The winners of an “ongoing industrial revolution” are mostly in Asia and California, according to Carmignac’s Xavier Hovasse, creating the opportunity for strong returns in emerging market equities.
Investing in these ‘winning’ companies when other investors feared a tech bubble is what propelled Hovasse’s £291m Carmignac Portfolio Emergents fund to the top of the IA Global Emerging Markets sector in 2020 with a 65.86 per cent total return.
“We understood very well that there was an ongoing industrial revolution,” Hovasse said. “In the last few years, there was this chat about whether there was a tech bubble or if Alibaba or Tencent were a bubble – and we understood that it was not the case.
“We're in a situation where we are experiencing an industrial revolution and in an industrial revolution, stock prices move very quickly.”
Performance of fund vs sector and index in 2020
Source: FE Analytics
The manager added that the moves in share prices are often very sharp because companies fall in either two camps: the ‘disrupters’ and the ‘disrupted’.
He said: “We have understood for the last few years that this was not a tech bubble – it was a proper change of the world.”
This is why Carmignac Portfolio Emergents was invested in the emerging market ‘winners’ of this industrial revolution. Many of these stocks have rallied dramatically, with investments in e-commerce companies paying off handsomely.
In Latin America, its holding in e-commerce retailer Mercadolibre was up 175 per cent in 2020, while in south-east Asia, it had a position in e-commerce and gaming firm SEA Limited, which was up 390 per cent.
Hovasse described these two firms as the ‘Alibaba’s’ of Latin America and south-east Asia.
Samsung and Taiwan Semiconductor Manufacturing Company (TSMC) were two other large holdings in the fund, which Hovasse described as “big winners” of the industrial revolution.
“This is because the digital revolution is going to imply more usage of semiconductors, because you will need more of them for servers, for the 5G rollout and for autonomous cars,” he said.
“They are beneficiaries and they are monopolies. TSMC is a quasi-monopoly in the foundry business and Samsung is a quasi-monopoly in the DRAM [dynamic random access memory] business, so they are the big winners of the of the tech revolution.”
Share price of TSMC over 1yr
Source: Google Finance
The standout performance in 2020 means Carmignac Portfolio Emergents is in the IA Global Emerging Markets sector’s top decile over three and five years, with much of this performance attributed to sticking to its investments in Asia. The portfolio is overweight Asia with more than 90 per cent invested in the region.
Aside from the fact that Asia holds many companies at the heart of the industrial revolution, parts of the region handled the Covid-19 pandemic much better than developed markets and without taking on the same amount of debt via monetary and fiscal support.
“Who are the winners of the industrial revolution? They are in California and Asia,” Hovasse said.
“Asia is where you have the factories that manufacture the technology products and that’s where you have the huge Chinese market as well.”
Aside from the fact that Asia is one of the main winners of the industrial revolution, there are several other reasons to be overweight emerging markets, according to Hovasse.
“First of all, they've underperformed for 10 years and by a lot,” he said. Indeed, emerging markets has lagged most other major equity markets over the last decade.
Performance of emerging markets versus other markets over 10yrs
Source: FE Analytics
“Secondly, in 2020 Asia did much better than the rest of the world and Asia is 80 per cent of emerging markets, as far as I'm concerned as an equity investor,” Hovasse said. “If you look at equities, market caps, the volumes are in Asia.
“Asia did much better than the rest of the world to manage Covid-19, so they had higher growth with lower stimulus.”
The third reason to reason to be positive on emerging markets is down to a weakening dollar environment.
“In the US, you had a huge fiscal deficit financed by the Fed printing money and that is bearish the dollar. It’s going to push the dollar probably into a three- to four-year bearish cycle and, if that is the case, it's very positive for emerging markets,” Hovasse said.
He is also bullish in the ex-Asia part of emerging markets, namely Latin America and eastern Europe, because currencies there have collapsed to the point where there are current account surpluses.
“Brazil has a current account surplus for the first time since 2006. Even South Africa is now in a current account surplus. India has a current account surplus for the first time since 2004,” Hovasse noted.
“So there's been a significant improvement in the fundamentals, even in the weak links of emerging markets. These are very spectacular changes that we are seeing.”
Therefore, the fund is now adding to Brazilian equities due to the cheap currency and its correlation to the prices of commodities.
“The Brazilian real is highly correlated to commodity prices,” the manger said. “Look at the price of iron ore last year, it had fantastic performance. Even the soft commodities, the agricultural commodities that are exported, performed quite well.”
He said there is as a result a “big discrepancy” between the fundamentals and the price action on the Brazilian currency, which makes it relatively attractive.
Performance of fund vs sector and index over 5yrs
Source: FE Analytics
Over the last five years, Carmignac Portfolio Emergents has delivered a total return of 174.97 per cent, compared to 119.81 per cent from the average fund in the IA Global Emerging Markets sector and 133.42 per cent from the MSCI Emerging Markets benchmark.
It has an ongoing charges figure of 1.15 per cent and holds an FE fundinfo Crown Rating of five.