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 any 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.

Liquidity is a characteristic of a market for an asset whereby an individual or firm can quickly purchase or sell an asset without causing a drastic change in the asset’s price. By definition, liquidity is a confidence trick.

In normal conditions a particular asset may be highly liquid with many transactions taking place per day. However, in extreme circumstances, if every owner of an asset is seeking to sell, there may be no matching buyer. 

Much of the financial innovation of recent decades has revolved around the creation of liquidity, the transformation of an illiquid security (such as a mortgage, credit card receivables or a portfolio of stocks or bonds) into a security that can be bought and sold on any given day (in the form of a mortgage backed security, an asset backed security, or an exchange traded fund (ETF)). This sleight of hand supposedly reduces the risk in owning such securities, reducing the compensating return demanded by investors and therefore increasing the access to credit for individuals and businesses.

So far so good. However, this ‘liquidity transformation’ is not a certainty investors can depend on, as became abundantly clear in the 2008 global financial crisis, and as has recently been highlighted once again.

Returning to our core area of competence of Global Emerging Markets, what is perhaps less commonly recognised is that there is an inherent liquidity mismatch at the heart of China’s capital markets. Global investors can purchase claims on Chinese cash flows mostly via purchasing shares on Hong Kong’s stock market, though China’s capital account remains closed.

Indeed, Hong Kong has historically thrived in its role as a financial valve, offering foreign investor’s access to China’s closed capital markets, and mainland companies access to international capital. However in this case the regulating role of the valve is not performed by the laws of physics and differential pressure, but by institutions, mostly institutions of the Chinese Communist Party.

For the past twenty years, China has been a massive exporter of capital, recycling foreign currency earned through overseas trade into international assets such as US Treasuries. However, in recent years, China has moved from a position of being self-financed by an excess of savings over investment, to being more reliant on outside capital. This is why the country has taken steps to make its equity and debt markets more attractive to foreign investors, partly by promoting liquidity.

Capital markets though are the ultimate democracies. If an individual sees attractive opportunities for returns, they will seek to invest their capital here. By contrast if they fear deteriorating investment prospects, they will seek to withdraw their capital. This fear of democracy is why China maintains a closed capital account.

A feature we regularly observe in analysing Chinese companies is very long payable days. It is not uncommon to see companies that take six months or more to pay their suppliers. Companies are able to do so, either by ‘paying’ their suppliers with IOU notes guaranteed by a bank, or by paying a bank to settle the bill (a process known as reverse factoring). This is not typically a sign of a healthy company or, in aggregate, a healthy economy.  If my employer took 6 months to pay me, I’d be very concerned (and angry!). If suppliers had any choice,  they would clearly opt for cash settlement. 

So it seems we have a highly cash-constrained corporate sector on one hand and on the other an investor base operating on the assumption that their investments can easily be turned into liquidity without unduly affecting the price. If investors collectively test this assumption and rush for the exits, the Chinese government can and will act to stop the flow of capital out of the country. Clearly this scenario would provide quite a shock to financial markets conditioned over the last decade to expect liquidity. How many investors in China are doing so in the expectation that they could liquidate their investments tomorrow?

We have very little exposure to Chinese companies, in part because of the balance sheet stresses we regularly observe (high payable days). Moreover, across our portfolios we have a strong preference for companies with healthy balance sheets, ideally with cash in excess of debt. Leveraged companies must periodically refinance their debts, and thus are implicitly assuming a continued ability to access capital markets. Emerging markets have benefited from an abundance of liquidity over the last decade, though this is liable to seize up with little warning, forcing indebted companies to divert resources to repaying debts and away from research and development, marketing investments and upgrades to manufacturing assets, to the long-term detriment of their competitive position and thus returns for long-term investors. Finally, we seek out businesses whose customers pay them in cash, rather than bank or company arranged credit.

Dominic St George
July 2019


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.

Download a PDF of this article >


Investment terms 

View our list of investment terms to help you understand the terminology within this document.

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.

This document is confidential and must not be copied, reproduced, circulated or transmitted, in whole or in part, and in any form or by any means without our prior written consent. The information contained within this document has been obtained from sources that we believe to be reliable and accurate at the time of issue but no representation or warranty, express or implied, is made as to the fairness, accuracy or completeness of the information. We do not accept any liability for any loss arising whether directly or indirectly from any use of this document.

References to “we” or “us” are references to Stewart Investors. Stewart Investors is a trading name of First Sentier Investors (UK) Funds Limited, First Sentier Investors International IM Limited and First Sentier Investors (Ireland) Limited. First Sentier Investors entities referred to in this document are part of First Sentier Investors, a member of MUFG, a global financial group. First Sentier Investors includes a number of entities in different jurisdictions. MUFG and its subsidiaries do not guarantee the performance of any investment or entity referred to in this document or the repayment of capital. Any investments referred to are not deposits or other liabilities of MUFG or its subsidiaries, and are subject to investment risk including loss of income and capital invested.

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.

Hong Kong and Singapore

In Hong Kong, this document is issued by First Sentier Investors (Hong Kong) Limited and has not been reviewed by the Securities & Futures Commission in Hong Kong. In Singapore, this document is issued by First Sentier Investors (Singapore) whose company registration number is 196900420D. This advertisement or publication has not been reviewed by the Monetary Authority of Singapore. Stewart Investors is a business name of First Sentier Investors (Hong Kong) Limited. Stewart Investors (registration number 53310114W) is a business division of First Sentier Investors (Singapore).

Australia

In Australia, this document is issued by First Sentier Investors (Australia) IM Limited AFSL 289017 ABN 89 114 194 311 (FSI AIM). Stewart Investors is a trading name of FSI AIM.

United Kingdom

This document is a financial promotion. In the United Kingdom, this document is issued by First Sentier Investors (UK) Funds Limited which is authorised and regulated in the UK by the Financial Conduct Authority (registration number 143359). Registered office: Finsbury Circus House, 15 Finsbury Circus, London, EC2M 7EB, number 2294743.

European Economic Area (“EEA”)

In the EEA, this document is issued by First Sentier Investors (Ireland) Limited which is authorised and regulated in Ireland by the Central Bank of Ireland (registered number C182306) in connection with the activity of receiving and transmitting orders. Registered office: 70 Sir John Rogerson’s Quay, Dublin 2, Ireland, number 629188.

Middle East

In certain jurisdictions the distribution of this material may be restricted. The recipient is required to inform themselves about any such restrictions and observe them. By having requested this document and by not deleting this email and attachment, you warrant and represent that you qualify under any applicable financial promotion rules that may be applicable to you to receive and consider this document, failing which you should return and delete this e-mail and all attachments pertaining thereto.

In the Middle East, this material is communicated by First Sentier Investors (Singapore).

Kuwait

If in doubt, you are recommended to consult a party licensed by the Capital Markets Authority (“CMA”) pursuant to Law No. 7/2010 and the Executive Regulations to give you the appropriate advice. Neither this document nor any of the information contained herein is intended to and shall not lead to the conclusion of any contract whatsoever within Kuwait.

UAE - Dubai International Financial Centre (DIFC)

Within the DIFC this material is directed solely at Professional Clients as defined by the DFSA’s COB Rulebook.

UAE (ex-DIFC)

By having requested this document and / or by not deleting this email and attachment, you warrant and represent that you qualify under the exemptions contained in Article 2 of the Emirates Securities and Commodities Authority Board Resolution No 37 of 2012, as amended by decision No 13 of 2012 (the “Mutual Fund Regulations”). By receiving this material you acknowledge and confirm that you fall within one or more of the exemptions contained in Article 2 of the Mutual Fund Regulations.

United States of America

In the United States, this document is issued by First Sentier Investors International IM Limited, as SEC registered investment adviser. Stewart Investors is the trading name of First Sentier Investors International IM Limited. This material is solely for the attention of institutional, professional, qualified or sophisticated investors and distributors who qualify as qualified purchasers under the Investment Company Act of 1940 (hereafter the “1940 Act”), as accredited investors under Rule 501 of SEC Regulation D under the US Securities Act of 1933 (“1933 Act), and as qualified eligible persons as defined under CFTC Regulation 4.7. It is not to be distributed to the general public, private customers or retail investors.

Other jurisdictions

In other jurisdictions where this document may lawfully be issued, this document is issued by First Sentier Investors International IM Limited which is authorised and regulated in the UK by the Financial Conduct Authority (registration number 122512). Registered office 23 St. Andrew Square, Edinburgh, EH2 1BB number SC079063.