Heenan (pictured) says that in recent years emerging markets have been overvalued, just as their performance dipped, and he has preferred to access the theme through Western companies selling into those markets.
Valuations are starting to come down, he explains, but corporate governance issues remain a concern. “Corporate governance and the rule of law are enormously important. We are concerned about the rule of law in China which is still a communist country, and people need to be reminded of that,” he said.
“We have doubts about the rule of law in Russia as well. Some of the actions politically such as the Yukos situation years ago come up more often than we may like.”
“You should never pay a premium for assets where you are not sure what your ownership is.”
The five-crown rated Kennox Strategic Value fund is a totally unconstrained but highly concentrated portfolio of just 26 holdings, which are selected according to a strict value process.
The fund is independently owned and amounts to only £153m in assets under management, but strong inflows has seen it almost double in size over the past year.
The team buy and sell stocks very rarely, looking for companies that are at a low point in their earnings cycle and also significantly undervalued by the market.
This contrarian, deep value style protects on the downside as the stocks to which it leads the team have already fallen a great deal.
The fund was launched in July 2007 and excelled in the crisis of the following year, when it made 6.38 per cent as the IMA Global sector fell 24.32 per cent.
Performance of fund versus sector and index in 2008
Source: FE Analytics
This is particularly impressive for what is effectively an equity-only fund – although the portfolio contains a 4.1 per cent holding in a physical gold ETF.
Since launch the fund has continued to protect against the downside.
Over five years its returns of 67.17 per cent put it amongst the top decile of the 181 funds in the sector, and are more than double the 30.6 per cent of the average global fund.
However, the annualised volatility of the fund is just 11.07 per cent compared to 16.91 per cent for the sector average.
The result of this combination of high returns and low risk is that the fund has the highest Sharpe ratio in the sector over that time - 0.67.
Performance of fund versus sector and index over 5yrs
Source: FE Analytics
The fund has recently opened up a new position, a rare event, buying a stake in Western Union, which Heenan says is a stock that is tied into the emerging market growth story.
“We have little direct exposure to emerging markets. We just haven’t found the right quality at the right price, but we think there are some things that are interesting,” Heenan said.
“Western Union for example. It’s a very specific part of emerging markets. The underlying earnings drivers are there.”
“Western Union is the biggest player in its area and has a network that’s practically impossible to replicate,” he added.
“It has developed into a money transfer business most of which is remittances for expat workers. A lot of South Asian, Indian, Pakistani and Bangladeshi or Middle East expats use it to send money home.”
“They have 500,000 agents. They have global footprint that’s difficult to replicate. Banks aren’t their competitors because they are sending small amounts of money back.”
“Plus, banks have major problems: they are too bureaucratic and too slow. Western Union can do most of its transactions in minutes not days.”
Heenan thinks that the market reacted over-hastily to some lukewarm announcements from the company, and has under-estimated the competitive advantages the firm has.
“The market felt there were a few issues around the company so the share price fell off, and the rest of the world is on high share prices.”
“People have been worried about mobile to mobile as a competitor, but people put a premium on cash, plus Western Union are developing mobile technology.”
“Western Union brought down their fees and said 2013 didn’t look like a great year for them. But the fees coming down is a part of their business. They have to stay competitive, and if they can keep cutting fees they can keep attracting new business.”
“We are looking for ideas that are different from whatever else is in our portfolio. If we have 18.18 per cent in Japanese mid-caps if we put more we would be over-concentrating the risk.”
“Western Union is quite different to anything in our portfolio.”
There have been few opportunities to access emerging markets directly in recent years for investors following a strict value process, the manager explains.
“Emerging markets had a good run and everybody said that it will continue for ever. We think they had a great run but we would be wary about buying at the end of the run.”
“Emerging markets had a tough couple of years, and we are becoming more interested as they have struggled.”
“Firstly, for us to be interested, they need to be less popular, lower earnings, lower p/e, lower valuations. We do not like peak earnings.”
“A couple of years ago they were all at peak earnings and they were late in the cycle. Now expectations are coming down, earnings are coming down and valuations are coming down from the top of the cycle.”
“Secondly, you need time for the cycle to move through a little bit.”
“You have to be wary of buying the most popular thing of the day in the market. If everybody is talking about global then I am worried that my sector is becoming too popular.”
Heenan says that over the longer term stocks like Coca-Cola and McDonalds are interesting ways to access the emerging market story through developed market stocks, although he stresses that he owns neither.
“We think one of the most attractive emerging market companies is Asia Satellite, which operates out of Hong Kong,” he added.
Asia Satellite, which is a holding on the Kennox fund, operates four in-orbit satellites that provide broadcasting logistics over Asia, Russia and the Middle East.
Heenan says that Tesco, which he bought after its profits warning last year, is another developed-world stock that accesses the emerging market story.
“The Thai assets and South Korean assets they have, if those economies continue to develop, being the leading player in a basic industry is a good place to be,” he said.
“It’s not exciting on a three to five years view, but over 15 years it is.”
Tesco has rallied since its profits warning last year, and is now up 20.88 per cent over the past year, according to data from FE Analytics.
Performance of stock over 1yr
Source: FE Analytics
“We bought Tesco at £3.25 and it’s now at £3.80, which is a good return, with a five per cent dividend,” Heenan said.
“We were hoping for it to be quieter, actually. I do not foresee it being able to continue to grow as has done over the last year.”
The manager says that although he generally likes to take money out of runners and put it into new ideas that is not the case with Tesco and he has no plans to sell the stock despite expecting it to perform more modestly in 2013.
The minimum initial investment is quite high for retail investors at £20,000 and the total expense ratio is 1.55 per cent. It is not available for a lower minimum via platforms.