While the addition of more companies to emerging market indices is improving access for investors, greater in-roads on corporate governance need to be made, according to Franklin Templeton’s Chetan Sehgal.
Sehgal became the lead manager of the £1.8bn Templeton Emerging Markets Investment Trust (TEMIT) earlier this year following the departure of former manager Carlos Hardenberg and has been with the asset manager for more than 20 years.
However, the closed-end fund has struggled in 2018 as emerging markets have fallen from favour amid greater uncertainty surrounding a potential trade war between China and the US as well as a strengthening dollar.
The trust has lost 8.34 per cent during 2018 compared with the 4.11 per cent loss for the MSCI Emerging Markets benchmark and a 3.88 per cent loss for the average IT Global Emerging Markets sector peer.
Performance of trust vs sector & index over 2018
Source: FE Analytics
“I think the last six months have been somewhat of a correction in markets and come at a time when trade issues have flared,” Sehgal said. “Earnings momentum had been strong and there was a big pick-up but that has stalled.”
The TEMIT manager noted that there have been a number of reforms going on in emerging markets more generally, which have also contributed to lower growth.
One example is in China, where authorities have acted to reduce overcapacity and tackle long-standing indebtedness.
As well as the possibility of higher trade tariffs for emerging markets following US president Donald Trump’s hard stance, countries have had to deal with the issue of a strong dollar.
“The ‘two-to-10 year’ bond yield has flattened; if it goes to 2-3.5 per cent I think emerging markets are still ok but if goes up people will get more nervous,” he said.
However, the manager said the deterioration in returns is not something that emerging market investors with a long-term view need to be too concerned over.
Sehgal said there were two types of investors in emerging markets – one tactical, the other strategic – both with different approaches to investing.
“[Tactical investors] will come in and out and an ETF provides for that. The other way to do it is to think about it strategically and think 10 years from now what is the best asset class to own,” he explained.
A decade ago, emerging markets were dominated by oil and natural resources companies and were seen as more of a commodity play, but more recently the growth in consumption has fuelled the growth of consumer staples stocks. However, Sehgal said that in 10 years’ time emerging markets will be dominated by technology.
Information technology represents a significant proportion of TEMIT’s portfolio with 33.5 per cent held in well-known names such as Samsung Electronics, Alibaba, Taiwan Semiconductor Manufacturing and Tencent.
“From a perception as high risk growth companies, these are slowly transforming into consumer companies and in some way becoming consumer staples companies,” he said.
“For example, the amount of time people spend on [Tencent’s] WeChat is now part and parcel of daily life – it’s not something you’re doing off and on. You can no longer even call it a fad.”
The recent inclusion of Chinese A-shares in the MSCI Emerging Markets index was welcome and a sign of its importance of the market but the manager said greater work on corporate governance needs to follow.
“Up until now MSCI has basically confined itself as an actor of the market and how emerging markets are defined,” he said. “Initially the concept of emerging market started because they wanted to improve capital markets of these countries.”
Corporate governance as a theme is important for the TEMIT manager as it represents one of the biggest risks to investment but also a significant opportunity.
“After 20 years of emerging market investing you have to say corporate governance has improved but it’s still there [as an issue],” he said. “They’re still slightly behind.”
Discount/Premium of TEMIT over 5yrs
Source: FE Analytics
He added: “People talk about the discount of the TEMIT but we have plenty of assets that are trading at a fraction of the real value of the underlying companies like Naspers, which is trading at a nearly 60 per cent discount to its underlying value.”
“In China we have a company that runs Bosch franchises but have two shares: both are reflecting the same underlying earnings but the two share classes are reflecting some, but the share classes themselves have over a 30 per cent gap,” the TEMIT manager said.
“If the management were good they would merge the share classes. Those opportunities need to be closed down and then the value gap can start narrowing.”
The downturn in fortunes for emerging markets this year has made some international investors more wary, with the latest Bank of America Merrill Lynch Global Fund Manager survey showing that investors had made a significant cut in allocations to a 1 per cent underweight.
However, Sehgal said that fewer emerging market economies are relying on external capital and becoming more self-sufficient, which will help long-term sustainability.
“I think the dependence on capital flows is one of the reasons the cycles get exacerbated,” said Sehgal. “But if you step back the number of countries dependent on capital flows has come down dramatically.
“China is not really dependent, Russia is probably a little bit but doesn’t have any capital flows [under sanctions]. As long as that dependency comes down over time, I think emerging markets can stand on their own feet.”
Over three years Templeton Emerging Markets Investment Trust has delivered a total return of 47.82 per cent compared with a gain of 43.54 per cent for the benchmark and a 33.43 per cent return for the average fund in its sector.
Performance of trust vs sector & index 3yrs
Source: FE Analytics
It is currently trading at a discount of 12.3 per cent to NAV, is 4 per cent geared has a yield of 2.1 per cent and ongoing charges of 1.09 per cent.