Templeton Emerging Markets Investment Trust — Broad opportunities in public and private markets

Ness considers that TEMIT has a competitive advantage as he and Sehgal can draw on the broad resources of Franklin Templeton’s emerging markets team, which has more than 60 investment professionals located in 14 countries across the globe who are able to provide regional insights. The manager highlights the research process, which he says is transparent with a long-term focus, seeking companies on a bottom-up basis that have sustainable long-term earnings growth and are trading at a discount to their estimated intrinsic value.

A consideration of environmental, social and governance (ESG) factors is integrated into investment decisions and risk management mitigates unintended risks from top-down factors. Ness comments that TEMIT’s portfolio is distinctive, diversified and high conviction, with the potential to outperform the benchmark in a range of stock market environments. He suggests that there is now a wider range of investment opportunities available helped by a broadening China ‘A’ share market and a booming initial public offering environment.

Discussing his outlook for 2022, Ness is ‘cautiously optimistic’ based on the growth prospects and relatively attractive valuations available in emerging markets. He says that the Chinese economic slowdown has been due to a range of factors including regulatory crackdowns, problematic high levels of leverage in the property sector and energy curtailment policies with the aim of improving China’s environmental performance. TEMIT’s Chinese exposure has been increased following share price weakness, but the trust remains underweight versus the benchmark.

The manager comments that the global move to full COVID-19 vaccination is ongoing and will take time and while the level of mortalities has declined, there is an increasing acceptance that the virus is endemic. Ness believes that the omicron variant will negatively affect economic activity and he suggests that full normalisation in the travel sector is unlikely before summer 2022. The global chip shortage and securing semiconductor supplies has meant significant price increases as well as higher capex in those sectors. TEMIT is overweight the semiconductor stocks that have sustainable cost and technology advantages, and which are in favourable competitive positions. Higher energy costs, freight rates and raw material costs have led to inflationary pressures on company margins. The managers’ preference is to remain focused on low-cost firms that are operating in areas of secular growth.

At 30 November 2021 there were 75 holdings in the portfolio, with the top 10 making up 54.4% of the fund compared with 56.6% a year ago; six positions were common to both periods. In terms of market cap, 45.8% of the portfolio was invested in companies above $50bn, 30.4% between $10bn and $50bn and 23.8% below $10bn.

The manager explains that the characteristics of TEMIT’s portfolio reflect the investment approach of focusing on companies with sound business models and sustainable earnings power that are trading at a discount to their intrinsic worth. The fund has clear quality characteristics with higher returns and margins and lower leverage compared with the benchmark, along with a lower forward P/E valuation. Ness comments that he and Sehgal have been exposed to crises in the past, so they try to be ‘masters of their own destiny’. He says that they are ‘doing something different’ versus the competition, as within the stock market there has been ‘a lot of herding into long-term quality growth names at any price’.

Considering TEMIT’s high-conviction top 10 active weights, Ness says that there is a diversity of businesses across a range of industries, with a mix of well known large-caps such as Taiwan Semiconductor Manufacturing Company and Samsung Electronics, and lesser-known names such as NAVER, which owns the leading search engine in South Korea, along with a selection of other online businesses such as entertainment, payments and logistics. The manager comments that TEMIT’s top 10 overweight companies are typically leaders in their industries, with competitive moats and attractive growth profiles; he is ‘happy to own these in size’.

TEMIT’s sector exposure, which is a product of bottom-up stock selection, is shown in Exhibit 2. Over the 12 months to end-November 2021 there is a higher technology weighting (+6.3pp) and this remains the largest active weight versus the benchmark by quite some margin (+13.3pp). The trust is overweight semiconductor and internet stocks and has a range of software companies; these are businesses that are benefiting from the rollout of the digital economy and increasing e-commerce volumes. Within the financials sector the trust is overweight emerging market banks, which are benefiting from increased demand from an expanding middle class in developing economies. Low levels of credit penetration will likely increase, and banks are well capitalised, ‘more so than 20 years ago’ reports Ness. Higher inflation should lead to higher interest rates, which is positive for bank net interest margins.

Over 12 months to end-November 2021, TEMIT’s largest changes in geographic exposure are higher weightings in Taiwan (+3.7pp) and India (+2.7pp) with lower weightings in China (-2.6pp) and South Africa (-2.4pp). Compared with the benchmark, the trust’s largest active weights are an overweight in South Korea (+10.0pp) and underweight in China (-5.2pp); this is despite the manager adding to TEMIT’s Chinese exposure in recent months, taking advantage of market weakness. Also, of note, the trust has no exposure to Saudi Arabia, which made up 3.3% of the benchmark at end-November 2021.

Looking at TEMIT’s five-year discrete performance data in Exhibit 4, the trust has outperformed its MSCI Emerging Markets Index benchmark in three of the last five years in both NAV and share price terms.

TEMIT’s relative returns are shown in Exhibit 6. Its NAV and share price total returns are ahead of those of the benchmark over the last three and five years, while lagging over one and 10 years. Ness notes that the trust’s performance over the last year has been ‘challenging’, although he says that it is more important to focus on the mid to long term; the managers aim to outperform the benchmark over a rolling five-year period. It should be noted that TEMIT’s underperformance versus the MSCI World Index over the last decade is largely due to the very strong performance of the mature US stock market in recent years.

Ness gives some colour on TEMIT’s performance over the last 12 months. Holdings that have made a positive contribution include ICICI Bank, which has benefited from higher economic activity and lending following COVID-19 lockdowns. The manager says that the bank has one of the strongest retail brands in India; its margins are supported by a low-cost deposit base and is trading at a discount to its private-sector peers. Within the electric vehicle (EV) supply chain, Chinese firm Guangzhou Tinci Technology Company is well positioned to benefit from increased demand for EVs and energy storage, and TEMIT has a large active weight in Taiwan Semiconductor Manufacturing Company, one of the largest global semiconductor suppliers, which has delivered strong earnings growth and has a robust operational outlook. Longshine Technology Group is a Chinese software and IT services provider to the power and electricity industries and is a relatively recent addition to the trust’s portfolio. Its businesses include online payment and EV charging payment services.

Moving on to the negative contributors to TEMIT’s performance, Ness reports that there has been significant share-price weakness in some of its Chinese names. Brilliance China, which has a joint venture with BMW, has seen its shares suspended since March 2021 following a delay in reporting its 2020 corporate results. Hence, the managers have imposed a fair value discount on the holding and are monitoring the situation very closely. Brilliance China’s operating earnings have exceeded consensus expectations as there is strong demand in China for European brands such as BMW.

There have been regulatory investigations into a range of leading businesses in China. Alibaba is the country’s largest e-commerce platform and has had some well documented challenges, including having to halt the planned listing of its fintech arm, and there has been an antitrust probe into online merchant pricing. Ness comments that the Chinese internet industry has seen heightened scrutiny in the past, and the strongest companies have proved to be resilient. He cites Alibaba’s distinct competitive advantages, which should support the firm’s long-term earnings growth in areas such as e-commerce and cloud computing.

Another of TEMIT’s holdings, Tencent, has been under pressure due to tightening online gaming regulation. Once again, the manager believes that Tencent’s businesses will thrive over the long term; the company is well diversified with a robust balance sheet. Ness believes that Tencent has a selection of attractive investments and long-term growth drivers. He suggests that within China we are ‘closer to the end of the regulatory process than the beginning’.

TEMIT is the largest of the 12 funds in the AIC Global Emerging Markets sector. Its NAV total returns are above average over three and five years, ranking sixth out of 12 funds and third out of nine funds respectively, while lagging over the last one and 10 years. As at 12 January 2022, TEMIT’s discount was modestly wider than the sector average, where just one fund was trading at a premium. It has the second-lowest ongoing charge, an average level of gearing and a dividend yield that is modestly below the mean.

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