COVID-19: implications for performance and portfolio positioning - Global Emerging Markets Sustainability Strategy
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- COVID-19: implications for performance and portfolio positioning - Global Emerging Markets Sustainability Strategy
Global emerging markets are traditionally, and rightly, perceived as high-risk assets. In times of financial panic and flights to safety such as we are witnessing now, the currencies and equity prices of assets in these countries tend to suffer. As of 18 March, the MSCI Emerging Markets Index was down 20.3% in GBP year to date, which was only marginally worse than the MSCI AC World Index (down 19.5% in GBP).
Within that performance there is material divergence, principally between China and everywhere else. The MSCI China Index has fallen 7.2% in GBP while the MSCI China A Onshore Index has risen 1.9% in GBP. The relative resilience of Chinese equity prices has perhaps reflected the seemingly successful containment of COVID-19 in that country. It may also indicate that the ‘National Team’ of state-linked insurers and asset managers which stand by ready to buy on weakness and prop up asset prices has been successful; the confidence that market participants have in the willingness of the state to support markets in itself creates resilience.1
Logically, then, the remainder of the emerging markets asset class has suffered disproportionately. Much of this has been through major currency adjustments in those countries which went into the crisis with weak fiscal positions, current account deficits, and significant exposure to badly damaged sectors like tourism and oil. The Mexican peso, Brazilian real, South African rand and Russian rouble have all been violently sold off, as fixed income investors have fled to the relative safety of dollar assets.
Our investment process is focused on selecting quality companies, which tend to be relatively more resilient to sharp market downturns. Our focus is on long-term returns and capital preservation as a means to capital growth. As the old maxim goes, it is defence which wins championships.
Whilst we hate losing money for clients and would by no means describe recent performance as pleasing, it is a modest silver lining that the portfolio has been doing what it is meant to do in markets like these and holding up better than its benchmark. Year to date to the 18 March, net of fees, the fund was down 12.0% in GBP (Class A shares) and was down 11.8% GBP (Class B shares), relative to an MSCI Emerging Markets Index performance of negative 20.3%.2
Relative performance is explained by our process and its focus on quality. We tend not to own companies with significant debt, and usually have very moderate exposure to industries like banking or industrials where cash flows can disappear quickly. Given our approach to sustainability, we also tend not to find the characteristics we look for in companies operating in some of the worst-hit sectors such as energy, restaurants, beer, airlines and shipping, where we had zero exposure.
In contrast, what has helped has been owning companies which are high quality, have robust cash flows and balance sheets, and operate in industries which allow them to generate predictable earnings.
Inevitably, there are always frustrations at times like this. There are plenty of examples of companies that we wish we had been either more aggressive in exiting, less quick to add to, or more decisive in adding to where they have been defensive. It is part and parcel of stewarding capital for clients that this occurs.
We have made very few transactions so far. Our only moves have been to exit a small handful of positions in companies where we feel that the prospects of hard currency earnings growth has now become very bleak. In some cases, these companies have already fallen precipitously.
This invariably causes a portfolio manager much mental anguish, loathe as we usually are to sell out of positions which have been detractors and ‘lock in’ losses.
But the reality is that the past doesn’t matter. We, like everybody else, have made mistakes which we must strive to learn from.
We must resist hindsight bias, endowment bias and anchoring. Our goal is to use this crisis as an opportunity to increase even further the quality of the companies that we are able to own for clients. That may mean selling out of companies that have declined significantly in value, and it is also likely to mean higher than normal turnover in the near future.
We have been saying for quite some time that the very best companies in our universe have been highly valued. As a consequence, we have had higher cash balances than we would like, and have held significant positions in multi-national companies like Unilever and Colgate-Palmolive which have done their job in providing sources of outperformance in down markets.
Whilst we have no ability to call the bottom, we will be slowly drip-feeding capital into companies which have greater growth prospects alongside high-return business models. This will be highly selective.
We have been unable to own many of these companies in a significant way for the last few years due to what in our view were quite stretched valuations. So it has proven for many of them. The silver lining in this crisis is that for us as stock-pickers, it is quite an exciting time. Many of our favourite companies – the very best in emerging markets – have for the first time in years become reasonably valued.
We look forward to the opportunities we are being presented with to own these companies for clients, and would like to thank you for your continued support during these difficult times.
20 March 2020
China A shares – also known as domestic shares are shares of mainland China-based companies that trade on the two Chinese stock exchanges, the Shanghai Stock Exchange and the Shenzhen Stock Exchange.
Hindsight bias – refers to the common tendency for people to perceive events that have already occurred as having been more predictable than they actually were before the events took place.
Endowment bias – also known as the endowment effect in behavioural economics refers to an emotional bias that causes individuals to value an owned object higher, often irrationally, than its market value.
Anchoring – is a behavioural bias which occurs when people rely too much on pre-existing information or the first information they find when making decisions.
Class A shares
Class B shares
These figures refer to the past. Past performance is not a reliable indicator of future results. For investors based in countries with currencies other than GBP, the return may increase or decrease as a result of currency fluctuations.
Source for fund: Lipper IM/Stewart Investors. Performance data is calculated on a net basis by deducting fees incurred at fund level (e.g. the management and administration fee) and other costs charged to the fund (e.g. transaction and custody costs), save that it does not take account of initial charges or switching fees (if any). Income reinvested is included on a net of tax basis. Source for benchmark: FactSet, income reinvested net of tax. Since launch performance calculated from 8 April 2009 for both share classes.
Additional index performance
These figures refer to the past. Past performance including simulated past performance is not a reliable indicator of future results.
For investors based in countries with currencies other than GBP, the return may increase or decrease as a result of currency fluctuations.
Source for fund: Lipper IM/Stewart Investors. Benchmark income reinvested net of tax.