The case for South Africans exposing themselves to a leading dollar-denominated emerging markets (EM) fund is a no-brainer. EM’s role in driving global growth should not be underestimated, either including or excluding China. EM ex-China accounted for 32% of 2017 real global growth in US-dollar terms, while China alone amounted to an additional 27%. By comparison the US contribution was 16%.
Launched in February 1991, the US-dollar denominated $965m Templeton Emerging Markets Fund has returned a cumulative 279% in US dollars since then, and 31% over the last three years.
This fund is managed by Chetan Sehgal, senior managing director and director of portfolio management, Franklin Templeton Emerging Markets Equity, and overseen by Manraj Sekhon, chief investment officer of Franklin Templeton EM Equity. While the team’s philosophy is value-oriented, the investment style is core, involving buying shares of companies with sustainable earnings power that trade at a discount to intrinsic value. The team generally aims to generate returns commensurate with the double-digit earnings growth typically seen in emerging markets, and alpha of 2% to 3% per annum over a rolling three-year period.
An important feature of the Templeton EM Fund is its global spread and broad diversification. From a geographic perspective it is linked to the MSCI EM Index with its main components comprising China 24% of the total (compared with MSCI Index’s 31%), South Korea 18% (14%), Taiwan 11% (12%), SA 8% (7%), Russia 7% (4%), India 7% (9%), Brazil 6% (6%) and Thailand 3% (2%).
The largest sectors currently are information technology at 33% (27%), financials 22% (23%), consumer discretionary 20% (9%), energy 7% (7%), and consumer staples at 6% (7%).
The primary themes within the portfolio are concerned with the growth of technology and innovation, as well as rising consumer penetration and ‘premiumisation’ of consumer demand (not just buying cars, but buying BMWs, for example). These sectors and companies offer diversification to South African investors given the dominance of financials and materials in the domestic economy.
While country and sector bets are limited, the fund relies on stock selection to generate returns – hence here the differences with the index are more evident, with a large number of non-index exposures. The five biggest holdings are Samsung Electronics 8%, Naspers* 7%, Taiwan Semiconductor Manufacturing 6%, Alibaba 4.6% and Brilliance China Automotive Holdings 3.5%.
Sehgal concedes that EMs suffered a setback in the first half of this year and that the impact of trade concerns, a strengthening US dollar and high volatility in markets such as Argentina and Turkey has been more profound than expected, but they discount the possibility of a wholesale derailment in EM fundamentals.
The sharp market gyrations (mainly downwards) in EM equities and currencies, in their view, have generally priced in scenarios worse than is likely to be the case.
If you look at EMs in general, most are in good shape with good earnings growth and better growth prospects than developed markets in the years ahead, they say.
Moreover, most EM currencies have floating foreign exchange regimes and as a group run a current account surplus. The effect furthermore of the strong US dollar will differ from country to country, depending on each nation’s economic structure and policies.
Nor does Sehgal maintain that a slight slowdown in China will bring downside risks for other EM markets. On the contrary, he argues, the quality of growth should continue to improve as the government takes up efforts to reduce financial stability risks and rebalance the economy. China’s efforts to rebalance by way of slowing investment growth are a positive development for the rest of the world.
Naturally, of course, there will always be risks too. The value of an EM portfolio and resultant yields can especially fall or increase due to changes in markets. This can result in the unit value falling below the amount you originally invested and obstruct you from reaching your investment goals.
So why consider this fund?
Franklin Templeton has been a pioneer in EM investment. It introduced the industry’s first closed-end fund dedicated solely to EMs in 1987.
The group keeps an active presence in local markets with a team of over 70 dedicated portfolio managers and analysts located across 18 offices around the world, maintaining a first-hand understanding of the economic trends of their respective regions.
The fund managers invest with a long-term view in EM companies it believes are under-valued relative to the sustainability of their earnings, fundamentally strong, growing, and capable of weathering difficult times.
This year’s slide in EM stocks has made them relatively cheap judged by the MSCI EM Index on around 11.2 times this year’s earnings, down from 13.3 times earlier this year and now hovering at their lowest in more than two years. The discount compared to developed markets (MSCI World) has widened considerably.
EMs have consistently proven their return potential and there is little reason to believe that this will not continue in the longer term.
*finweek is a publication of Media24, a subsidiary of Naspers.