Portfolio Manager Archie Hart reviews Q1 2019 for Emerging Market Equity and provides his outlook going forward.
Hello. It is Archie Hart. I run the 4Factor Emerging Market Equity Strategy for Investec Asset Management, just commenting on Q1 performance for the strategy.
Before talking about the strategy let’s talk about the market. Emerging market equities had a very strong quarter, up 10%, with China up 18% and also up 12%.
Notably, only 6 out of 24 countries outperformed and only 4 out of 11 sectors. So it was a very narrow quarter, focused very much on China. What happened with China was that the stimulus the government is applying there came through. We saw a rebound, particularly in the A-share market, and I think the market became more optimistic about the positive conclusion to the trade talks.
Sector-wise, consumer discretionary stocks were up 20%, real estate up 16% and technology up 13%. What ties those sectors together is a high element of China exposure. So really the key to performance in the first quarter was an underweight in China. As you know, we have been relatively positive on China for some time and this came through very significantly this quarter.
Our strategy outperformed for the quarter as a whole. One of the highlights was that our A-share exposure came through very strongly. For example, Sany Heavy, the Chinese manufacturer of excavators, was up 57% in Q1. Where we held the A-shares in Conch Cement, they are up 33% and Weifu Hi-Tech, which we bought during the quarter, was up 11%. So China was very positive and stock selection in the A-share markets was very positive.
All 5 of the best performers were Chinese stocks. WH Group, the Chinese American manufacturer of pork, saw a significant recovery, again partly I think on the market becoming more enthused about the benefits from a trade deal. Ping An, the Chinese insurance company, benefitted as it is essentially a geared play on financial markets improving.
On the more negative, some of our China stocks did underperform, so Geely and Alibaba, for example. Hindalco, the Indian aluminium company, suffered I think from a large acquisition which would tend to weaken the balance sheet. We have sold the stock. KB Financial, the Korean bank, suffered from continued government squeeze on the financial sector and we sold that as well.
Looking at current positioning, we remain overweight China. We have recently taken profits in some of the more extended names, but we remain positive on the market and we think it is still a very rich place to pick stocks. We’re also overweight Thailand, as well as South America to a smaller extent. The underweights are Korea, where we struggle to find good stocks in a very challenged corporate governance environment; Taiwan, where we think much of the hardware sector looks challenged; and India, where we think we have an election coming up, which raises risk in that market, which is also equally highly valued as well.
If we look at sectors, we’re somewhat positive on financials. I think a more muted interest environment is not so good there; positive on materials, where we see a lot of very cheap companies with managements doing the right thing, paying down debt and returning cash to shareholders; and positive on technology, where we see some decent interest around the Indian IT services companies which continue to benefit from stock-specific improvements and also a generally firm demand environment for their businesses. The semi-conductor cycle is fairly weak at this point but we believe the market is now looking through that at recovery and we are seeing those stocks holding up surprisingly well.
It’s interesting to step back and look at recent market performance. Q3 2018 was a relatively flat quarter. The final quarter of 2018 was very poor, with much capitulation selling and very disorderly markets. The first quarter of 2019 was very strong. So pull that together, I think it is interesting to note that markets are broadly flat over the last 9 months in emerging market equities.
I would say the negative is that Q1 we saw the US yield curve invert. That is typically a sign of a US recession a year or two out, so we need to be cautious. We need to be very astute around how we manage risk in the individual companies in the portfolios we hold.
More positively, Q4 2018 saw signs of hope on the corporate earnings side. Earnings were missing consensus by about 1%. Interestingly, in China they beat consensus by about 3%. So expectations are now sufficiently low that corporates are beginning to sort of beat or at least match expectations.
I think the environment going forward is going to be difficult, but we are looking now at more muted market expectations and valuations which are still attractive. So it may be a difficult and volatile year, but I think the outlook is certainly a little bit better on the corporate earnings side. We believe this is profoundly important for the direction of markets.
The value of investments, and any income generated from them, can fall as well as rise. Where charges are taken from capital, this may constrain future growth.
Past performance is not a reliable indicator of future results. If any currency differs from the investor's home currency, returns may increase or decrease as a result of currency fluctuations.
Investment objectives and performance targets may not necessarily be achieved, losses may be made.
No representation is being made that any investment will or is likely to achieve profits or losses similar to those achieved in the past, or that significant losses will be avoided.
Specific risks: Currency exchange: Changes in the relative values of different currencies may adversely affect the value of investments and any related income. Derivatives: The use of derivatives is not intended to increase the overall level of risk. However, the use of derivatives may still lead to large changes in value and includes the potential for large financial loss. A counterparty to a derivative transaction may fail to meet its obligations which may also lead to a financial loss. Equity investment: The value of equities (e.g. shares) and equity-related investments may vary according to company profits and future prospects as well as more general market factors. In the event of a company default (e.g. insolvency), the owners of their equity rank last in terms of any financial payment from that company. Emerging market (inc. China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.
Calendar year performance (%)
Strategy (Index*): 2018: -5.8 (-5.1), 2017: 31.5 (27.1), 2016: 8.8 (11.7), 2015: -3.1 (-4.3), 2014: 8.2 (6.9)
Source: Investec Asset Management, 31 March 2019. Performance stated as gross of investment management fees in AUD. Gross income reinvested. *MSCI Emerging Markets Index NDR.