Global Emerging Markets All Cap

Over the course of the quarter, we have sold out of one of our Indian banks. RBL Bank (India: Financials), which we purchased in December 2023. The new management team seemed determined to move the bank towards less risky (more secured) lending which at 1x price-to-book (P/B)¹ appeared attractively priced. Unfortunately, the quarter after we purchased the company, it became clear that unsecured bank loans had been growing at over 30% and the path to a more balanced loan portfolio would be a lot longer than we had expected. Added to that, we are seeing a few banks that are struggling to grow their deposit base which impacts how they can fund their loan growth. For many years, most depositors avoided the public sector banks fearing either insolvency or potential loss of deposits. They have been cleaned up and professionalised which is great for the Indian saver and borrower but tougher for the private sector banks who benefitted from weak competition in the public sector. With prospects for RBL looking riskier and with better ideas elsewhere, we decided to exit.

We exited Yifeng Pharmacy Chain (China: Consumer Staples) which was another name where we were becoming worried about increased regulatory oversight having a negative impact on profit margins. We are confident that they will continue to roll up the pharmacy sector in China – in much the same way that RaiaDrogasil (Brazil: Consumer Staples) is doing in Brazil – but we worry that Beijing could well impose price cuts on those drugs purchased through medical insurance plans.

Claudia Sheinbaum was elected the first female President of Mexico with such a resounding victory that her party now holds a two-thirds majority in both congressional houses, which means it could make constitutional changes such as the proposal that Supreme Court judges would be directly elected by popular vote. India completed the largest democratic election in the world with a surprise vote removing Narendra Modi and the Bharatiya Janata Party’s absolute majority in the Lok Sabha (also known as the House of the People and the lower house in the Indian Parliament). The Nifty 50 (top 50 stocks by market capitalisation listed on the National Stock Exchange of India) rose the day before the election on the expectation that Modi would get over 400 seats. It then fell 7% when the news broke that he had lost his absolute majority before rising again in the days afterwards as the market decided Modi staying in power with a reduced majority was a positive for Indian democracy¹. It is at times like this that we are thankful for our philosophy and bottom-up stock picking process with a focus on quality and a 10-year time horizon on growth, allowing us to take advantage of irrational price movements.

We sold out of seven companies and only added one through the second quarter which is higher turnover than previous quarters. We sold Amoy Diagnostics (China: Health Care) after a period of better performance. Whilst we still like the way the business is managed, the high operating margins (c.27%) generated in the healthcare sector means we have become worried about the regulatory environment potentially aiming to reduce those margins. We sold Kingmed Diagnostics (China: Health Care) for the same reason and both Amoy and Kingmed are good examples of where top-down or macro views on a country and sector can break an investment case.

We also sold Tech Mahindra (India: Information Technology) and Dabur (India: Consumer Staples) having bought into both in 2009. Tech Mahindra (known then as Satyam) and Dabur have delivered mid-teen annual performance since first bought. Whilst we still believe that they are good companies, valuations are becoming problematic. Tech Mahindra has been a great investment over the last ten years but we believe we have a better option for the next ten years in Tata Consultancy Services (India: Information Technology). Tech Mahindra has seen margins reduce and it is also expensive. Dabur is a soaps and detergents producer in India which has delivered high earnings but we expect growth to be lower in the future. Valuations in India remain one of our biggest concerns and we have been trimming back our positions there including Marico (India: Consumer Staples) and Mahindra & Mahindra (India: Consumer Discretionary) due to valuations. We also sold Pigeon (Japan: Consumer Staples) as we lost conviction in the speed and extent of the evolution of the franchise which is facing rising headwinds such as declining birth rates.

The first of the three exits was Vinda International (China: Consumer Staples), a Hong Kong listed tissues maker that was steadily offering higher-quality hygiene products with higher pricing power. The company was stewarded by the combination of the Li family as owner-managers and Essity, the Swedish multinational. We exited our holding in the company after a bid to acquire the company was accepted by the majority shareholders.

We also exited Komerční banka (Czech Republic: Financials) and Infosys (India: Information Technology). Both companies remain high-quality, well-run franchises but were getting closer to fairly valued rather than cheap. As such, we decided to use the proceeds to invest in ideas where we saw the potential for better returns.

One such example is Allegro (Poland: Consumer Staples), a dominant e-commerce platform in Poland with c.40% market share, nine times larger than their nearest competitor. Allegro has been able to steadily defend this market share against new entrants, even through a period of mismanagement. With a new CEO in place, Allegro is focused on improving their international operations and re-focusing on profitable growth.

We also took the opportunity as valuations have come off across a number of our high-quality Chinese holdings to continue to build position sizes. A few of these include Glodon (China, Information Technology), Milkyway Intelligent Supply Chain Service (China: Industrials), and Yifeng Pharmacy Chain (China: Consumer Staples) – all well placed to be the leaders in their respective industries, aligned with the broader sustainable development of the economy, and remain on reasonable valuations for steady earnings growth.

Centre Testing International provides inspection and certification services for industrial and consumer products across China, ensuring product quality and safety standards. The franchise benefits from being one of the first movers in the country, and continues to take share in a fragmented market as scrutiny rises on health, environmental and product standards. The balance between long-term family stewards and a professional manager who spent decades at one of the world’s leading inspection and certification services firms helped us build conviction in the quality of people here as well.

We also initiated a position in Midea, China’s dominant domestic home appliances manufacturer. Midea is taking the cash flows from this business, and reinvesting behind expanding into attractive growth areas like digital building automation, integrated energy management and industrial robots.

The third new position was a re-initiation in Samsung Electronics (South Korea: Information Technology). We have long admired the strength of the Samsung Electronics franchise, along with the ability they have shown to evolve. We believe current valuations do not reflect a recovery in the memory market, or the investments that Samsung Electronics continues to make behind long-term growth. The business continues to have an impressive ability to generate cash, and a solid balance sheet.

Finally we initiated a new position RBL Bank (India: Financials), a private bank in the midst of a turnaround. The bank lost its way through aggressive growth leading to high non-performing loans (NPLs). As a measure of abundant caution India’s central bank stepped in to change management and solidify the foundations of the bank. We believe new management is putting in place the right systems to build a quality credit culture with a focus on lower risk assets funded mostly by deposits. A successful turnaround could yield attractive returns for shareholders.