Global Emerging Markets Letter

This document contains information which is no longer up to date. As such, it is maintained solely for information purposes to provide historical information. This document should not be relied upon, including for the purposes of making an investment decision. Reference to the names of each company mentioned in this communication is merely for explaining the investment strategy and Stewart Investors does not necessarily maintain positions in such companies.

Risk Factors

In the UK, EEA and Switzerland, this document is a financial promotion for the St Andrews Partners Global Emerging Markets strategies intended for retail and professional clients in the UK and professional clients in Switzerland and the EEA only and professional clients elsewhere where lawful.

Investing involves certain risks including:

> The value of investments and any income from them may go down as well as up and are not guaranteed. Investors may get back significantly less than the original amount invested.

> Emerging Market risk: Emerging markets tend to be more sensitive to economic and political conditions than developed markets. Other factors include greater liquidity risk, restrictions on investment or transfer of assets, failed/delayed settlement and difficulties valuing securities.

> Currency risk: the strategies invest in assets which are denominated in other currencies; changes in exchange rates will affect the value of the strategies and could create losses. Currency control decisions made by governments could affect the value of the strategies investments and could cause the strategies to defer or suspend redemptions of its shares.

Reference to specific securities (if any) is included for the purpose of illustration only and should not be construed as a recommendation to buy or sell. Reference to the names of any company is merely to explain the investment strategy and should not be construed as investment advice or a recommendation to invest in any of those companies.

If you are in any doubt as to the suitability of our strategies for your investment needs, please seek investment advice.

Some very brief political thoughts

It is never our intention to out-pundit the pundits, but as Global Emerging Markets (GEM) investors we had a couple of thoughts.

The first lesson from GEM is that voters think in absolute terms about whether a system has looked after them, not about whether an alternative is better or worse. GEM electorates know that the future is uncertain but the present can certainly be dispatched.

As such the GEM list of what Western journalists call a “leap into the unknown” includes Humala (Peru), Duterte (Philippines), Evo Morales (Bolivia), Lula (Brazil), Tsipras (Greece), etc.

Financial papers popular with investors didn’t endorse any of these campaigns (though rapidly forgave a couple when the commodity boom kicked off in the mid-2000s).

Of course, the other thing that GEM shows us is that voters don’t need votes to get regime change.

Despite repressive surveillance, control of the Internet’s “off button” and a lack of meaningful democracy, regimes were changed from 2011 onwards in the Arab Spring.

It is this second point that leaves the unelected Chinese central planner with little choice other than to allow debt to rise at mind-boggling rates. The alternative to ballooning debt for the Chinese ‘electorate’ is a miserable recession; the alternative to being in power for Chinese autocrats is bleak with little chance of, for example, a seat in the House of Lords or well-paid investment bank junkets. (A former British Prime Minister is billed to give a keynote speech at a conference in China organised by an investment bank; he will be joined by a former coalition partner who was given a knighthood in the 2015 Dissolution Honours list and now has a prominent role in China’s Asian Infrastructure Investment Bank).

Another thought we had concerns the “who has the nuclear codes” question, popular in the United States just now. This reminded us that there are four confirmed nuclear powers in the MSCI Emerging Markets universe. Two of them gaze at each other through rifle sights across the Line of Control; one has taken to militarising rocks in the South China Sea, and the fourth recently annexed part of a neighbouring state.

GEM goes all a bit GEM again (and about time)

After a decade of plentiful US dollar debt finding its way around the world it doesn’t take much dollar strength to cause mischief. “Months of import cover” is still not a widely seen term, but between our emerging markets and frontier strategies, we have three countries for which currency repatriation has been slow or difficult.

Short-term this makes life more difficult and we have been working closely with custodians to make sure, for example, that where possible Nigerian dividends are kept in country and used to buy more stock rather than subjected to a long queue for an official exchange rate (we are of course unable and unwilling to use a black market rate, nor able to “do what is necessary” to hop to the front of the queue).

Longer term, the returns of good franchises in GEM should increase if the supply of capital dries up and especially if it coincides with less active state intervention.

We wrote a year ago about how Brazilian financial institution, Bradesco, probably prefers an environment of rationed credit to that of cheap loans for all. Indeed, in the last year, the annual disbursements of BNDES (the state-controlled and outlandishly generous Brazilian development bank) have fallen by a further third.

In the more frontier end of GEM, we sometimes see that the deposit rates paid by the best and highest capitalised GEM banks remain flat or even fall in times of stress. Depositors in GEM are far less complacent than developed world depositors and don’t trust deposit guarantees or the inevitability of generous state bailouts. While it is too much to hope for that Italy gets added to the MSCI Emerging Markets Index (ah! The food…), depositors in Italy have started thinking with a GEM mindset.

Amidst all the fun and games of GEM economics, all we are trying to do is find those management teams and franchises that will be in the best position to enjoy the next cycle by surviving whatever the nearer future brings – a little like (apparently), a racing driver seeks to exit a corner quickly by not whizzing in too fast in the first place.

Hence the attraction of well-capitalised banks in preference to the fastest growing or the highest return on equity; hence a belief in strong balance sheets rather than “efficient” balance sheets, and hence a preference for franchises that can price their way through trouble rather than simply cross their fingers that input prices fall back.

“Pricing power” in the developed world has barely raised its head for years – for many the only recent experience was the “Marmite vs. Tesco war” a few months back (a reasonably fair fight), or the overnight decision by Apple to jack up the £ prices of its kit (immediate surrender by the consumer).

Pricing power in the typically more inflationary GEM world is vital but fortunately many companies have decades of experience – a favourite example being the brewers of Brazil who, having priced through double digit inflation at home, used these cashflows to build an empire selling a third of the world’s beer and making perhaps half of its operating profit after the ABI-SAB merger.

Investors are prisoners of recent history though, and recent history has been mostly of low inflation. This might have led to the assumption that almost any company filed under “consumer staples” has pricing power. We have never thought this to be the case and are particularly focused on risks to our companies’ abilities to increase prices. Some of these risks are not seen in the developed world. At one end of the price spectrum there are basic foodstuffs with political controls or influence. At the other are products that a UK buyer considers staple, but which are discretionary in GEM. We now own an Indonesian chocolate company which we bought after it suffered a tough year partly because chocolate consumption is discretionary for the less well off.

As ever, all of our investment is carried out with the foremost consideration that the only thing that really gives you a chance to survive until and through the next cycle is an owner and manager combination with the patience to avoid bad decisions and the integrity to let minorities participate in the good decisions. This is most difficult of course for state-controlled companies, or in industries in which the state has the desire for micromanagement of its own.

Some quick points on “Tech”

At a sector level we have few holdings in the Information Technology sector. In a relative sense this has been a detractor to performance. Three quick points might be made here:

  • “Tech” is not a coherent sector (one of our team likens it to Geography A-level being a dumping ground for what Chemistry, Biology, Economics and Sociology didn’t have room for). The sector includes jazzy internet companies, boring manufacturers who just so happen to manufacture computers, and Indian IT service companies employing small armies in Bangalore mending and writing software code for investment banks on Wall Street.
  • We hold some “tech” businesses in extremely high regard, having held large positions in some Indian software firms for many years. Other “tech” companies are amongst the finest businesses that GEM has to offer but are at the upper limits of our valuation range.
  • As in any sector, many tech companies do not fit our investment philosophy for reasons of corporate governance (we don’t own a very popular South Korean electronics business; the de facto CEO of which is giving evidence about the latest political scandal to embroil corporates in the country) and sometimes because we either don’t understand or even fear what truly underpins monopolistic franchises (well-known Chinese internet businesses).


We are, as usual, fairly gloomy about the prospects for the world, and especially for those countries still trying to print and/or borrow their way out of trouble (most, sadly).

As usual though, we are more cheerful about the prospects for many of our companies. As a broad generalisation we are probably finding more reasonably valued ideas amongst smaller companies and have even found one or two interesting small ideas in South Korea, a country in which new companies typically struggle to survive amidst the politically influential conglomerates.

The greatest risk to clients’ money would be a significant Indian political event, which might include problems with Pakistan. We mention this not as a prediction, but simply because an embarrassment of riches of well-managed companies has allowed us to invest approximately a fifth of client funds in Indian-based businesses.

Tom Prew
January 2017

Source for company information: Stewart Investors investment team and company data. For illustrative purposes only. Reference to any companies mentioned in this communication is merely for explaining the investment strategy, and should not be construed as investment advice or investment recommendation of those companies. Companies mentioned herein may or may not form part of the holdings of Stewart Investors.

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