Portfolio Manager Archie Hart reviews Q2 2019 for Emerging Market Equity and provides his outlook going forward.
Hello, this is Archie Hart Portfolio Manager of the 4Factor Emerging Markets Equity Strategy, reporting on the second quarter of 2019.
The second quarter was very much like the last year. The benchmark was up 0.6% for the quarter but that incorporated a flat April, a very down May and a very up June, resulting in a flat quarter as a whole.
For the last 12 months until June, markets have similarly exhibited a lot of volatility and very little returns. So US dollar returns in the 12 months have been all of 1.2%.
Looking at the different regional performances:
Asia was actually down in that period, led by China, down just under -4%;
Eastern Europe was robust, up 13%, including Greece in the run-up to an election where market-friendly candidates were elected. Russia also gained, mainly on a rerating of the index heavyweight Gazprom;
South Africa was robust, up 7%.
South America gained 4% and Brazilians saw continued support around reform.
The major news item of the quarter was obviously the continuing US-China trade dispute, which caused various ups and downs, but the quarter ended with the meeting of President Trump and President Xi on the periphery of the G20. At that meeting, Trump delayed tariffs on a remaining US$300 billion plus of China’s exports to the US and also exempted Huawei temporarily from further moves to handicap that company. This seems a tactical move rather than any major change of strategy but it is positive nonetheless that the avenues for negotiation remain open. I think a near-term solution is quite unlikely but a longer-term solution is still in the interests of both parties.
Finally, one interesting item was the move by US Senator Marco Rubio to introduce the Equitable Act in the US Senate. This would lead to Chinese ADRs effectively being forced to relist elsewhere, potentially either in Hong Kong or China. One of the strange side effects of this bill might be to make the Chinese equity market even more significant and even more relevant for China, which may not be the impact that Mr Rubio intends. In that regard, it’s notable that Alibaba announced a secondary listing in Hong Kong, which is an obvious hedge against the Equitable Act coming into force.
In terms of how our strategy performed, highlights were Baidu (which we didn’t own). It announced a significant profit warning and plummeted during the quarter. Our lack of a holding was a significant contributor. China A-share exposure benefitted the portfolio through Wuliangye. To refresh you, Wuliangye is a 600-year-old spirits and liquor brand in China. I tell my American clients it is twice as old as your country. It is a stock we very much like, where we think there is significant potential to expand distribution, to move up pricing and probably one of the oldest brands in the world.
Brazilian utility, CTEEP (Compania de Tansmissao de Energia Electrica Paulista), did very well and the theme of Brazil is around economic reform. I think we are seeing the market benefitting very much from that trend but particularly interest rates look like they could be moving down. CTEEP is a utility with a double-digit dividend yield and looks relatively more attractive versus the bond market.
Other significant contributors were Li-Ning (the Chinese sportswear brand), which performed very well as management there made significant improvements, and AIA, which has been a holding in the strategy since inception, representing a strong play on the growth of financial inclusion in Asia generally.
Detractors included Gazprom, a stock we didn’t hold. There is much excitement in Russia, which drove the Russian market, that corporate governance is beginning to improve. We may see higher dividend pay-outs; we may see an improvement in management and potentially a lessening of corruption in that company. The evidence for this is [slow] so far but clearly, if we are seeing governance improvements even in Russia, I think it is something to be interpreted quite positively.
Two other stocks which detracted during the period were Cognizant (the Indian IT services company), where we saw a muted recovery nipped in the bud, and Ternium, (the major business is in Mexico, with a smaller business in Argentina) where economic weakness in both countries impacted that company and we significantly reduced our holdings.
Sasol (a South African energy company), was also a detractor. It is building a global-scale US chemicals facility in America, which is experiencing delays and cost overruns, which were met with much anguish by the market.
Finally, to show what a stock-picking market the China A-share market is, Weifu High-Tech (which is an auto component maker and makes fuel injection systems) had a weak period. We think this is a very interesting company. It is essentially controlled by Bosch, the German auto components maker. We can buy this on seven times earnings with access to growth of the Chinese car market and a very strong governance coming from Bosch. It had a poor quarter but we remain enthused both by the quality of the business and the low valuation.
Moving to the outlook for the remainder of the year and into next year, one of the major positive changes in the outlook is the policy stance of major central banks globally. The market is 100% discounting a move in US interest rates down when the US Federal Reserve next meets. Secondly, we have a dovish European Central Bank and, thirdly, we have stimulus in China. So most of the world’s major economies are in a significant stimulus track at this point. That is clearly positive for the emerging market asset class. If that were to lead to weakness in the US dollar, that would redouble the positive impact on the asset class.
That is very much the silver lining going forward. The dark cloud is the continuing trade war between the US and China and the US and almost everywhere else. This results in a lot of disruption, which is introducing market corporate uncertainty that is unlikely to go away in the near term.
Having said that, if we look at our emerging market equity strategy, the asset class is [very out] of favour. The environment is one of improving stimulus. We remain confident that there will be a fair amount of volatility going forward, but also that there is significant upside when those clouds eventually clear.
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: -9.9 (-9.3), 2017: 29.7 (25.4), 2016: 29.2 (32.6), 2015: -8.8 (-10.0), 2014: 5.2 (3.9)
Source: Investec Asset Management, 30 June 2019. Performance stated as gross of investment management fees in AUD. Gross income reinvested. *MSCI Emerging Markets Index NDR.