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.*Long-term approach
*Source: Thomson Reuters Datastream as at 31 March 2018.
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.
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.
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.
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.
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.