Glen Finegan, Head of Emerging Market Equities, provides a detailed update on the Henderson Emerging Markets Strategy, covering performance, investment activity, portfolio positioning and his outlook for the asset class
Q1 2017 performance and investment activity
The strategy marginally outperformed the MSCI Emerging Markets benchmark index over the quarter. Broadly speaking, returns from the asset class were strong in absolute terms, and outperformed developed markets*.
Our investment process seeks to identify and align our investments with individuals who own or control businesses that have long track records of integrity and financial delivery. We believe that this approach is especially important within global emerging markets. The low level of economic, political and regulatory maturity in many developing countries can increase risk for minority shareholders. Weak governance structures often mean incentives for management and long-term owners of equity can be misaligned. We like to think of this as the 'hire car phenomenon'.
Source: iStock
The modern day truism that a 'hire car is the fastest car on the road', reflects the view that a driver who does not own the vehicle, is likely to drive it with reckless abandon. The same can often be seen within equity markets. There is the increased potential for corporate management teams with little or no equity stakes within a business to take too many risks, and to place the longer-term health of a franchise at jeopardy.
* Source: Henderson Global Investors / Thomson Reuters Eikon as at 31 March 2017.
Family ownership
In contrast, we believe that companies in which the founders or their families have maintained a strong presence - be it through hands-on management, sitting on the board, or being significant shareholders - perform distinctively better over an economic cycle. The generational perspective, which many founder and family companies possess, enables capital to be allocated patiently, and risky short-term profits ignored for the prospect of harvesting lower-risk, long-term gains.
Investment activity
We have been increasing the portfolio's exposure to the family-owned Aditya Birla Group by initiating positions in Grasim Industries and Aditya Birla Nuvo, which are both part of the group, while selling the strategy's direct position within Ultratech Cement.
Grasim is a diversified Indian conglomerate, with cement operations through its majority ownership of India's leading producer, Ultratech Cement, as well as businesses in textiles and chemicals production.
By selling the position in Ultratech Cement on valuation concerns and investing this capital into the holding company, we have moved higher up the equity structure and are now more closely aligned with the shareholding of the Chairman, Kumar Mangalam Birla. The Birlas are a respected family who have built some strong brands, and have an impressive track record of corporate governance and creating value for shareholders.
Innovative new brands
While portfolio activity has been muted this quarter, the team has continued to travel widely to further enhance our understanding of the risks and opportunities available to the strategy. Team members recently visited South Korea. The meeting with LG Household & Healthcare reinforced our view that the revitalised product-development process within the cosmetics business is creating innovative new brands that consumers are positively responding to. We used weakness related to geo-political tensions on the Korean peninsula to add to this position.
Portfolio positioning
Portfolio positioning has not changed dramatically since last quarter and continues to have a bias towards companies listed in markets that bore the brunt of commodity price declines, such as Brazil, Chile and South Africa. The resulting economic shock resulted in weaker currencies, more attractive valuations and the tantalising possibility of improving national governance. This attractive confluence of factors also contrasts with what we perceive are unattractive valuations for a large proportion of the Asian exposed consumer-related equities. We do not doubt the attractiveness of the growth opportunity, but the valuations appear to suggest that a lot of the good news is factored into prices.
Outlook/strategy
Source: iStock
Enthusiasm for the emerging markets equity opportunity picked up during the quarter, but we believe that it is important to stick to our belief not to compromise on quality, to maintain a long-term approach and to apply a strict valuation discipline.
Instinctively, we find ourselves becoming more cautious as shorter-term market commentators become bullish on lower quality and more cyclical emerging market assets. Lower-quality assets include many state-controlled enterprises and companies listed in countries with little or no respect for property rights.
The timing of these bullish views, which follow a period of strong absolute returns from the asset class, appear based more on momentum than fundamentals.
In line with our more cautious view the strategy's cash level increased slightly over the quarter. The fact that emerging markets have immature legal and political systems often means inadequate levels of minority shareholder protection and higher levels of economic volatility compared to developed markets.
With a long-term perspective, however, we are positive about the prospects that emerging markets offer equity investors. This is due to the opportunity to gain exposure to the structural trend of rising living standards in some parts of the developing world.
Note: The above stock examples are intended for illustrative purposes only and are not indicative of the historical or future performance of the strategy or the chances of success of any particular strategy. Henderson Global Investors, one of its affiliated advisors, or its employees, may have a position mentioned in the securities mentioned in the report. References made to individual securities should not constitute or form part of any offer or solicitation to issue, sell, subscribe or purchase the security.
For more information on the Henderson Emerging Markets Opportunities Fund, please click here.
Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
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