stage Model Seeks to Closely Follow Transitions in EM
Growth Cycle
Contraction
Emerging
Markets
Growth Cycle
Double Dip
Re-AccelerationExpansion
Recovery Slowdown
For illustrative purposes only.
Source: Lazard
Exhibit 3
Sector Ranks during the Recovery and Slowdown Stages of
the Growth Cycle
CommunicationServices
ConsumerDiscretionary
ConsumerStaples
Energy
Financials
HealthCare
Industrials
InformationTechnology
Materials
Utilities
Recovery 7 1 8 6 3 9 5 2 10 4
8 2 9 7 3 10 6 1 4 5
8 2 9 6 3 10 5 1 4 7
9 1 8 5 3 10 6 2 4 7
9 1 7 5 3 10 6 2 4 8
9 1 7 5 3 10 6 2 4 8
9 1 7 5 3 10 6 2 4 8
9 2 7 5 3 10 6 1 4 8
Slowdown 1 2 8 5 6 7 10 3 9 4
5 6 4 2 7 1 10 9 8 3
5 8 4 2 6 1 9 10 7 3
4 6 5 3 7 1 9 10 8 2
5 6 3 2 7 4 9 10 8 1
5 6 4 2 7 3 9 10 8 1
6 5 4 1 7 3 9 10 8 2
8 5 4 2 6 1 9 10 7 3
7 5 3 2 8 4 9 10 6 1
As at 26 June 2019
Shows sector ranks through recovery and slowdown phases that have occurred
between September 1998 and April 2018 for the MSCI Emerging Markets Index.
Cumulative mean ranked using relative monthly returns against the MSCI Emerging
Markets Index.
Source: Lazard, MSCI

4. 4
Sectors Perform in Lockstep
Irrespective of Geography
The performance of the same sectors across different countries
can be highly correlated when adjusted for country impact, as the
same industries are largely subject to similar drivers and market
forces—irrespective of their country of domicile—and can be
similarly impacted by shifting investor preference (e.g., rotations
between cyclical and defensive sectors).
We reviewed the performance of the top- and bottom-performing
industries at different phases of the growth cycle relative to their
country benchmarks over the past 20 years. Our analysis shows
that the excess returns of such industries over their country
benchmarks exhibit meaningful correlation during the phases
when the performance of such industries is strongest or weakest.
We consider this as a good starting point to understand the
cross-regional similarities and differences in industry returns.
For example, during the recovery phase of the growth cycle, the
performance of health care stocks ranks poorly relative to other
industries, potentially offering short opportunities to exploit.
This characteristic can be explained by the defensive nature of
most of the constituents of this industry—a feature investors
have actively sought during weak growth environments and one
that becomes less attractive in high growth environments. We
find that on average, 50% of the country pairs in the health care
industry are 0.4 correlated. That is to say that the correlation
of the excess returns of the health care stocks relative to their
domestic benchmarks has been positive (Exhibit 4).
Similarly, during the contraction phase of the cycle,
communication services stocks tend to rank high in terms of
performance relative to other industries, potentially offering long
opportunities to exploit. Over the time horizon of our study, we
find that during the contraction phase of the cycle, 40% of the
country pairs exhibit a 0.4 correlation (Exhibit 4). The fact that
investors seek the defensive characteristics of this group during
periods of economic downturn explains this dynamic.
Exhibit 4
Sector Performance Tends to Be Correlated Irrespective of Geography
Recovery Expansion
Positive
0
20
40
60
1.00.50.0-0.5-1.0
(%)
Positive
0
10
20
30
40
1.00.50.0-0.5-1.0
(%)
Contraction Slowdown
Positive
0
10
20
30
1.00.50.0-0.5-1.0
(%) (%)
Positive
0
10
20
30
1.00.50.0-0.5-1.0
Double Dip Re-Acceleration
Positive
(%)
0
5
10
15
20
1.00.50.0-0.5-1.0
(%)
Positive
0
10
20
30
1.00.50.0-0.5-1.0 1.00.50.0-0.5
Consumer Discretionary Communication Services Health Care Energy
Information Technology Consumer Staples Industrials Utilities
As at 31 May 2019
Shows the correlation of excess returns of sector indices over their respective country benchmarks over two-year rolling periods of bi-weekly returns. We selected as an example
sectors that have the highest score (rank) in performance for that specific phase. Correlations are grouped by frequency for each of the six growth stages that have occurred between
1 January 1997 and 31 May 2019.
Source: Lazard, MSCI

5. 5
Putting It All Together
Understanding which phase of the growth cycle emerging
markets are experiencing and anticipating when it might
transition to the next underpins the successful application of
our growth model. We quantitatively interpret wide-ranging,
high-frequency macroeconomic activity indicators on a
recurring basis to categorise the prevailing growth environment
in emerging markets into one of the six stages. We update our
industry ranks after the conclusion of each cycle phase. We
acknowledge such industry ranks are backward-looking but
we find the consistency of the return ranks as offering a good
starting point for our analysis.
We further improve industry allocation by incorporating
valuation, sentiment, and positioning measures as a means to
describe the prevailing market backdrop and to confirm the
conclusions of our cycle analysis. Data-intensive quantitative
processes are also employed to monitor the interactions
occurring between cycle characteristics and industry dynamics,
and we continually track the evolution of these interactions.
This approach offers a framework within which to identify the
most attractive industries during different phases of the growth
cycle—from a long and short perspective.
Putting It into Practice
The Lazard Emerging Markets Long/Short Equity strategy
employs this industry allocation approach to portfolio
construction in a manner that combines fundamental and
quantitative processes to exploit industry divergences through
different stages of the emerging markets growth cycle. The
investment team believes this approach generates an uncorrelated
source of returns to emerging markets that minimises—or in
some cases even neutralises—style impact and country and
currency risk. Industry allocation (through large capitalisation
stocks that act as industry proxies)1 is expected to be the primary
source that drives excess returns, while efforts to minimise
market, country, and currency risk are expected to dampen
the volatility of returns over the longer term, especially in
comparison to the benchmark (Exhibit 5).
Conclusion
We believe an industry allocation approach to investing offers
a differentiated way to access uncorrelated sources of returns in
the emerging markets, irrespective of the prevailing economic
backdrop. Lazard’s Emerging Markets Long/Short Equity team
seeks to gain exposure to the right set of opportunities at the
right point in the growth cycle using its proprietary growth
model, which tracks the evolution of industry performance
through various market conditions. Potential opportunities are
fundamentally assessed to add further rigour to the investment
decision-making process.
By combining their expert knowledge of the top-down macro­
economic environment with detailed quantitative and qualitative
analysis of the fundamental drivers at the industry level, the team
seeks to profit from the divergence in industry performance in
emerging markets. By expressing ideas in a long/short equity
framework, it is hoped that investors may benefit from a broader
universe of opportunities that has the potential to generate stable,
attractive risk-adjusted returns less correlated to equity and fixed
income markets.
Through this differentiated approach, the team seeks to generate
attractive returns with only a third of the volatility of the broader
market over the long term, by minimising country and currency
impact and emphasising industry factor performance. Given its
strong focus on capital preservation and liquidity, we believe that
such an approach would serve as an attractive complement to
investors’ existing emerging markets exposures.
Exhibit 5
Industry Allocation Minimises the Impact of Macro Risks at
the Portfolio Level
Overall Volatility (%)Volatility by Factor (%)
0
20
40
60
80
100
Lazard EM
Long/Short
Equity Strategy
MSCI EM
Index
0
3
6
9
12
15
Lazard EM
Long/Short
Equity Strategy
MSCI EM
Index
Style
Market
Industry
Stock Specific Country and Currency
As at 30 June 2019
Forecasted implied volatility, annualised since inception of the strategy (1 October
2016).
Source: Lazard, Axioma

6. 6
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Notes
1 With a strong focus on liquidity. The Lazard Emerging Markets Long/Short Equity strategy focuses on stocks with a market capitalisation greater than $2 billion and average daily trading
volumes above $10 million.
Important Information
Published on 15 July 2019.
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opinions expressed herein are as of the published date and are subject to change.
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