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.
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.
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.
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.
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