While emerging markets have endured a number of challenges during 2018, Franklin Templeton’s Chetan Sehgal believes there are reasons for optimism and several opportunities for investors.
Sehgal – manager of the £2bn Templeton Emerging Markets Investment Trust (TEMIT) – said markets have been “discounting a far more pessimistic scenario than we currently envisage”.
“Emerging market fundamentals remain strong and we believe that the sell-off provides attractive investment opportunities for long-term investors,” he said.
“We do not expect contagion from markets such as Turkey and Argentina to spread across the entire emerging market asset class.
“Moreover, Turkey accounts for less than 1 per cent of the MSCI Emerging Markets index, while Argentina is not in the index and its weighting is expected to be even smaller than Turkey’s when it is included in 2019.”
Additionally, Sehgal said emerging markets are very different than they were in past crises, highlighting floating exchange rates, current account surpluses and more favourable debt levels than developed markets.
Concerns over a US-China trade war may also have been overplayed, according to the manager, as Chinese dependence on trade has been declining and its trade with the US “represents a modest percentage of the Chinese economy”.
Imports of goods and services (Balance of payments, current USD)
Source: World Bank
Sehgal said that intra-emerging markets trade has become increasingly important in recent years and that any US tariffs could prompt China to focus toward more regional agreements.
“The long-term structural case for emerging markets continues to centre around demographics, consumption and technological advances, and we believe that the best investment results are achieved by buying companies which have sustainable earning power and trade at a discount to their intrinsic worth,” he added.
As such, Sehgal believes there are three issues worth keeping an eye on.
Brazil’s presidential election
The first area that Sehgal is more optimistic about is Brazil, which saw the election of right-wing populist Jair Bolsonaro as president in October.
The Franklin Templeton manager said Bolsonaro’s victory had solidified investors’ optimism for a more market-friendly policy approach.
“Looking forward, we believe this should be positive for earnings growth and for the Brazilian equity market generally,” he explained.
“Political stability could also result in a more favourable climate where consumer and business confidence can pick up again and lead to an acceleration in domestic economic activity.”
Performance of index YTD
Source: FE Analytics
The fund manager said the local market is now trading at what it views reasonable price-earnings levels and should have scope for further improvement as the economic situation strengthens.
“Initiatives such as pension reform and an acceleration in privatisation could also be expected under the next president as part of efforts to tackle the deficit, improve the efficiency of the state-owned companies and lower corporate taxes,” he added.
Limited China downside risk
Following a recent correction, further downside in Chinese equity markets should be limited, the TEMIT manager said.
Over the past three months, the MSCI China index has fallen by 9.26 per cent in sterling terms, according to data from FE Analytics.
Moreover, there is potential upside if trade issues with the US are addressed and reform initiatives are followed through.
“We are of the opinion that China has the policy tools to manage economic challenges and provide stimulus as it continues with structural reforms,” he said.
“We saw regulators implement a number of measures, including a 1 per cent cut in banks’ reserve requirement ratio, an increase in export tax rebates and tax deductions on household income, in October.”
Sehgal said China offers an “unparalleled range of investment opportunities” with rapid digitalisation and growing consumption support growth across a number of different industries.
“Accordingly, when we look at the valuations and earnings potential of Chinese companies, underlying strength in the Chinese economy and ongoing reform efforts, we remain optimistic for China’s long-term potential,” he added.
Excessive pessimism
Concerns over the future global growth, the US-China trade spat, rising US interest rates and a strengthening of the dollar have prompted many existing investors to switch to more defensive stocks. Yet, the manager said this might be the wrong move.
Indeed, Sehgal said while pessimism has been behind much of the fall in emerging markets this year, too much of it may have been priced-in.
After a strong 2017 in which the MSCI Emerging Markets index rose by 25.4 per cent, in sterling terms, this year so far it has recorded a loss of 9.51 per cent.
“We think the market reaction has been excessive,” he explained. “We believe areas such as e-commerce, digital banking and mobile computing will likely be fundamental drivers of the global economy for years to come.”
The manager added: “Emerging markets’ accelerating internet usage and penetration are likewise hastening opportunities for efficiencies, cost savings and ease of doing business.
“Promising fields such as artificial intelligence, autonomous driving and the ‘Internet of Things’ continue to attract investment, signalling strong prospects.”
Sehgal took over management of Templeton Emerging Markets Investment Trust in January following the departure of former manager Carlos Hardenberg from Franklin Templeton.
Among the trust’s top holdings are Korean firm Samsung Electronics (8.1 per cent), Taiwan Semiconductor Manufacturing (6.5 per cent), and South African internet and media group Naspers (5.8 per cent).
Its largest country position is China/Hong Kong, in which it has 22 per cent of the portfolio invested, followed by South Korea (13.9 per cent) and Taiwan (11.5 per cent).
Performance of trust vs sector & benchmark YTD
Source: FE Analytics
Since the start of the year the trust has lost 11.61 per cent, compared with a 9.51 per cent loss for the MSCI Emerging Markets benchmark and a 11.36 per cent fall for the average IT Global Emerging Markets trust.
Templeton Emerging Markets Investment Trust is currently trading at an 11.7 per cent discount to net asset value (NAV), is 4 per cent geared, a yield of 2.2 per cent and ongoing charges of 1.09 per cent, according to the Association of Investment Companies (AIC).