Ian Beattie from NS Partners, Portfolio Manager of the Nedgroup Investments Global Emerging Markets Equity Fund reflects on how emerging markets have fared during the crisis.
While we prefer to have outperformance on a positive nominal number, we were on the right side of the index with performance at -13.8% versus the MSCI Emerging Markets Index return of
-16.6% for the period. We see policy response being super bullish and unprecedented. There are going to be dramatic changes for the future – taxes and deficits and more government interference.
We are going to have to get used to investing in this environment with more government interference, possibly to deal with the unintended consequences of their policy response on top of the Coronavirus crisis. Our thinking in terms of looking for bargains in beaten down sectors is not to buy low quality but there are some industrials and quality companies that will give you some exposure to that upside, which we’re starting to look at now.
Emerging vs developed markets
Emerging markets have not behaved the same as the developed markets. Since the start of 2020, developed markets’ quality and growth have led the way, especially in the tech and health sectors. Quality in emerging markets has not performed as well, probably as a result of some of the staples that have not done well, especially in India. In terms of performance by countries, China’s response was eventually draconian and it is coming out of the crisis relatively quickly. Factories are back up and running, restaurants are open, however, productivity is not as high even though everyone is back at work because of distancing and other rules. We were overweight in China, which worked for us. India is also starting to bounce back, but Brazil, where we were underweight, was doing very poorly in the early part of this crisis. Mexico, where we’ve been very bearish for quite some time, but have had almost no weighting for this period, is one of the worst performers. South Africa has also been a very poor performer. Taiwan has been the best emerging market performer where we had a small weighting in the tech sector, but we’re starting to spread out from there into other high quality, tech names.
Attribution by country
Stock selection has been very positive over this period with some positives on the country selection as well. We had good stock selection in emerging Asia - very strong in China (2.04%), but negative in India (-1.26%) and Thailand (-0.54%) where we have hotel exposure. In Emerging markets Europe, Middle East and Africa, we had good performance from Poland (0.74%) with our holding in software gaming company CD Projekt. Country selection has been positive in Latin America (0.85%) and South Africa (0.53%) as well as cash (0.87%), which gave us a bit of help. Buying a few stocks in India after the collapse also helped.
Contributors and detractors
Top performers in the portfolio were China Education Group, a higher education college, university and older age group school. It has the strongest financials in the sector, good governance and with best in class reputation. Next was Conch Cement, a regional cement producer with strong market position and pricing that makes a decent return on invested capital throughout the cycle. It is profitable both in good and bad times. Third was Accton Technology, which has done very well for us with IT being a beneficiary of increased demand for datacentre equipment and 5G investment. Fourth was Chin Feihe, an infant milk formula co in China, which has delivered for us and finally, LG Chem Limited, which makes batteries for electric vehicles.
The detractors were Minth Group Ltd which is in the global auto sector and isn’t benefitting from Asia being first in and first out, Minor International Pcl-Foreign, a hotel company as is Lemon Tree, Branco Brandesco-ADR is a bank and, while we’re underweight in banks, they’ve done very poorly. Lojas Renner is a very high quality Brazilian fast fashion retailer. It has a very strong balance sheet and really good mall locations and will be a good investment as the Brazilian economy bounces back and the middle class gets wealthier.
We look for companies with higher levels of profitability that are growing faster than the index. We’ve been outperforming lately so the momentum is positive. Leverage is negative, which means that our companies have less debt than the index as a whole.
Transactions during the period
We rotated into LG Household & Health Care (1.67%) away from Amore Pacific because we prefer the internet focused distribution model and product mix of LG H&H at times like this. We bought into Quanta Computer Inc (1.58%). They are a beneficiary of data centre capex growth as well as enterprise notebook sales for the work-from-home growth and is a very good and safe stock in the technology space. Hiwin Technologies Corp Industrials was another purchase of 1.29%. It is more cyclical with a very good return on capital and factory automation play and we see those trends accelerating as well. NAVER Corp (1.22%) is an online gaming business with their social media division popular in Asian markets. It is not as good as the US or Chinese online businesses but is good with exposure in Korea and Japan. Ulker Biskuvi Sanayi As is a Turkish biscuit and confectionary producer with strong sales and growth throughout Middle East.
We sold some Airtac International Group (1.95%) to keep the IT industrial-linked exposure down. We wanted to reduce our cyclical exposure to industrial capex as the global impact of Coronavirus escalates. We sold our position of 1.58% in Reliance Industries Energy to reduce our energy exposure. JD.com Inc-ADR (1.50%) is a Chinese online retailer, which we sold to reduce Consumer Discretionary exposure as lockdowns took hold. Win Semiconductors Corp (1.05%) was sold to reduce cyclical semiconductor exposure in response to the crisis. We took profit in Mediatek which is a very strong player in 5G fabless chip design and we have in fact since topped this up again as the price fell after we’d sold it.
The unprecedented fiscal and monetary stimulus will drive a strong recovery in H2 2020/2021. Equity markets will discount return to growth as new Covid 19 infections peak. We will remain overweight in IT, internet, consumer discretionary and staples and underweight in materials, telecom, autos and energy but adding to this second group with high quality stocks as we start to look for the recoveries.
We will be overweight in China and Taiwan and underweight in India, South Africa and GCC markets although we are looking for opportunities to add good quality names in India as their extreme lockdown starts to become more sensible. We will retain our focus on high quality, high ROIC companies and will look for bargains in quality and growth companies. The EM checklist (E7 above G7 real money growth, low absolute valuations, above DM earnings revision ratio, an upswing in global industrial cycle, positive real money, upswing in commodity prices, falling USD) is becoming bullish, but we need to watch out for the USD in the short term.