FINDING THE EARNINGS POWER ON THE ROAD TO RECOVERY

Chetan Sehgal, lead portfolio manager of TEMIT, and Andrew Ness, portfolio manager of TEMIT, provide an outlook for emerging markets along with an update on the portfolio.

Given the challenges of recent months, it is important to emphasise our long-standing investment philosophy.

We believe that alpha—which is the excess return over the market—is created by investing in companies which have sustainable earning power and buying them at a discount to intrinsic worth. In 1957, Sir John Templeton set our foundation in his belief that the best bargains are not stocks whose prices are down the most, but rather those stocks which have the lowest prices in relation to their possible future earnings power.

In navigating the COVID-19 pandemic and the road to recovery, we recognise some new realities of emerging markets along with many reasons to remain positive:

  • In times of severe financial and economic strain across markets and across the globe, many emerging markets institutions and central banks made aggressive policy improvements to support and facilitate recovery.
  • Consumption and technology provide secular growth factors for emerging markets, which were once dependent on commodities such as energy and materials in the early 2000s.
  • Innovation and “leapfrogging” of established business models have been driving EM companies forward.

OUR OUTLOOK

Despite the setbacks we have seen in the firs t quarter of the year, Emerging Markets have been able to bounce back. Given the preparedness of some countries in North Asia to deal with the COVID-19 crisis and signs of recovery in Q1, the strong YTD performance of China, South Korea and Taiwan was not unexpected. Looking forward, earnings outlook for companies and regions is dependent on a range of factors including healthcare outcomes and societies opening up as economies try to achieve some form of normalisation. We are bottom-up stock pickers and our focus is on investing in companies that will be resilient going forward.

We continue to focus on companies where we see long-term sustainability and earnings power, reflected for instance in holdings such as Taiwan Semiconductor Manufacturing Company (TSMC) or Tencent1. We think one of our advantages is our exposure to communication services and information technology within the portfolio.

Businesses that require physical contact, such as those providing onsite entertainment are likely to face significant challenges. It has also been a challenging time for financial institutions which face continued uncertainty. The impact of COVID-19 on consumer lending as well as small- and medium- enterprises has been felt nearly everywhere; for example, some banks in Brazil have seen their shares fall by more than 40%. Financials remain a key area of secular growth given the low levels of credit penetration across the asset class, and our holdings are primarily in dominant well-managed incumbent banks with strong capitalisation levels and robust deposit franchises, which should emerge stronger post crisis given their stronger positions versus smaller fintech players.

As co-managers we have half a century of combined experience investing in emerging markets through multiple previous crises, which provides perspective and insights in the current landscape. At a time when COVID-19 related measures have exacerbated investor concerns, we have taken a calm and rational approach.

ARE TECHNOLOGY, E-COMMERCE AND CONSUMPTION GROWTH THE KEY?

Innovation and technology have been the driving forces behind the recovery in emerging markets from the COVID-19 fallout. These areas have been a large focus for TEMIT over the years—and continue to be today. We continue to have a high conviction for innovative technology companies within our portfolio. Lockdown measures and social distancing has enforced the growth of effective digital communication, speedier food deliveries, enhanced online learning platforms, better entertainment streaming and online shopping.

We favour companies within South Korea, Russia and Brazil for e-commerce or food deliveries, for example, and, China’s leading video streaming platform (an equivalent of Zoom) for friends, families, and colleagues to connect. We have confidence that some of the trends and themes we have seen over the past few months to continue in the post-COVID-19 world. We anticipate that we will likely continue to have a large tilt toward information technology and communication services across both hardware and software names, and where technological leadership exists in countries.

Outside of e-commerce, the TEMIT portfolio also has exposure to the under-penetration of a wide range of goods and services, for example through credit products in Peru or personal care products in India. We are optimistic about the long-term outlook for consumption growth, particularly in the trend of “premiumisation,” where consumers in emerging markets are keen to upgrade the quality of goods and services that they consume as their wealth rises.

THE IMPORTANCE OF DIVERSIFICATION

In addition to seeking a well-diversified portfolio, we believe it’s important to keep our eyes peeled not only on the revenue side, but also how a company diversifies itself. For example, Tencent is not just a game company—it has elements of Netflix and Spotify too, so it is a broader entertainment company, and it also has a bank, so it’s also a fintech company.

Overall, TEMIT’s portfolio continues to reflect our investment beliefs investing in well-managed, well-rounded and sound business models with sustainable earnings power, trading at a discount to what we view as intrinsic worth. Our positioning is in well capitalised companies and we are cognisant of leverage with a clear preference for low or appropriately levered companies. With exposure spread across many different countries and sectors as well as access to some of the fastest-growing companies globally, we think our performance this year demonstrates the high-quality characteristics of our stock selection. Additionally, our role of stewardship and stakeholder engagement with the companies that we choose to invest in allows us to positively influence strategy and direction. Coupled with our team’s presence in over 15 countries and multiple time zones, we believe having teams on the ground helps us better understand what is happening in each of these countries.

Although the timing of the eventual global economic recovery is uncertain because of the lengthy lockdown period, we expect to see some recovery next year. A lot of that depends on the robustness and continuity of trends we have previously observed such as policymaking, the evolution of a country “preparedness” and recovery in battling the virus, consumer consumption and technology trends.

1As of 31/05/2020, Taiwan Semiconductor Manufacturing Co. Ltd. Represented 8.87% of the TEMIT portfolio while Tencent Holdings Ltd. represented 8.55%. Holdings subject to change. These securities do not represent all of the securities purchased, sold or recommended for clients, and the reader should not assume that investment in the securities listed was or will be profitable.