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.

The world of emerging markets is its usual mixed bag

A Chinese initial public offering (IPO) highlights the frothy end of the market. No fewer than four “Joint Sponsors” and a further twenty “Joint Global Coordinators and Joint Bookrunners”1 are involved in the promotion of a smartphone company onto the market at a valuation of roughly US$60bn. The IPO multiple of sales sought puts it on a similar valuation to that of Apple – yet this is a company with significantly slimmer operating margins. One assumes the generous price discounts very high future growth, and in common with almost all Chinese tech-related stocks, the Chairman has a desire to “become an internet services company”.

The company has chosen to copy US tech stocks (though not Apple) through a dual share-class structure.2 After missing out on a well-known listing of a large Chinese technology company a few years ago, the Stock Exchange of Hong Kong has duly found new rules to help.

We shall not be investing client funds in the IPO but have, as ever, filed a copy of the prospectus (pretty much the only time a company gets close to having to tell the whole truth) and we look forward to meeting the company once the hysteria has subsided and we are able to test action versus “forward looking statements”.

Even as the performance of an increasingly narrow sliver of companies makes index performance appear respectable over the last twelve months and more, much of the rest of Global Emerging Markets (GEM) is less frothy than a year ago. We don’t own any of the very fashionable Chinese tech companies which means that our strategies’ performance is well behind the index. Regardless of whether the current fashion for strange corporate structures, domineering Chairmen and acquisition fever continues, as bottom-up stock enthusiasts, valuations elsewhere are beginning to show a little more hope.

An example for the true enthusiasts (optimists?) is Pakistan. Many countries promoted by the MSCI from the Frontier to Emerging Market categories find it a difficult leap, and newly re-promoted Pakistan is feeling the curse rather severely. The market has lost 25% or so in US dollar terms since promotion last summer unlocked a new wave of foreign capital, and the latest government of the day is waging another one of GEM’s losing battles to defend a currency in the face of twin deficits. We have not owned a company in Pakistan in recent years and erratic politics make “buy-and-hold” far more challenging. However, we have identified two possible companies that some of our smaller strategies could perhaps tiptoe into: firstly a net cash auto company, part-owned by a high quality multinational, and secondly a conservative bank trading at a little over book value. Both are controlled by high quality families – as always, our research on the companies  focuses foremost on governance, in particular historic attitude to risk, treatment of minority shareholders and proximity (preferably extreme distance) to government and associated cronyism.3

Outside Greater China, quite a few larger companies are beginning to look more attractively valued. We don’t spend time forecasting currency moves, but the recent miserable performance of the Brazilian Real, Turkish Lira and Mexican Peso encourages us to look again at some  of our favourite companies. There is often a trade-off between attractive company valuation and unattractive political or economic risk. Rather than worrying about  this, or trying to pick the bottom of a market, we simply consider the quality of management, franchise and financials.

Our conservative approach has delivered acceptable returns to clients over the last three decades. In Turkey Akbank appears to be good value at 0.7x tangible book, but the only reason we might consider it in the first place is because of its amazing track record of crisis-survival, a record we are unsure other Turkish banks could match.

Similarly, in Brazil we would expect the owner-manager entrepreneurial spirit of a company such as Ultrapar to enjoy the opportunities that the current unpopularity of the market might offer, even while their personal net worth has taken a beating.

We have approximately one quarter of the GEM strategies invested in Indian companies. These significant holdings are in some cases approaching uncomfortable valuations despite trimming and sometimes selling the most optimistically valued holdings. In our view, many banks and financial groups in India have been growing worryingly fast for a worrying length of time. We retain significant positions in some of the country’s IT outsourcers. From current valuations (a little above 20x P/E ratio), we are unlikely to make exceptional returns in one such company, but take comfort that the low-to-middling returns we hope for are at least to be made in one of the highest quality companies in GEM. Its customers are predominantly based in the US and Europe, so the free cash flows to which we are entitled are of a harder currency nature.

Tom Prew
June 2018


Post-script: the Chinese company mentioned above is yet to trade at time of writing but closed the IPO book at the lower end of the pricing range. Three of the “cornerstone” investors are officially controlled by the Chinese state.

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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Investment terms 

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Important Information

This document has been prepared for general information purposes only and is intended to provide a summary of the subject matter covered. It does not purport to be comprehensive or to give advice. The views expressed are the views of the writer at the time of issue and may change over time. This is not an offer document, and does not constitute an offer, invitation, investment recommendation or inducement to distribute or purchase securities, shares, units or other interests or to enter into an investment agreement. No person should rely on the content and/or act on the basis of any matter contained in this document.

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Past performance is not a reliable indicator of future results.

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.

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Footnotes

  1. A bookrunner is usually an underwriter or coordinator in equity or debt issuances.

  2. Corporate structure involving more than one class of shares with different shareholder rights depending on what class is owned.

  3. The appointment of friends and associates to positions of authority, without proper regard to their qualifications.