Templeton Emerging Markets Investment Trust — Good opportunity to revisit an unloved asset class

Ness comments that global markets have been ‘challenging’ this year; for the first nine months of 2022, the MSCI World Index declined by 25.4% and the MSCI Emerging Markets Index by 27.2% (both in US dollar terms). According to the manager, the macroeconomic backdrop is not being helped by the ongoing war in Ukraine. Higher inflation and a strong US dollar are leading to interest rate hikes in developed markets, the magnitude and timing of which have not been seen in many years. While COVID-19 no longer dominates the headlines, Ness is nervous about the potential for a bad UK flu season, while China’s zero-COVID-19 policy is weighing on its economic activity. The manager also points to the global climate crisis, including the devastating floods in Pakistan, commenting that the world is changing and the need to transition away from fossil fuels will bring costs and burdens for companies and consumers, which is a headwind to economic growth.

However, Ness is relatively upbeat about the prospects for emerging economies, which he considers to be more resilient due to an improved policy environment. Despite this, the manager says that emerging market equities is an asset class that is ‘unloved, under-owned, undervalued and underappreciated’.

Ness reiterates that TEMIT offers a high-conviction portfolio of best ideas, with the two managers being part of a team of more than 70 investment professionals located in 13 countries. The fund has exposure across the market cap spectrum and the managers are also able to invest up to 10% of the portfolio in pre-IPO companies, although they have not done so yet. There is an emphasis on good corporate governance and the managers focus on businesses with sustainable earnings power that are trading at a discount to their intrinsic value.

The manager highlights what he considers to be the new emerging markets landscape. He says that institutions in these regions have made policy improvements that should contribute to increased economic resilience during times of stress. He opines that emerging markets are underappreciated, despite having employed orthodox monetary and fiscal policies; the regions did not experiment with negative real interest rates in recent years and there was a lack of aggressive fiscal support during the pandemic, avoiding big hits to government balance sheets. Emerging market central banks have been proactive by raising interest rates in response to higher inflation and some countries have largely finished tightening rates. For example, in Brazil, the next move is likely to be down as the base rate rose from 2.00% in March 2021 to 13.75% and inflation is coming down (c 7% now compared with c 12% in April 2022). Ness also explains that emerging markets are typically less levered than developed markets at the government, corporate and household levels. He also highlights how emerging market economies have diversified, with consumption and technology providing secular growth drivers. The manager believes that investors are underestimating the resilience and quality of some emerging market companies and the regions are home to some of the most innovative technology companies in the world, including those involved in the development of electric vehicles, electric vehicle batteries and the transition towards renewable energy. Ness says that some emerging market companies have been leapfrogging established business models in developed markets through innovation and technology advancements.

TEMIT’s top 10 holdings represent a range of countries and sectors, and these companies tend to be respective industry leaders that can navigate challenging environments. At-end-September 2022 they made up 46.6% of the portfolio, which was a noticeably lower concentration compared with 55.1% 12 months before; eight positions were common to both periods.

Over the 12 months to end-September 2022, the largest portfolio changes on a sector basis were a higher exposure to financials (+5.4pp) and lower weightings to communication services (-5.5pp) and technology (-4.2pp). Compared with the benchmark, TEMIT’s largest overweight positions are technology (+9.7pp), despite this being one of the largest reductions in sector exposure, and financials (+4.0pp), while the largest underweight position is utilities (-3.1pp).

In terms of TEMIT’s geographic exposure, the largest changes over the 12 months to end-September 2022 are Brazil (+5.0pp) and the rest of the world (-8.2pp). Notable variations compared with the benchmark are overweight exposures to South Korea (+6.7pp) and Brazil (+5.3pp) and an underweight exposure to the rest of the world (-14.5pp).

Ness highlights some of the most important portfolio transactions in Q322. There is a new holding in HDFC Bank, which is the largest private-sector bank in India with a strong presence in the retail segment. The manager says that the company should be an important beneficiary of the long-term growth potential in India, with a possibility of a cyclical uptick over the next few years. India-listed Zomato was added to TEMIT’s portfolio as it has a strong standing in the food delivery market, which Ness expects to grow in the medium term. There is also a new position in Banco Santander Chile, which is the largest financial institution in the country. Sales included Brazilian financial exchange B3 and food-delivery firm Delivery Hero.

TEMIT’s relative performance has improved in recent months, although its NAV total return lags that of the benchmark over the last one, three, five and 10 years. Ness explains that this year has been a very challenging environment for stock pickers as markets have been driven by top-down factors. He stresses the importance of remaining steadfast to the philosophy of focusing on companies that have sustainable earnings growth that are trading at a discount to their intrinsic worth.

The manager highlights that TEMIT’s Russian exposure had a meaningful negative impact on the trust’s performance. These shares were written down to zero in the first week of March 2022. However, there was also an indirect impact from Russia’s invasion of Ukraine as the Saudi Arabian stock market was very strong due to high oil and gas prices and positive fund flows as investors sought to maintain their energy exposure. TEMIT does not have any Saudi Arabia-listed shares, which has turned into a performance tailwind in recent months as they have pulled back.

Ness says that China has been a difficult market to navigate this year given its zero-COVID-19 policy and regulatory crackdown, which have negatively affected a range of industries, especially internet companies. However, he believes that we are closer to the end of increased regulatory scrutiny than the beginning.

TEMIT is the largest of 11 funds in the AIC Global Emerging Markets sector by a considerable margin. The trust has had a tricky period of absolute and relative performance over the last 12 months with its NAV total return ranking eighth. It ranks ninth out of 11 funds, eighth out of 10 funds and seventh out of nine funds over the last three, five and 10 years respectively. Comparing TEMIT with the two funds that its managers consider its closest peers, Fidelity Emerging Markets and JPMorgan Emerging Markets Investment Trust, TEMIT ranks first out of the three funds over the last 12 months and second over the other periods shown.

The trust’s discount is narrowly wider than the sector average and it has a competitive ongoing charge, which is c 30bp below the mean. In line with the majority of its peers, TEMIT is currently ungeared, and it has a modestly below-average dividend yield.