EM equities: positioning and opportunities (Q2 2018 update)

24/04/2018

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Glen Finegan, Head of Global Emerging Market Equities, provides an update on the Janus Henderson Global Emerging Market Equities All-Cap Strategy, covering performance, investment activity, portfolio positioning and his outlook for the asset class.

Q1 2018 performance and investment activity

Concerns relating to high stock market valuations and US central bank policy, a potential trade war between the US and China and increasing geopolitical tensions in the Middle East led to increased volatility and global equity markets falling during the quarter. Overall, emerging market equities also fell (2.2% in sterling terms), with the Philippines, Poland and Indonesia among the weakest performing markets, while Brazil, Pakistan and Egypt were some of strongest.*
*Source: Thomson Reuters Datastream as at 31 March 2018.

Long-term approach

We believe the best opportunities can be found by following a bottom-up, stock picking approach and maintaining a long-term investment time horizon when assessing the value of companies. We also believe emerging market investing requires conviction. Rather than simply owning the largest index constituents, we seek to maintain a high-conviction portfolio of reasonably valued, high-quality companies reflecting only our best ideas.

Understanding risk and taking advantage of volatility through the allocation of capital is a key requisite for any successful business leader. Over a long period of time, chief executive officers and business leaders have to do two things well. They need to manage the business to maximise the sustainability of their competitive advantage and profit pool, and they must deploy the capital produced by these profits to ensure continued business success. When operating within emerging markets the rewards and perils for success or failure in allocating capital are often magnified.

This is why we prefer to spend more of our time gaining comfort with the quality of management and franchises by developing an understanding of corporate histories and assessing their capital allocation skills.


Source: iStock

Financial results of Brazilian companies we hold, such as Duratex, are beginning to show evidence of cyclical recovery. Duratex manufactures and sells reconstituted wood panels and laminated floors through its wood products division, and bathroom fixtures and fittings through its Deca arm. Bradesco, a leading Brazilian commercial and retail bank that is a patient allocator of capital, was a strong contributor to the return of the portfolio. Uncertainty, however, about upcoming elections has kept valuations reasonable.




Understanding risk and taking advantage of volatility

Tiger Brands, a South African packaged goods company, experienced significant weakness in its share price during the period. This was caused by concerns about Enterprise Foods, a subsidiary of Tiger Brands, being affected by the listeria outbreak in South Africa. Enterprise Foods’ meat business comprises less than 5% of Tiger Brands’ profits.

We added to the portfolio position in Tiger Brands on the back of the fall in the company’s valuation. As long-term investors our belief in the underlying quality of Tiger’s management, franchise and financials gives us the confidence to add to the holding at this time. Bad things can happen to good companies. We believe that the company’s response demonstrates the ability of management to handle a difficult crisis with professionalism, transparency, speed, and sincerity. We understand this crisis is still unfolding, which will likely result in a financial cost for Tiger and reputational issues in the eyes of the consumer. It is our view that Tiger Brands will move forward from the current crisis a stronger franchise, able to capture the growth of consumer goods consumption across the African continent.

Detractors to returns also included Newcrest, the Australian-listed gold miner with assets in Australia, Papua New Guinea, the Ivory Coast and Indonesia, and PZ Cussons, the consumer-goods group, which has brands established in Africa, as well as countries such as Indonesia and Thailand.

Portfolio activity

Our portfolios will continue to be shaped by seeking to identify companies with long-term owners whose wealth is invested in the same equity as that available to third party investors. This provides comfort that our interests are aligned.

We initiated a new portfolio position in Vinda International, a tissue and personal products company that is headquartered and operates in China. The founder and Chairman of the business still has a significant stake in Vinda, which is majority owned by Essity, the Swedish family-owned global tissue business. We are attracted by the presence of long-term oriented owners, the likely continued growth in the Chinese tissue and personal products market and the potential for improved free cash flow and returns at an attractive valuation.

A new holding was also initiated in Remgro, a South African holding company controlled by the Rupert family, which has a long history of risk-aware cash flow and capital growth, Remgro has more than 30 investee companies (listed and non-listed) that are predominantly operating on the African continent. We are attracted by the current valuation and the company's focus on efficient and long-term focused capital allocation.

Strategy


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The portfolio has a bias towards companies listed in markets that bore the brunt of commodity declines such as Brazil, Chile and South Africa. The economic shock resulted in weaker currencies, more attractive valuations and the tantalising possibility of improving national governance. During 2016 emerging middle class voters in South Africa delivered a message to the ruling ANC party, demanding less corruption and more focus on improving living standards. Following Cyril Ramaphosa’s appointment as President we have observed an improvement in the confidence of South African company management teams and expect to see private investment pick up after a long period of stagnation.

Exposure to Chinese equities remains limited. This is due to the presence of a large number of state-controlled enterprises, which raises concerns about their alignment with minority shareholders. Against a policy backdrop focused on deleveraging there is also a significant risk of large, cash rich private Chinese corporations being required to perform ‘national service’ rather than focusing on sustainable growth and returning profits to shareholders. We have, for example, observed some questionable capital allocation decisions by China’s leading internet companies during the last 12 months. While opportunities within China for long-term investors with an absolute return mindset have been limited, our team is building a watch list of interesting companies listed on the ‘A’ share market, although currently high valuations mean we have yet to invest.

Outlook

We believe that it is important to stick to our belief of not compromising on quality, maintaining a long-term investment approach and applying a strict valuation discipline. While we are concerned by currently high levels of appetite for risk within emerging markets, with a long-term perspective we remain positive about the opportunities for equity investors within the asset class created by supportive demographic trends, such as population and middle income consumer growth, within some parts of the developing world.

The above stock examples are intended for illustrative purposes only and are not indicative of the historical or future performance of the strategy or the chances of success of any particular strategy. Janus Henderson Investors, one of its affiliated advisors, or its employees, may have a position in the securities mentioned in the report. References made to individual securities should not constitute or form part of any offer or solicitation to issue, sell, subscribe or purchase the security.

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

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Important information

Please read the following important information regarding funds related to this article.

Janus Henderson Emerging Markets Fund

Specific risks

  • Shares can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
  • This fund is designed to be used only as one component in several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.
  • Emerging markets are less established and more prone to political events than developed markets. This can mean both higher volatility and a greater risk of loss to the Fund than investing in more developed markets.
  • Changes in currency exchange rates may cause the value of your investment and any income from it to rise or fall.
  • If the Fund or a specific share class of the Fund seeks to reduce risks (such as exchange rate movements), the measures designed to do so may be ineffective, unavailable or detrimental.
  • Any security could become hard to value or to sell at a desired time and price, increasing the risk of investment losses.

Risk rating

Janus Henderson Emerging Markets Opportunities Fund

Specific risks

  • This fund is designed to be used only as one component in several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • This Fund may have a particularly concentrated portfolio relative to its investment universe or other funds in its sector. An adverse event impacting even a small number of holdings could create significant volatility or losses for the Fund.
  • The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.
  • The Fund may use derivatives with the aim of reducing risk or managing the portfolio more efficiently. However this introduces other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • Emerging markets expose the Fund to higher volatility and greater risk of loss than developed markets; they are susceptible to adverse political and economic events, and may be less well regulated with less robust custody and settlement procedures.
  • Shares can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
  • If the Fund holds assets in currencies other than the base currency of the Fund or you invest in a share class of a different currency to the Fund (unless 'hedged'), the value of your investment may be impacted by changes in exchange rates.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.

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