Templeton Emerging Markets shareholders make 48% in a year. Templeton Emerging Markets (TEMIT) generated a return of 47.8% on net asset value over the year to the end of March 2017. Shareholders did even better as the discount narrowed slightly leaving them with a return of 48.3%. By contrast, the MSCI Emerging Markets Index returned 35.2%. The dividend was maintained at 8.25p. The Board has reviewed TEMIT’s allocation of expenses and has decided that, with effect from 1 April 2017, 70% of the annual AIFM fee and 70% of the costs of borrowing will be allocated to the capital account. TEMIT secured a three-year £150 million unsecured multicurrency revolving loan facility with The Bank of Nova Scotia’s London Branch in January.
Manager’s report
31 March 2017 marked the end of the first full accounting year in which Carlos Hardenberg has been the lead portfolio manager. He says that “Emerging markets returned to form in 2016 and, following an encouraging start to 2017, many of the factors that originally attracted investors to this sector may be coming back into play, including stronger earnings growth, higher economic growth and robust consumer trends. Even in regions that are still going through adjustment and rebalancing, we are seeing improved visibility and increasing signs of robust underlying economic conditions such as low debt, stabilising commodity markets, reduced currency volatility and improving consumer confidence. Growing scepticism surrounding the timing and the extent of US President Donald Trump’s ability to enact a pro-business agenda was also countered by positive sentiment following signals from the Trump administration of potential moderation from its earlier protectionist stance on trade.
While TEMIT’s NAV benefited in sterling terms from a reduction in the exchange rate following the decision to leave the EU, we believe that the long term impact of Brexit on emerging markets will be limited. Generally speaking, emerging markets’ trade and investment is widely diversified and the amount of trade with the United Kingdom is relatively small for most emerging market countries.
The general landscape of emerging market corporations has undergone a significant transformation from the often plain vanilla business models of the past (tending to focus on infrastructure, telecommunications, classic banking or commodities) to a new generation of innovative companies that are moving into technology and higher value added goods and services. The information technology (“IT”) sector represents over 24% of the MSCI Emerging Markets Index: in fact, the top four constituents by weight are IT companies (as of March 2017). Further, this is a larger weighting than information technology’s proportion of the United States index. In comparison, in 2008, IT companies represented about 7% of the MSCI Emerging Markets index. Furthermore, we are starting to see the establishment of globally represented brands originating from emerging market countries.
The performance of emerging market currencies against the US dollar varied over the reporting period. The Mexican peso plunged to a record low against the US dollar in November but then recovered slightly to end the 12 month period down about 10%. Geopolitical issues weighed on the Turkish lira, which was down about 30% against the US dollar. The Russian rouble, Brazilian real and South African rand, however, strengthened. Waning confidence in the ability of the US government to stimulate growth or impose trade sanctions led investors to adopt a weaker view on the US dollar in the latter part of the year.
China’s economy remains on a fast growth trajectory and is expected to grow by 6.5% in 2017. Chinese stocks rose over the 12 month period, despite a decline in late 2016 caused by the Chinese renminbi’s depreciation and concern over potential protectionist policies from the incoming US presidential administration. Chinese internet stocks, in particular, came under pressure. The Chinese government, however, remains focused on its “Internet Plus” strategy, where the internet sector will play a key role in fuelling China’s next stage of economic growth. There are numerous opportunities for companies to expand locally, especially in attracting consumers from rural areas, where more than 40% of the population resides. Since the sell-off, valuations also became more attractive, leading TEMIT to invest in select internet related stocks.
South Korean equities performed better than their emerging market peers, driven by strong performance in IT companies. After growing 2.8% in 2016, the Korean economy is forecasted to expand by 2.7% in 2017. An accommodative monetary policy and reform implementation have further supported the economy and stock market. Politically, however, President Park Geun-hye was impeached and subsequently arrested over her alleged connection to a corruption scandal which is also said to include major listed companies. While this event resulted in increased uncertainty in the interim, over the longer term the investigation could lead the government and corporates to address some of the concerns around corporate governance and reforms, which would be in the interest of all shareholders.
A robust performance in the IT sector also drove performance in Taiwan, with the MSCI Taiwan Index reaching a 5-year high in March 2017. Momentum in the equity market was supported by solid demand for smartphone and personal computer components. Taiwan’s first quarter GDP growth exceeded expectations at 2.6% year on year, supported by domestic consumption and an increase in exports, compared to a 1.2% increase for 2016 as a whole.
Brazil stood out with a strong performance over the year as an expansionary monetary policy, approval of key reforms, appreciation in the Brazilian real, an improvement in business sentiment and generally positive economic data drove investor sentiment. Although we reduced our positions in Brazilian banks to diversify our holdings, we remain well positioned in financials as well as consumer related stocks in the country. Financial stocks are benefitting from positive sentiment towards the reform process. Banks are showing signs that the worst of the provisions for bad loans have been completed and we believe that we could see improved asset quality in 2017. In the consumer space, we continue to favour companies with low ticket cash sales that may be able to weather the weak consumer environment and whose balance sheets could benefit from the potential for a further decline in interest rates during 2017.
The uncertainties created by the new US administration in late 2016 led to lower valuations in Mexico, providing long-term investors such as TEMIT an attractive entry point. In our view, the valuations of both Mexico’s currency and stocks are compelling as country risk is falling and unemployment remains at decade lows. Inflation expectations, however, continue to be revised upwards and consumer confidence remains depressed. We believe that the financial sector looks attractive, with sound asset quality and structural growth opportunities. The Mexican industrial sector is also globally competitive and trading at low valuations. We are also monitoring other sectors, including the consumer sector.
Several economists trimmed their 2017 GDP growth forecasts for India, expecting a temporary negative impact on consumption from cash shortages resulting from a surprise move to withdraw large denominated currency notes from circulation in late 2016. However, growth is still expected to be 7.2% in 2017 and accelerate to 7.7% in 2018, making India one of the fasting growing major economies in the world. The country also recorded better than expected fourth quarter 2016 GDP growth of 7.0%. We continue to favour companies that we feel are well placed to benefit from higher per capita income and growing demand for goods and services, which, in turn, should support the earnings growth outlook for those stocks.
The Russian economy is expected to return to growth in 2017, after two consecutive years of contraction, supported by a rebound in oil prices coupled with recoveries in mining, manufacturing and agriculture. Energy, financials and IT companies continue to look attractive due to their appealing valuations. Higher oil prices and technological developments could further support the earnings recovery of these sectors.”
The top contributors to performance – Brilliance China Automotive, Buenaventura and Itau Unibanco.
Brilliance China Automotive manufactures and sells automobiles for the Chinese domestic market, predominantly through its joint venture with German luxury car manufacturer BMW. They expect luxury car demand to remain resilient and be supported by the continued rise of China’s upper middle class. Furthermore, they view the automobile market favourably, as penetration rates remain quite low in comparison with developed markets. They are of the opinion that the stock has an exciting outlook based upon new vehicle launches, increased financing revenues, a supportive macroeconomic environment and attractive valuations.
Buenaventura is the largest precious metals company in Peru and a major holder of mining rights in the country. It is engaged in the mining, processing, development and exploration of primarily gold and silver, but also copper, zinc and lead. A rebound in precious and industrial metal prices, and successful cost-cutting efforts resulted in a turnaround in operating performance in 2016 from 2015. The political environment in Peru has also stabilised and improved, somewhat, as a result of the election of a more pro-business government.
Itaú Unibanco is one of Brazil’s largest financial conglomerates. It operates across a wide range of segments, including asset management, insurance, wholesale banking, full retail operations, credit card and general corporate and personal lending. It announced solid fourth quarter results with an improvement in asset quality and lower provisions, and an increase in the payout ratio, driving the stock price in the latter part of the reporting period. A higher than expected income forecast for 2017 and expectations of continued improvement in credit quality, also benefited sentiment.
The top detractors from performance – Hyundai Development, Vale and Daelim Industrial
Hyundai Development is one of the leading residential property developers in South Korea. With a strong brand name – “I Park”, the company is one of the largest participants in the residential construction business. The company reported below consensus fourth quarter operating profits mainly due to higher expenses. Earnings from the housing division, however, remained strong. Sentiment towards the stock was also influenced by new housing market regulations and measures to curtail household loan growth.
Vale is a major mining company based in Brazil with ownership of very large reserves of iron ore and nickel as well as transport and logistics assets. The stock performed well during the reporting period on a rebound in iron ore and ferrous metal prices, supported by stimulus measures in China. TEMIT no longer holds this stock on concerns of uncertain Chinese demand, excessive supply, and a highly leveraged balance sheet given the low iron ore prices at the beginning of 2016. In addition, there is a pending class action lawsuit against the company over the collapse of a tailings dam in Brazil.
Daelim Industrial is a leading South Korean construction and petrochemical company. The company reported worse than expected fourth quarter operating profits mainly due to one-offs, including the booking of plant and civil engineering costs in domestic and international projects. Daelim’s architecture/housing and petrochemical divisions, however, continued to contribute to earnings. A gradual recovery in Daelim’s Middle East operations in recent years, higher oil prices and long-term housing demand in South Korea support their positive view on the firm and led them to increase our holdings in the stock during the reporting period.
TEM : Templeton Emerging Markets shareholders make 48% in a year