EM equities: positioning and opportunities (Q3 2018 update)

17/07/2018

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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.

Q2 2018 performance and investment activity

Global emerging market equities, as measured by the MSCI Emerging Markets Index, fell 2.1% in the second quarter of 2018. The markets of Argentina, Brazil and Turkey were the weakest, while Colombia and India were among the strongest (all returns in sterling terms).*

*Source: Datastream, as at 30 June 2018.

Members of our investment team have just returned from a company research trip to Brazil and Argentina. They found a degree of nervousness about forthcoming elections but also real signs of an improvement in consumer and business confidence.

Brazil’s recent recession was the harshest in living memory for a number of companies that we met. A period of deleveraging has meant that, with a potentially more stable political environment, there is significant room for improvement in many areas of business related activity.

During the period Bradesco, a leading commercial and retail bank, and Duratex, a producer of industrialised wood panels and sanitary ware, were two of the largest negative contributors to returns. The strategy has benefited strongly from the strength of these two Brazilian stocks over the past three years. Our perception is that there has been little in the way of company specific news or events to cause the recent share price weakness. In fact, we believe that Duratex’s recently announced joint venture in viscose fibre production with Austrian firm Lenzing moves it higher up the value chain and should be beneficial to long-term returns.

The share price weakness appears related to concerns regarding Brazil’s forthcoming elections. With no politician yet to take a clear lead in the presidential election polls, political uncertainty has led to weakness in the local stock market. There has also been a nationwide truck strike over fuel prices and the public mood is febrile.

Tiger Brands, a South African listed food manufacturing and consumer goods company, had an adverse event in its meat processing business – Enterprise Foods – during the early part of this year and the impact has continued to linger. The subsidiary accounts for less than 3% of profits but its involvement in a listeria crisis has led to a class action law suit. In our view, the business has the financial strength and management team to cushion this blow. Long term, the franchise, returns and stock multiple can recover from what are now low levels. We added to the position at the end of the previous quarter and the company remains one of the portfolio’s largest holdings. 

Notes from the road in India

The team recently visited Mumbai as part of a trip through India, Sri Lanka and the Middle East. Mumbai is the second most populous city in India behind New Delhi, according to the United Nations. It has become a centre for financial services in the country and was host on this occasion to a conference run by a local bank, Kotak Mahindra.

The importance of trust

In a speech to welcome delegates, the chairman talked about the development of the mutual fund industry and the need for financial services to earn the trust of the people, many of whom were putting their money into markets for the first time. For us, as investors in the banking sector, trust is a key component of trying to understand the financial services industry, as trust that can take many years to build can be destroyed in an instant as more developed markets proved in 2008.

In many industries we believe innovation is key but in financial products it tends to make us nervous as the core services that customers need has not changed since the advent of modern banking in Italy in the 12th century. The rise of computers, however, has meant that the only limit to creating new financial products is the imagination of the user.

Keep it simple

The approach of the Housing Development Finance Corporation (HDFC), an Indian financial conglomerate that was founded in 1977 and pioneered housing finance in the country, is to be applauded. When asked what had changed with the rise of computers in how they made loans we were reassured by the answer: “Nothing”. The business of lending is not a complicated one but short-term incentives to keep up with your peers repeatedly lead to cycles of boom and bust. HDFC has become more complex but the conservative lending culture has not changed.

Portfolio activity

We 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 our best ideas.

We sold the portfolio position in Chroma ATE, a Taiwanese manufacturer and distributor of electronic testing and measurement instruments. This is a high-quality business which has experienced strong revenue growth and a significant improvement in operating margins over the past three years as a result of strong demand in its end markets and a competitive suite of products. The company’s valuation has re-rated significantly and now appears to be full, limiting the potential for further absolute gains. The company will be added to our watch list and we will continue to monitor the business and its valuation.

The position in Antofagasta, a Chilean copper and gold miner that is majority owned by the Luksic family, was also sold. We continue to believe in the long-term quality of the asset base, as well as the capital allocation skills of the management team and family. While the stock has reached our long-term valuation target we will continue to monitor the company.

Strategy

We have made no significant change to our outlook or strategy over the period. We take a long-term approach to allocating capital and this can be illustrated by the strategy turnover, which is running at an annualised level of approximately 14%*.

*Source: Janus Henderson Investors, 12-month turnover of a representative global emerging market equities portfolio as at 30 June 2018.

For some time now we have been highlighting our view that valuations of many good-quality Asian companies are too high and, unsurprisingly, this has been reflected in the strategy’s current positioning. The portfolio has a bias towards companies listed in markets that have recently faced periods of economic hardship and political instability, such as South Africa and Brazil.

High-quality businesses within these markets can be found at attractive valuations. There is the potential for improved consumer confidence and economic activity over the long term, albeit we recognise that this is starting from a low base today.

While the opportunity set within China has been limited for long-term investors with an absolute return mind-set, our team is building a watch list of interesting companies listed on the A-share market. We have held concerns over whether A-share listed companies will return to a habit of suspending trading in their shares during periods of market weakness and, therefore, we are monitoring the current situation. The long-term attractiveness of this market would be greatly increased if prices could be maintained through both peaks and troughs of market cycles, so we will continue to monitor the situation.

Outlook

Appetite for emerging market equities has waned over the period, which contrasts with the positive appetite and investment flows that occurred at the start of the year. We believe that such abrupt changes in enthusiasm highlight the importance of a consistent investment philosophy and approach. We are mindful of the need to stick to our belief not to compromise on quality, to maintain a long-term approach and to apply a strict valuation discipline. With a long-term perspective, we remain positive about the opportunities for equity investors created by the structural trend of rising living standards in some parts of the developing world.





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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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.

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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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