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.
Q4 2018 performance review
Global emerging market equities fell in sterling terms in the fourth quarter of 2018, with the markets of Brazil, Indonesia and Hungary among the strongest performers, while Pakistan, Colombia and Mexico were the weakest.
Source: Thomson Reuters Datasteam as at 31 December 2018, in sterling terms.
Brazilian-based Duratex, a manufacturer of wood panelling, sanitary ware and metal fittings, and Bradesco, a banking and financial services company, were two of the largest positive contributors to the strategy’s returns during the period. This was not related to any specific bottom-up driven company news but rather the removal of uncertainty surrounding the outcome of the Brazilian presidential election. This was won by Mr Bolsonaro, a politician who mixes conservative populism with a liberal economic agenda. The Brazilian stock market reacted favourably to the election result as his economic policy is believed to be more business friendly and aims to reduce the role of the state. The valuations of both companies appear quite reasonable at this time.
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Newcrest Mining was also a significant positive contributor to the strategy. A presentation to investors during the period was well received due to the company’s belief that it can significantly improve recovery rates at its Cadia mine, where new mining technology is being adopted. The stock’s price has also been supported by an improvement in the underlying gold price during the period. This commodity is seen as providing a store of value during times of increased risk aversion.
Uni-President Enterprises, the Taiwanese Holding company that owns Uni-President China amongst other subsidiaries, was a key negative contributor to returns. The stock had performed very strongly during the early part of 2018 but results produced in the second half of the year were slightly weaker than those in the first. There are some signs that Tingyi, a rival food and beverage producer, is willing to be more price competitive, which is impacting the margins at Uni-President China. Over the long term we continue to believe that the business can produce strong profit and cash-flow growth due to its portfolio of strong consumer food brands.
We acquired a new holding in Raia Drogasil, which is a family-owned operator of the largest national chain of drugstores in Brazil. There is still significant opportunity for the business to grow and take market share as it has only 2% of the country’s drugstore base. Healthcare spending should continue to rise in Brazil as the population and economy matures. Near-term financial results and margins have been challenged as a result of weak consumer confidence and a shift to lower priced generics. This has bought the stock price down to an attractive level, which we believe does not account for the ability to double the store count and improve the return on invested capital over time as its store base matures.
Over the period we sold the entire holding in WEG, a Brazilian manufacturer and distributor of industrial machinery. The position was sold purely on valuation grounds as there has been a significant cyclical improvement in both the profitability of the underlying business and the valuation of the equity. We also sold the entire holding in China Resources Gas. This was partly on valuation grounds as the share price had been strong following good volume growth. We also had concerns developing over the long-term sustainability of the user connection fee so decided to redeploy the capital into higher conviction ideas.
Portfolio activity has been in-line with our long-term time horizon. Trailing twelve-month portfolio turnover is running at just under 20% for the All-Cap strategy.
Source: Janus Henderson as at 31 December 2018, based on a representative portfolio.
There has been no noticeable change in our investment outlook over the past quarter. We still view the valuations and growth expectations for many good-quality Asian companies as being too high. We do have to recognise though that there has been some tempering of expectations. A recent investment trip to India, however, highlighted that the opportunity for absolute return minded investors seeking high-quality businesses in this market is hindered by the starting valuations of these companies. There are some signs that around the edges the investment environment might become more challenging and provide an opportunity for long-term investors, such as us, to acquire at more reasonable levels. It is important to recognise that our aim is not to predict such events, but rather be in a position to take advantage of any dislocation should it occur.
Watching from the side-lines
Recent liquidity problems in India’s non-banking financial company (NBFC) area of the market highlight how risky a rapidly growing financial system can become. Weaker NBFCs are being significantly challenged as a consequence of them growing books of low-quality assets that the wholesale market is no longer willing to fund. A number of leading private banks have less risky funding models and are able to use the liquidity squeeze to acquire high-quality assets from distressed sellers. Sadly, current valuations of these good-quality banks are too high for us.
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India’s domestic equity opportunity
There are elections in India in 2019. During a recent trip it was clear that the incumbent is less popular on the ground than many investors willing to pay India’s sky-high valuation multiples may believe. Policies like demonetisation and the introduction of a new goods and services tax (GST) regime have annoyed people. Also, the weak currency has crimped the spending power of India’s large population of low-income earners. An election upset could create an interesting opportunity for long-term investors. In the event of a significant market correction, we believe that India would be a stock-picker’s paradise, with its deep and broad market containing many high-quality listed companies. Aside from the leading private banks, we would be excited to get an opportunity to purchase at more reasonable prices some of the leading consumer-facing businesses in the country, which are well run and have scope to grow for many years. Some listed multinationals could also make for good long-term investments if valuations were to correct. Unilever, Heineken, Nestlé and Colgate all have high-quality Indian franchises listed locally. Hindustan Unilever, for example, currently trades on a forward (March 2019) price to earnings multiple of more than 60 times* meaning a significant de-rating would be required for us to feel able to buy this good-quality company at a reasonable price.
*Source: Bloomberg as at 31 December 2018
Outside of Asia, particularly in Africa, valuations look more reasonable, as long as one is prepared to take a long-term view. As headwinds abate, many high-quality African businesses should return to growth and current valuations do not appear to reflect this. We have a slightly less sanguine view with regards to the opportunity in Brazilian equities following the rally in the local market after October’s election. Valuations appear fair, particularly given the inevitable social challenges that will accompany the new President’s liberal economic agenda.
Notes from the road in Taiwan
Recently, the team visited Taiwan, a country that we have consistently found to be a source of high-quality companies over the years we have been visiting. Taiwan sits in an interesting strategic position given its proximity as well as its economic and political ties with China, a short distance away across the Taiwan Strait. The country has a population of approximately 23 million people and is a global hub for high-tech manufacturing.
Self-governed Taiwan, however, has never been formally declared independent from China and in January 2019 Chinese President Xi Jinping stated Taiwan must and will be reunited with the mainland. This complicated relationship casts a shadow that hangs over many of the Taiwanese companies that we have spoken to.
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We continue to think about the risks posed to the companies that we own and recognise that the tense relationship between China and Taiwan has the potential to cause disruption. What we have learned over many years, however, is that by backing high-quality, resilient businesses, with managers and owners who have demonstrated integrity over long time periods, we believe we can significantly reduce the risk to our investments from events that we can neither predict nor control and ultimately grow capital over time.
Following a period of optimism and rising valuations at the start of the year, appetite for the emerging market asset class has waned over the period. It does appear that there are a number of fault lines opening up across the regions, and more broadly globally. 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.
Finally, it is probably worth noting that as liquidity continues to be removed from the global financial system, there are some signs of sanity returning to the allocation of capital. We noted during a trip to China last year the masses of rental bikes from the likes of Ofo and Mobike scattered everywhere, literally in large piles at the side of the road. This was as a result of a number of companies competing against one another to be part of the ‘sharing economy’. Recent news reports indicate cash-flow problems and insufficient return on capital are forcing the founder of Ofo to consider bankruptcy. We believe that if such a shake-out occurs in these and other related areas that have put growth ahead of returns, it would remind investors of the value of those businesses that have allocated capital and managed their balance sheets sensibly.