Emerging markets tend to be one of the more volatile asset classes and as such, it is particularly important to diversify your portfolio if investing in the region, according to Neptune Investment Management’s Ewan Thompson.
To do this, the manager of the five FE Crown-rated Neptune Emerging Markets fund said within his portfolio he has three silos; structural growth, economic recovery and special situations.
To maintain the fund balance, Thompson must keep a minimum of 20 per cent of the portfolio invested in each silo.
He said: “The whole point is to have three different buckets, which kind of in themselves, represent a growth portfolio, a value portfolio and a real bottom-up, special situations portfolio.
“Put them together and that vastly reduces correlations, it reduces the risk of the fund and it also means we’re style-agnostic.”
In the structural growth bucket are the companies that are going to remain in the portfolio for a long time. He said they have solid business models, are bringing in high levels of profitability every year and, perhaps most importantly, can continue to do so because they have protected their businesses with a moat.
Chinese washing machine manufacturer Haier Electronics, the sixth-largest holding in the fund, is one such company that Thompson highlighted.
He said: “It is relatively unexciting, although you’ve got a nice structural backdrop in China of lots of people wanting to buy washing machines.”
Performance of stock over 5yrs
Source: Google Finance
But he noted that lots of people can make washing machines, so what makes Haier Electronics special?
“What makes Haier interesting is it has its distribution network across China, so that allows it to control its own destiny in a much bigger way, and its competitors don’t have that,” he said.
Thompson added that Haier has recently teamed up with Alibaba, the e-commerce giant, who are using the company’s distribution channel to access rural areas of China.
“It’s a bit odd - it’s like Amazon tying up with a washing machine manufacturer in the UK. It seems an odd way around to do it, but actually, it’s so well entrenched in its distribution channel that even Alibaba would need to go to them for help.
“So, that’s their kind-of moat. It’s a very profitable company and it continues to do very well. It has been in the fund for a very long time.”
In the next silo, Thompson holds economic recovery funds, which are stocks that are at points in the economic cycle when things aren’t going their way.
These companies don’t have the pricing power or the levers they can pull to control their own destiny, he said, but the valuations make them attractive.
An example of one such company is Antofagasta, a Chilean copper mining company listed in the UK.
Thompson said: “It has a very strong balance sheet and it’s a best-in-class operator. But it’s still selling copper and they can’t control the copper price.”
Indeed, year-to-date, the price of copper has fallen from near $7,200 to just above $6,600 per ton.
Regardless of this, he commented on the quality of Antofagasta’s balance sheet, as the company managed to remain net-cash when peers were having problems with debt.
Another benefit is that it is a pure-play copper producer in a world where there aren’t many pure-play copper producers, Thompson said.
Long-term, copper is one of the manager’s preferred commodities. He noted: “Ultimately, copper’s great longer term. People will need it for a long time to come and no one has found any for the last 30 years.
Despite his long-term conviction in copper, he said the stock’s inclusion into the portfolio was driven by short-term global growth.
“So, that’s going to be something that, as the economic cycle works, that will help them,” said the manager. “[In this silo] they are good companies, but there are times when you maybe don’t want to have such a high conviction in these stocks.”
Performance of stock over 5yrs
Source: Google Finance
Finally, there are companies in the Neptune Emerging Markets fund that fall under the special situations bracket.
Thompson said: “Special situations are things that are ultimately just not going to fit into these other buckets. So, they’re being driven by something other than the economic cycle or they’re not these long-term, repeatable businesses.
“It could be a management change, it could be a balance sheet restructuring, it could be a government policy which is to restructure an industry and change the competitive dynamics in an industry. So, these stocks are doing something quite different.”
Pampa Energia, an Argentinian electricity company, is a company that the manager owns within the silo.
Thompson went out to Argentina to meet the company a few years back when Cristina Kirchner was President of the country and was driving the economy into the ground.
Pampa Energia was operating a massive loss at the time, but Thompson said the company was just “trying to keep the lights on” because one day the situation would change.
He said: “In Buenos Aires province, an incredibly affluent area, people were getting an entire month’s electricity for something like three or four dollars. Yet, because they’re rich people, their mobile phone bills would be thirty dollars.
“And you think, they can afford all these things, but it was so politically unacceptable for the Kirchners to ever put up electricity rates because they’re good socialists.”
Fast-forward to the present, Kirchner has been replaced by Mauricio Macri who has brought improving macroeconomics with him.
Thompson said the new President has dealt with the debt hold-out issue that was hurting hedge funds, he has reduced currency controls and reduced inflation.
Performance of stock over 5yrs
Source: Google Finance
“But specifically, for a company like Pampa, they’re saying, ‘well the only way we’re going to have a functioning electricity system is, ultimately electricity prices need to be 10x higher’.”
This means the company would be able to charge 10x more but operating levels wouldn’t be affected, according to the manager.
“So, it happens over time, but that’s something again that has been very much driven by policy in Argentina, the specifics of regulation in the electricity sector within Argentina,” he said.
Thompson has run the Neptune Emerging Markets fund since its launch in 2008 and has overseen it to a top-quartile performance among its IA Global Emerging Markets peers over one, three and five years.