The Janus Henderson Global Emerging Market Equities Team provides an update on the Janus Henderson Global Emerging Market Equities All-Cap Strategy, covering performance, investment activity, portfolio positioning and their outlook for the asset class.
Q3 2018 performance and investment activity
Global emerging market equities, as measured by the MSCI Emerging Markets Index, were broadly flat in sterling terms in the quarter with the markets of Thailand, Qatar and Poland among the strongest, while Turkey, Greece and China were some of the weakest.
*Source: Factset, as at 30 September 2018.
Uni-President Enterprises (UPE) the Taiwanese Holding company that owns Uni-President China amongst other subsidiaries was a large positive contributor to returns. The business continues to demonstrate strong profit and cash flow growth as a result of its strong consumer food brands. In Taiwan, the business is also benefiting from its 5,200 convenience stores, which are well positioned to take advantage of the increasing demand for ‘last mile’ e-commerce fulfilment services.
Tata Consulting Services (TCS), the Indian multi-national information technology company, was also a significant contributor to returns. Demand for digital services from enterprise customers has been driving revenues and its experienced management team continues to demonstrate strong execution. We are mindful of the valuation at current levels and have started to slightly reduce the position to fund other high conviction ideas.
While we prefer to only comment on absolute performance of stocks held, we note that the strategy’s zero exposure to Chinese e-commerce giant Alibaba, which announced that Chairman Jack Ma will be retiring, was a significant positive contributor to relative performance. Within the strategy section of this update we provide further thoughts on this and the importance of alignment with those who own or control a business.
Tiger Brands, the South African-listed food manufacturing and consumer goods company, was the largest negative contributor to returns during the period. In addition to an adverse food safety issue affecting its meat processing business during the early part of this year, the company has been trading down to lower margin products in its milling and baking division. The pricing differential relative to private label brands has been improving as the competition is struggling to make acceptable returns. To that end we believe Tiger’s significant scale in this sector should allow an improvement in margins and returns in the medium term. At the current share price the market appears to be paying a very low multiple, on a cyclically low level of profitability, for Tiger Brands. We feel that the current valuation also does not give the company any credit for the strong cash flow dynamics of the business and strong balance sheet. We believe that the franchise is still fundamentally strong, and that the management team have the skills to improve returns at this time. Ultimately, we believe the long-term risk reward trade-off is attractive and the stock is worthy of a significant holding.
Uni-President China (UPC) was another significant negative contributor to returns during the period. UPC is a food and beverage business operating in China and a subsidiary of Taiwanese listed Uni-President Enterprise, in which we also invest. The stock had been one of the largest positive contributors to performance last quarter, and there was no significant fundamental news impacting the stock.
We bought a new position in Cipla, the third largest Indian pharmaceutical company, which has a focus on speciality, complex and generic pharmaceuticals within its key markets of India, South Africa and North America but also has a presence in more than 80 countries worldwide. Cipla’s objective is to provide access to quality and affordable medicines for patients. We are attracted by its strong ethical roots and conservative financial culture. Acquisitions by the company have been financed sensibly and the balance sheet is conservatively managed. We recognise that the broader generics industry has been facing challenges of late but these appear more than reflected in Cipla’s valuation, which does not seem to account for its leadership in key markets and geographies.
We acquired a new holding in VTech, a Chinese manufacturer of early learning products and a leading electronic manufacturing services company. The entrepreneur-led business has a strong track record of generating cash flows and producing strong returns, while managing its balance sheet in a conservative manner. The valuation has become attractive relative to the long-term growth prospects and high-return nature of the underlying businesses.
A new position was initiated in China Resources Beer following our assessment of the long-term opportunity created by the announcement of a tie-up with Heineken. This partnership offers the potential for the business to gain a dominant position in China’s high-end beer market utilising Heineken’s premium brands and marketing knowledge. The valuation looks attractive when set against the opportunity for significant revenue growth and improved margins.
We sold the residual portfolio position in Compañía Sud Americana de Vapores, the Luksic family-controlled Chilean shipping group. We had been reducing the position over the last six months because the benefits of consolidation within the global shipping industry had come to the fore and we are conscious that this is a very cyclical industry.
We have increasing concerns about the franchise strength of a number of telecommunication businesses as a result of regulatory and competitive pressures. This has led us to sell holdings in XL Axiata, the Indonesian-based mobile telecommunications services operator, and Empresa Nacional de Telecomunicaciones (Entel), the Chilean and Peruvian mobile telecommunications services operator.
Finally, we sold the portfolio holding in Natura Cosmeticos, an environmentally responsible Brazilian cosmetics and skin care manufacturer and retailer. The business model appears to be evolving to embrace a debt-funded, international M&A strategy and moving into physical retail in developed markets. There are a lot of moving parts with such a strategy, which potentially undermines the strength of the franchise while weakening the balance sheet.
Proceeds from the sales were invested in higher conviction ideas within the portfolio. Portfolio turnover is currently running at an annualised level of approximately 20% per annum* and is consistent with our long-term time horizon.
*Source: Janus Henderson Investors as at 30 September 2018.
For some time we have been highlighting our view that valuations and growth expectations for many good-quality Asian companies appear high. Unsurprisingly, this view is reflected in the strategy’s current positioning, which has a bias towards good-quality companies where expectations for growth appear less inflated and valuations more reasonable. Indicative of this has been our caution to those stocks with a predominantly local focus to the Indian consumer. There are a number of high-quality businesses on our watch list in this segment of the market, but there has appeared to be a degree of complacency in the valuations that made these equities unattractive. The Reserve Bank of India’s current tough stance towards both public and private sector providers of capital could administer a healthy dose of realism. It could also be an opportunity for those businesses with strong balance sheets and prudent risk management to take market share and provide us with some interesting investment opportunities.
Assessing sustainability: kicking tyres, not ticking boxes
We are long-term investors, with a fiduciary duty to be responsible stewards of our clients’ capital. We consider this responsibility in a holistic sense. Investment returns and environmental, social and governance (ESG) concerns are not separate entities – they are intertwined.
A company that abuses its customers, dumps toxic waste in a river or has questionable governance is providing a warning sign that it does not care about the long-term future of its business. That should ultimately be reflected in its valuation and long-term return potential. A business that simply seeks to improve its returns in the short term is likely to be caught out when customers, or the government, respond to these abuses. It is why we are uncomfortable about following the industry trend of placing an ESG title on our strategies. Sustainability is an indivisible part of our investment philosophy and process.
Watching from the side lines: VIE’s & Jack Ma
The strategy continues to have limited exposure to Chinese equities, and we find ourselves to be interested observers of the country, watching from the sidelines at this time. This is due in part to the presence of a large number of state-controlled enterprises, which raises concerns about their alignment with minority shareholders. We have also held worries that there are poor levels of protection for the rights of minority investors in a number of private Chinese companies that have utilised variable interest entity (VIE) structures to gain access to pools of equity capital in developed markets.
We therefore note with interest that Jack Ma has decided to head towards the sidelines himself by announcing that he will retire as Alibaba’s chairman next year. We are also aware that he has removed himself as one of the owners of its main VIEs, the vehicles that hold the company’s operating licenses and certain assets on the Chinese mainland. This means that there is no longer an identifiably significant holder of the equity and the controlling entities. It could be the case that this does not signal any significant change in the current status quo for these entities, but it is not a risk that we are willing to bear. Our preference is for companies with long-term owners, sometimes a family group, whose wealth is invested in the same equity as that available to third party investors. This provides comfort that our interests are aligned.
Following a period of optimism and rising valuations at the start of the year, appetite for emerging market equities has recently waned. It does appear that there are a number of fault lines opening up across the asset class, which we believe will remind investors of the value of those businesses that have allocated capital and managed their balance sheets sensibly. 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.