Global Emerging Markets Sustainability


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Strategy overview

The strategy was launched in February 2009 and invests in companies in emerging markets or whose business is predominantly based in emerging markets and are positioned to contribute to, and benefit from sustainable development. 

 

Strategy update

1 January - 31 March 2022

Over the course of this quarter we made a small number of meaningful transactions in the strategy.

After a more than 50% rally from its trough, we made the decision to exit our position in Alibaba (China). In light of the comparatively more muted growth prospects the company has going forward, a lower price-to-earnings or price-to-cash-flow multiple would seem appropriate. Our primary mistake has perhaps been in being too backwards looking in assessing quality of franchise. It is a truism, no less powerful for its simplicity, that all companies – indeed all organisations – are at any given time either strengthening or weakening relative to their competitors. The last two years have seen the company, encouraged by regulation designed to promote competition and weaken the market power of incumbents, slide into a much more competitive, capital intensive and less profitable position than it had been previously.

We used some of the proceeds from exiting our position in Alibaba to add to a number of our Chinese holdings. These included companies like Estun Automation, the leading domestic robotics manufacturer, and Yifeng Pharmacy Chain, a rapidly growing drug retail chain consolidating China’s highly fragmented market. We believe these companies to be either lower risk or at an earlier stage of life (and thus enjoying greater prospects), or both. Both companies benefit from strong sustainability tailwinds, improving efficiency and reducing prices in the respective sectors in which they operate.

We also purchased Tube Investments, an Indian industrial conglomerate. The founding Murugappa family continues to own 48% of the business, and next generation owner-manager, Vellayan Subbiah, has embarked on a journey to both improve execution within the core franchise and broaden the remit of the business. Looking to the histories of global industrial conglomerates such as Halma and Danaher for inspiration, and with a wonderfully long-term time horizon, Tube has set out to create something similar in India. The first step on this journey was the acquisition of CG Power, an electric motors business that is the beneficiary of strong, sustainable tailwinds selling into electric vehicles and renewable energy. India is home to numerous small, family-owned industrial businesses that are looking for homes for their franchises when the next generation might not want to take control. The reputation of the Murugappa family, Vellayan’s history of successful execution, and the strength of the balance sheet, mean that Tube has the opportunity to provide these companies this home and continue to grow their own business. This balance of a century-old family legacy alongside the ambition to create something that endures for at least another century, we believe, provides an opportunity for solid returns over the coming years.

Along with Tube Investments, we also initiated a position in IndiaMART, an online B2B classifieds platform in India, connecting suppliers and buyers across a range of end industries. Founded by the Agarwal cousins in 1996, IndiaMART has grown to control 60% market share in the country, about 10 times larger than their nearest competitor, but are only at the starting stages of continued penetration of the platform, with only a small percentage of small and medium-sized enterprises (SMEs) across the country having a digital presence. The founders have demonstrated a focus on building a resilient business over the long term, balancing growth and profitability, and on maintaining a solid balance sheet. This is a cash-generative business, and the managers have consistently reinvested behind growth to remain beneficiaries of the structural growth tailwinds around them. 

Our strategies do not invest in oil, gas or coal, and we are always likely to underperform on a relative basis for short periods when fossil fuel markets are rallying. As ever, our focus remains on long-term absolute returns, which we believe are best achieved through avoiding investing in fossil-fuel reliant businesses. Through this period, we have continued to build up position sizes across a number of our favourite companies – such as Mahindra & Mahindra (India), WEG (Brazil) and Network International (UK-listed company operating in the Middle East and Africa) – where we have high conviction in quality as well as the long-term opportunity.

The latest video strategy updates from the portfolio manager can be found here.

1 October - 31 December 2021

We exited two positions over the quarter; both weaker franchises in economies which are less likely to be resilient in a rising interest rates environment.

These were SPAR Group, the South African grocery retailer, and Banco Bradesco, one of Brazil’s largest financial conglomerates.

Both companies had been attractive to us a year or so ago based on what appeared, at the time, quite modest valuations; both companies have dividend yields over 5%. However, in our experience it can be difficult to preserve capital in companies that are by nature dependent on their local economic environment when those economies are sailing into solid global headwinds – as South Africa and Brazil appear to be now – even when they are trading at ostensibly cheap valuations.

As often as not, in companies like these without growth tailwinds, any value creation in local currency is more than offset by currency devaluation. Therefore, in countries like South Africa and Brazil, we tend to look for companies with sufficient growth to enable them to overcome the long-term impacts of devaluation. We believe this is our best chance of deriving attractive hard currency returns in these economies.

During the quarter, we re-initiated a position in a Brazilian electrical motor company that is an archetypal example of this kind of business. A world leader in motor efficiency, the company derives most of its sales outside Brazil, which means it is naturally hedged against devaluation. It is growing rapidly as it benefits from sustainable development tailwinds around energy efficiency, electric vehicles and renewable energy generation.

We had owned the company for many years but exited in late 2020 when we felt valuations had become excessive. In US$, the share price fell 23% in the year¹, to the point where we felt a small position is again an attractive addition to the portfolio.

We also initiated a small new position in a Chinese company; a leading drug store chain. We already own several such businesses (Raia Drogasil in Brazil and Clicks in South Africa), and we note numerous similarities between these companies and our new holding in China.

Leading drug stores benefit from a virtuous cycle that tends to see them consolidate fragmented local markets over time. Superior purchasing power and logistics efficiency enables lower costs, allowing large chains to offer reduced prices to consumers. This not only drives access to medicine for people at the bottom of the pyramid, but attracts more consumers and puts the company in an ever-better position over time to continue outcompeting smaller peers.

The result can be exceptional long-term value creation, when the model is run competently and is properly stewarded by high-quality people. In the case of our new Chinese holding, the combination of a private entrepreneur as owner-manager as well as a cadre of executives who have joined from multinationals, means we believe the company can contribute positively to the portfolio over time.

1 Source: FactSet

Source for company information: Stewart Investors investment team and company data. This stock information does not constitute any offer or inducement to enter into any investment activity. Portfolio data shown is from representative strategy accounts of each strategy shown above. Named new investments disclosed relate to holdings with a portfolio weight over 1%. It is not a recommendation or solicitation to purchase or invest in any fund. Differences between the representative account-specific constraints, currency or fees and those of a similarly managed fund or mandate would affect results. 

1 July - 30 September 2021

During the course of this quarter, we chose to exit a few of the positions in the strategy. These changes were driven primarily by our continued focus on incrementally improving the quality of the portfolio, and adding instead to companies we think have better long-term sustainable and structural tailwinds of growth for the decade ahead. 

Four of the positions exited include Unilever, Kasikornbank, Samsung Electronics, and Tencent. We have slowly trimmed our longstanding holding in Unilever, and chose to exit this quarter as we have struggled to find conviction in their efforts to reinvigorate the franchise. Without this, their opportunities for growth over the next decade look to be more challenged than they have been over the previous one. We also exited our holding in Kasikornbank, which remains in our minds the best bank in Thailand. We admire the stewardship of the Lamsam family and the conservatism they have embedded in the bank post the Asian Financial Crisis. However, we worry about their limited opportunities for loan growth in the country and the rising threats from fintech disruption. We chose to exit the position and add to companies where we had more conviction.

Samsung Electronics is another company we exited through this quarter, primarily due to the cyclicality of earnings. Given our long-term approach, we are unlikely to be able to make a call on when memory chip prices reach their peak or trough, thus chose to exit our position after Samsung delivered strong absolute returns for clients. We owned Tencent only for a brief period – unlike our typical holdings. We engaged with Tencent, shortly after we initiated a position, on issues around data privacy and government regulations. A few actions of the company, including de-platforming LGBTQ student groups, and the rising threats around government regulation led us to correct our mistake quickly, and we chose to exit the position.

We also exited our position in Avast. The company is a global leader in cybersecurity software for consumers, based out of the Czech Republic. While we believe the company has a long runway for growth, they have announced a merger with the US-based NortonLifeLock. The combined entity will be ineligible for our emerging markets strategies and we have therefore had to sell out of our position.  

Through this quarter, we have re-initiated a position in Foshan Haitian, the leader in soy sauce and other condiments in China. Foshan is the domestic leader in these condiments by a high margin, continues to have a long runway to evolve into other condiments, and has focused on growing through volumes rather than by increasing prices. We had previously exited our position in the company due to valuations reaching all-time highs, and had an opportunity over these past months to buy back into the company at a more attractive valuation.

We also added to many of our other Chinese holdings including Glodon, Guangzhou Kingmed, and Estun Automation, amongst others. We believe these companies continue to be well managed by their owner-managers and are the leaders in their respective industries, providing necessary products and services, setting them up well to continue growing in the coming years.

We also initiated a position in Quálitas, a Mexican auto insurance company. We have long admired the conservative culture focused on steady, profitable growth that was built by the founders of the company over decades. Quálitas is the leader in Mexico, with opportunities of growth in continued penetration within the country and seeding new geographies for the long term too. The company maintains a very conservative balance sheet and remains well stewarded for the decade ahead. 

Source for company information: Stewart Investors investment team and company data. This stock information does not constitute any offer or inducement to enter into any investment activity. Portfolio data shown is from representative strategy accounts of each strategy shown above. Named new investments disclosed relate to holdings with a portfolio weight over 1%. It is not a recommendation or solicitation to purchase or invest in any fund. Differences between the representative account-specific constraints, currency or fees and those of a similarly managed fund or mandate would affect results. 

1 April - 30 June 2021

We initiated a number of new positions during the quarter in the strategy.

During the first half of 2021, there has been a continuing rotation away from quality-growth and towards value-cyclicals, as economies around the world rebound from the COVID-19 pandemic and associated lockdowns. The broader market has been attracted to owning companies that have the best chance of rapid earnings growth in the next twelve months. In many cases, this means companies in cyclical commodity industries like shipping and mining whose earnings collapsed last year and which are most sensitive to re-opening. Whilst these companies may outperform in the short term, we believe in the long run the owners of their equity will likely realise a return more commensurate with their modest returns on invested capital.

One consequence of this rotation has been that a number of high-quality companies which were more resilient throughout 2020, but which now do not offer the same short-term upside, have become much more reasonably valued. This has been particularly true in China, the country which is most advanced in its economic recovery.

Many of the most attractive long-term companies to own in China have become significantly more affordable over the last two quarters.

For instance, we have been watching one specific Chinese plasma and vaccines company for some years. Our first meeting with the company was ten years ago, but it has been in the last few years that we built conviction up to feeling the company met our quality criteria. It has a well-stewarded balance sheet, a competent owner-manager and is the domestic leader in China in an industry we know well, having been long- term shareholders in companies like CSL in Australia.

Since February, the company’s share price has fallen by around a third as solid, defensive earnings streams have become less popular relative to those driven by re- opening and recovery. With a return on capital above 20% and medium-term growth rates at a similar level, this felt like an opportune time to initiate a position in what we believe will be a long-term winner in China.

The same pattern and fundamental logic underlies recent new positions in a China software company and two Chinese medical diagnostics companies, plus Mercadolibre, an Argentina; e-commerce and fintech company.

In order to fund these ideas, we trimmed some existing positions. These were primarily holdings which have done very well and where a combination of resultant position size and valuation multiple has led us to take some profit, whilst retaining meaningful exposure.

One example would be EPAM Systems, a Belorussian IT services company listed in New York, which has benefited hugely from a surge in corporate spending on ‘digitalisation’. Another would be Dabur, an Indian ayurvedic consumer goods company which has seen very strong results as people increasingly spend on wellness products in the wake of the COVID-19 pandemic.

We continue to believe the companies we own in the strategy in emerging markets offer attractive long-term opportunities for capital growth.

In order to fund our new positions, we exited a total of five holdings over the quarter. We sold AVI Limited, a food producer in South Africa, and Jerónimo Martins, a grocery retailer with most of its cash flows from Poland. Both are companies whose earnings were relatively resilient during 2020 but which seem unlikely to grow quickly as the global economy recovers. Pigeon (a Japanese babycare company deriving the vast majority of its cash flows from China), OdontoPrev (a Brazilian insurance company) and Selamat Sempurna (an Indonesian auto components company) were all small positions which we exited after changing our minds on quality and in order to invest in better ideas.

As we hopefully move beyond COVID-19 throughout 2021 and beyond, we are optimistic about the opportunities for long-term returns through owning high-quality companies in emerging markets.

1. Past performance is not a reliable indicator of future results. Source: FactSet.

Source for company information: Stewart Investors investment team and company data. Portfolio data shown is from representative strategy accounts. New investments disclosed relate to holdings with a portfolio weight over 1%. It is not a recommendation or solicitation to purchase or invest in any fund. Differences between the representative account-specific constraints, currency or fees and those of a similarly managed fund or mandate would affect results.

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Proxy voting

1 January - 31 March 2022

Global Emerging Markets Sustainability

During the quarter there were 60 resolutions from ten companies to vote on. On behalf of clients, we voted against one resolution.

We voted against the approval of fees to be paid to the directors and commissioners at Bank Central Asia as we believe they are excessive. (one resolution) 

Source for company information: Stewart Investors investment team and company data. This stock information does not constitute any offer or inducement to enter into any investment activity. Portfolio data shown is from representative strategy accounts of the strategy shown above. Named new investments disclosed relate to holdings with a portfolio weight over 1%. It is not a recommendation or solicitation to purchase or invest in any fund. Differences between the representative account-specific constraints, currency or fees and those of a similarly managed fund or mandate would affect results. Proxy voting chart numbers may not add to 100 due to rounding.

1 October - 31 December 2021

Global Emerging Markets Sustainability

During the quarter there were 17 resolutions from four companies to vote on. On behalf of clients, we voted against one resolution.

We voted against Shenzhen Inovance Technology's request to make amendments to the procedural rules of the company's information disclosure management system as we did not have sufficient information at the time of voting to know what these changes were. (one resolution)

Source for company information: Stewart Investors investment team and company data. This stock information does not constitute any offer or inducement to enter into any investment activity. Proxy voting chart numbers may not add to 100 due to rounding. 

1 July - 30 September 2021

Global Emerging Markets Sustainability

During the quarter there were 162 resolutions from 22 companies to vote on. On behalf of clients, we voted against four resolutions.

We voted against Kasikornbank and Philippine Seven’s request for management to approve all other business matters before the annual general meeting (AGM) of shareholders. We consider ourselves active shareholders and prefer to vote on such matters at the AGM. (two resolutions)

We voted against the election of two directors at Dabur as we do not believe they are truly independent. (two resolutions)

Source for company information: Stewart Investors investment team and company data. This stock information does not constitute any offer or inducement to enter into any investment activity. Proxy voting chart numbers may not add to 100 due to rounding. 

1 April - 30 June 2021

Global Emerging Markets Sustainability

During the quarter there were 403 resolutions from 31 companies to vote on. On behalf of clients, we voted against 11 resolutions.

We voted against Vinda International and AK Medical Holdings’ request to repurchase issued shares, and issue shares without pre-emptive rights, as the share discount rate had not been disclosed and the share issuance was excessive. (four resolutions)

We voted against Shenzhen Inovance Tech’s issuance request to adopt a long-term stock ownership request incentive plan as there was a lack of disclosure and transparency on the plan. We also voted of against their request to elect an individual to their Supervisory Council as we do not believe they are truly independent. (four resolutions)

We voted against Natura’s request to establish a Supervisory Council as we do not believe it necessary given they are a one share, one vote company and we are comfortable with management. (one resolution)

We voted against Tencent’s request to issue without pre-emptive rights as the share discount rate had not been disclosed and the share was excessive. We also voted against their to adopt the share option plan of a subsidiary as there was a lack of detail provided on the terms the plan. (two resolutions)

Source for company information: Stewart Investors investment team and company data. This stock information does not constitute any offer or inducement to enter into any investment activity. Proxy voting chart numbers may not add to 100 due to rounding. 

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Investment terms 

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Important information

This information has been prepared and issued by First Sentier Investors (Australia) IM Limited (ABN 89 114 194 311 AFSL 289017) (FSI AIM).

Stewart Investors is a trading name of FSI AIM. FSI AIM forms part of First Sentier Investors, which is ultimately owned by Mitsubishi UFJ Financial Group, Inc (MUFG), a global financial group.

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Some of the information has been compiled using data from representative accounts. This information relates to existing Stewart Investors strategies and has been provided to illustrate Stewart Investors’ expertise in the strategies. This material is provided for information purposes only and does not constitute a recommendation, a solicitation, an offer, an advice or an invitation to purchase or sell any fund and should in no case be interpreted as such.

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.