October 2018

Global Emerging Market Equities Webcast (3Q18 Update)


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Speaker Key:

Jessica Marriott, Sales Support Manager
Ian Tabberer, Portfolio Manager
Stephen Deane, Portfolio Manager

Jessica Marriott: Good afternoon, everybody, and welcome to today’s Janus Henderson webcast. I’m joined today by Stephen Deane and Ian Tabberer, Portfolio Managers on our Global Emerging Market Equities Team here at Janus Henderson. In today’s webcast they’re going to provide an update on our emerging markets strategy, talking about positioning, their outlook.

So briefly before I pass over to them, if you have any questions you’d like to ask during the presentation today you should be able to send those via the questions tab that shows on your screen. And just a brief reminder that this webcast is designed for clients, so if there are any journalists on the line we’d appreciate it if you leave the call now and get in contact with our PR team. Right, guys, over to you.

Ian Tabberer: Great. Good afternoon, everybody. My name’s Ian Tabberer. I’m a Portfolio Manager on the Global Emerging Markets Team based here in Edinburgh and actually we are sort of living what we say at the moment in terms of kicking the tires because I’m joined with Stephen Deane, a fellow Portfolio Manager, who’s actually based in Taiwan as we speak, so he’s coming down the line. So the wonders of modern technology allowing to bring the investment team together to talk about, well, what we’ve been seeing and doing over the last six months. So, what’s the aim of today?

Our aim over the course of the next 25 to 30 minutes is just to give a quick, brief overview of the investment philosophy, just a reminder of how and why we do it just to set the scene, and then Stephen’s going to talk about the piece that he wrote a while back about his recent travels with Mike Cahoon, a fellow Portfolio Manager in India.

After that, we’ll talk briefly about strategy portfolio positioning, what we’ve been buying and selling over the past six months, and then finally we’ll focus a bit on our latest paper, which is discussing our view on sustainability, why we think it’s important and how we approach it. And then finally hopefully at the end of that we’ll have some time for your questions, if there are any. So, moving on …

Just a quick overview of our investment philosophy. I think it’s really important to remember that this Global Emerging Markets investment strategy we believe is pretty unique, and we’re unique because we’re really focused on bottom-up investments. We don’t follow the index and we have an absolute return mindset. Our aim is to invest in quality companies for the long-term and use a very strict valuation discipline, and I think it’s important to note our portfolio turnover  for the strategy, and our aim is to talk about the strategy today, the All Cap strategy, currently the trailing 12-month portfolio turnover is around about 20% so this means that we are holding the businesses in our portfolio for on average five years and so we’re less interested in news and macroeconomic events and more interested in what’s happening to the long-term competitive position, franchise and valuation of businesses and companies which we hold, so we really do have a long-term mindset and you can see the proof of this can be seen in our portfolio turnover. So that’s a quick reminder of our investment philosophy.

And I suppose, Stephen, what I’d like to do is just kick off by asking you, I know you went out to India, I think it was with Glen [Finegan, Head of Global Emerging Market Equities] a while back, what were the key insights that you came back with? What did you find interesting out there?

Stephen Deane: Yes, thanks, Ian. Well, it’s very interesting actually to look at some of the things that we talked about, when, after we came back in February and mainly how, to some extent, things have panned out over the subsequent months. One of the things that I guess struck us when we were there was just reminding us again of how you invest in banks. Banks are the most leveraged companies that we own in our portfolios and effectively only exist on the basis of trust and it’s a very interesting thing to look at how trust manifests itself in banks and particularly the banks in India.

So emerging markets are unusual to when you compare them to the developed world because what you find is that the state is still very heavily involved in the banking sector. And it’s funny in a way because in India you look at the state banks and they have very strong deposit franchises, but the problem ultimately with state banks is that you’re not aligned with the interests of the people who control them. We’ve always said that politicians make terrible lenders and I think you can see this coming home to roost in India.

And for the longest time the non-performing loans (NPLs) in the state banking sector are much, much higher than those of the private sector and so it’s something that we’ve always stayed away from, and so we generally tend to prefer private banks that either have an owner, a long-term family owner because if the money in the bank is yours, you behave in a very different way to if you’re an agent and simply running the bank for somebody else.

Or, if that doesn’t happen, and HDFC I think that we talk about in the piece, HDFC is a good example of a bank where it doesn’t really have a family. In fact, it doesn’t have a family controlling it, but it has developed a culture that is extremely risk aware and if you look at the history of NPLs in both HDFC, the holding company and the bank, they’re much lower than the system overall because of this culture that the bank has. And one of the things that we quite liked is when we talk to them about how their credit policy had evolved, and some of the banks we talk to these days are talking to us about artificial intelligence making decisions on banking or new systems that they’ve developed that somehow take away all the risk.

And we just don’t really believe that those things truly work; the simple face-to-face interactions in commercial banks or in mortgage lending are still actually very important and knowing people is actually quite critical. And that’s the way HDFC has approached things and they haven’t changed their lending approach in 30 odd years and so a lot of that kind of conservatism, and we like private banks that are run by the right kind of people.

The second thing that we took away, which I think was quite interesting, was that for a long time we’ve been very sceptical of some of the Internet companies in emerging markets and we’ve talked about those before but the reality is that the Internet is disrupting and is causing very profound change across our markets and we’re looking for ways that we could invest in that.

And one of the things that really struck us when we were in India was that actually every business has to change and it has to make its goods and services available to some extent over the Internet, and to do that, if this is a new journey for you as a company, you will probably need some help and that’s why the Indian IT services companies are very interesting. We think about them, the metaphor that we’ve used is thinking about the gold rush in California, and the saying that the streets were named after the people that sold the picks and shovels, not after the prospectors, and we think that applies here as well.

And what we like about companies like TCS [Tata Consultancy Services], Infosys, Cognizant that we own across the strategy, that these are well-run companies. So we think by owning these kinds of companies we indirectly benefit from the changes that are happening in the world.

Then thirdly, and I think we’ve talked about this previously, the valuations and the consumer sector were very high and unfortunately we haven’t really seen much change there. I mean, Hindustan Unilever today still sits at a forward price earnings ratio of about 53 times, which, to put it in very simple English, means that it’s extremely expensive. Now, we think it’s a company that can grow for a very long time, but if we think about a return, a required return that we would like to make for our clients, we think at that kind of valuation it’s going to be very difficult to achieve and so we wait patiently.

And we’ve seen some stress in India recently, and interestingly talking about banks and trust and how important that is, the failure of one of the non-banking financial corporations, IL&FS, recently caused a liquidity tremor, I would probably best describe it, in India just very recently and it was interesting to see how the banks that we own have responded to that and we’ve spoken to them subsequently and it is something that concerns them.

But what we saw during the [Global Financial] crisis in the U.S. was that the strong financial institutions, the ones that people had trust in, they had no problem getting access to funding and we continue to believe that to be the case. We’re not predicting any kind of a crisis in India, but we think that it’s easy sometimes to forget that these systems are vulnerable and therefore if you’re going to own a company in that system, you always want to own the highest quality one you possibly can.

Tabberer: OK, great. Thanks, Stephen. Do you think that there’s chances ahead of any companies you’re interested in looking at, or does it just sort of speak about the value of the watch list?

Deane: Yes, I think what it did mostly was update our view on many of the companies. We didn’t, I think fundamentally we didn’t really change our view on most of them. There was one actually that I think we’ll talk about, so when we get to companies that we bought and sold we did change our view actually on a company called IDFC which is a bank actually, and I’ll talk to why we changed our mind on that.

Tabberer: OK, great. well, that’s probably a good segue into looking actually into what we’ve been doing over the last six months, so we’ll move on now to the positioning and the portfolio updates.

So just looking at the buys and sells, Stephen, is it worth just going through sort of the key ideas or a theme or at least the key drivers of some of the portfolio changes that we’ve seen over the last six months?

Deane: Yes. If if I talk about the sells perhaps first, so these really come into two categories I would say, you know, that we’ve talked about the philosophy of the strategy really being around trying to answer two questions. First of all, are businesses high quality and, second, are they available at an attractive price? And if you look at the reasons that we’ve been selling the companies on the right of the slide that should be displayed in front of you at the moment, those really fall into those two categories. So Antofagasta and Chroma are two companies that reached our price targets and had done rather well and so we decided to sell those.

IDFC Bank, I talked about the importance of owning the best banks that you can. Now, IDFC came out of an infrastructure finance company in India that was very high quality, but the interesting thing in forming a bank is that because of the speed at which they had to grow, they were taking people from all sorts of different cultures so it was very hard to predict what kind of culture would emerge. But we figured with the caliber of the parent that there was a good chance that it would work out very positively and it was only a very small position in the portfolio because we wanted to watch it over the longterm and see how it developed.

Now, unfortunately, what’s happened is that in its quest to grow, IDFC has been looking to merge with another bank, and in the end it’s chosen to merge with a bank who we met at this conference and felt that the CEO who’s likely to take over had a risk attitude I think that was quite different to our own and subsequently, I think, put us in a position where we didn’t feel like we owned a bank that was as conservative as a bank operating in India should be, and so we decided to sell out of that.

Very briefly on the others, Natura we’ve owned for quite some time. It’s a company we like, but it is changing in its nature and becoming more of a physical retailer and it’s taken on quite a lot of debt to do that, and given some concerns we have around debt in emerging markets and specifically here at Natura, we decided that it was time that we should sell out of that one.

Genomma Lab is a company that we owned that we had believed was in the process of turning around, but some of the recent actions of management weren’t consistent with that and again, we decided to sell that company. And Axiata we sold really on the basis, I think, of some of the learnings that we’ve taken away from owning companies in India and just the fact that the franchises in telecoms are not as strong as perhaps we once believed they were. And Axiata, we were offered quite an attractive price for it, for what we thought it was worth, and so we decided to sell that.

Coming into the portfolio then, we’ve added three companies. So VTech, a company that was set up in 1976. Any of you who are parents on the line may have come across VTech toys; they’ll be the things that make loud noises that you’ll stand on in the middle of the night. Really designed for kids somewhere between birth and six years of age and it’s been very successful. It’s now the largest early learning toys company in the world and it has some businesses that are in decline, but we think fundamentally it’s a very strong business and run still by its founder, Allan Wong, so we think that’s a very interesting business.

Cipla at the bottom there is another family-controlled company – the Hamied family – and it’s primarily a maker of drugs in India, so about nearly 40% of its revenues are in India and really it’s focused on trying to make medicines accessible to people. And we like the long-term stewardship here, we think the franchise is good, particularly its exposure in India, and we think that business can grow for many years to come.

And then finally CR Beer, so this is unusual for us in that this is a state-owned company. We tend not to generally like state-owned companies, but where we find alignment we have owned them in the past and we’ll continue to do so, and CR Beer is a good example of that. We first got to know it when it was a partner of SABMiller, but when Anheuser-Busch InBev took over SAB they were effectively forced to divest their partnership, and so Heineken, that we’ve owned in strategy for some time there, Heineken has become their partner and they formed a JV [joint venture] together.

And we think Heineken’s oversight of the board makes us comfortable in owning this company and there’s a huge potential here for this. The whole beer market in China is undergoing what is euphemistically referred to as premiumization where brands become more important. Beer is still sold in some parts of China in plastic bags so there’s a long way to go to developing brands and we think Heineken’s expertise combined with the distribution of CR Beer is certainly a very interesting opportunity.

Tabberer: Great. Thanks, Stephen. What I’ll probably do now is I’ll move on to looking at our top 10 holdings and this is at a strategy level, just to be clear. I suppose the point that I really want to make here is actually there’s not much change over the past six months. I’ve said about being long-term holders. With approximately 20% portfolio turnover, the only real change to note or discuss is really the presence of FEMSA, so that’s Fomento Económico Mexicano, apologies for my pronunciation, which has effectively entered the top 10 holdings in the last six months.

One thing that changed, this is a position that we put into the portfolio/strategy in Q3 or Q4 last year. It’s a really attractive business. The FEMSA holding company has effectively two strands and potentially a third, so it’s got FEMSA Coke which is the second-largest Coke bottler, and then it also has a retail business with the Oxxo convenience stores that are very high returning, growing very fast and benefiting from the increasing formalisation of the Mexican economy.

But also interestingly, actually in some ways a bit like TCS and Infosys benefiting from the growth of Internet shopping in emerging markets what we’re seeing with this and the likes of Uni-President Enterprises in Taiwan is that actually that last mile delivery is very difficult for Internet companies and they’re using convenience stores to effectively act as local logistics hubs.

So Oxxo has seen very strong growth from its package storage/pick-up offering which is driving significant footfall.

FEMSA’s Coca-Cola [bottling] business had been under some cyclical pressure due to a business that they’d acquired in the Philippines, which they’ve now passed back and that gave it the opportunity to buy what is a really good business at an attractive valuation last year. We’ve met the management team recently and have been building the position, taking advantage of what we think is a really attractive price for a great asset, so that’s the one stock of difference.

The second thing probably to note is just the cash has increased and you can see that with the buys and the sells that Stephen’s discussed. So effectively we’ve been sort of net sellers and the cash level has risen to around about 7% for the representative portfolio or strategy and that should be seen as indicative of where we are.

Just moving on, the key here looking at the regions and countries, again, I suppose two things to take away: not much change since the last webinar and, secondly, just to stress that this really is an output of our bottom-up stock collection. We don’t view the world as, “we need so much in country A or country B” this really is an output [of our stock picking] and it’s just indicative of where the risks and rewards lie. I think what we would argue is that we give a very broad and diversified access to global emerging markets and are very willing to look very different to the index as we try to grow and protect the clients’ capital.

So I suppose, Stephen, that brings us onto the final point we were going to discuss and that’s looking at sustainability. Why do you think that’s important for us to consider?

Deane: Yes, I mean, there’s two reasons really I guess and I think it’s, I guess it’s important probably to note that as a team, we always refer to this as sustainability and not ESG because it reminds us really of the primary purpose which is as long-term investors in companies, whether or not that company is sustainable, i.e., is it going to be around in the long term, is key for us. I mean, we’re lucky enough investing in emerging markets that we have these fantastic demographic tailwinds in growing in many countries’ growing populations and rising middle classes.

But what’s key is if you’re going to own a company for the long-term, is it behaving in a way that violates either interests that are explicit, understandings it has with all of its stakeholders and not simply us as shareholders? So a company that’s polluting a river, or abusing its employees, or selling a service that fundamentally is bad for the long-term future of the world, we think that those things do manifest themselves and in extreme instances can lead to the value of your equity going to zero.

So sustainability is key and it’s always been an integrated part of the way that we think about companies, and so every report that we write on a company will always have a section in it on what we call sustainability positioning and that’s an understanding of the company’s strategy for how it thinks about all of its stakeholders.

And the second reason that it’s important is that often it gives you insights into the company that you might not gain otherwise, i.e., into the character. And when we talk about the importance of people in our investment process, the character of people often manifests itself when you get into questions on this. It’s interesting, as the focus changes and more of this data is being measured, it gets a little bit harder because people are sort of less willing perhaps in many ways to be honest with you or as honest as they were before.

We’ve had instances of talking to companies: one told us its competitive advantage was the fact that it was able to pour engine oil into the ground because it was never audited. Now, that is not a sustainable advantage from our viewpoint. So we think that looking at the way companies think about stakeholders often times gives us good insights into just the general quality of the company and how we might be treated ultimately as minority shareholders. And you’ve written about it, Ian, I mean, maybe you could elaborate on how we go about figuring this out.

Tabberer: Yes, sure. I suppose it’s worth just talking about why we decided to write about it and that’s because we get a lot of questionnaires and people asking us to rank the various ESG factors or sustainability factors, and I think we also wanted to write something to say why it is that we don’t believe that actually these ranking or the sort of quantitative is necessarily the best way to think about sustainability.

And basically just to put some meat around that, and the example that I like the most, that I thought was useful, thinking about why just because you can measure something doesn’t mean that it’s valuable, and I like the example that we found or know of through our watch list with Magnit. With Magnit it’s fascinating because in the real world what we’ve seen over the last six months is really different to what you would see if you looked at some quantitative data on corporate governance in Russia.

So in the real world Sergey Galitsky, who is the founder of Magnit, ended up selling a 29% stake, well, all, his entire financial stake in Magnit – a Russian retailer – to VTB, which is the state’s second-largest bank. And then within about six months VTB bank then sold 12% of this business to Marathon Group, which just funny enough happens to be owned by the son-in-law of Russia’s current foreign minister. So, in effect, what happened, the founder could have sold it via a transaction that had gone from the hands of person A to person B, but actually it went via bank C that just happened to be owned by the state.

And so, therefore, what it shows you is that there’s the risk in Russia that effectively the state is coordinating, that the potential the state is coordinating changes in ownership of valuable parts of equity and that you as a minority shareholder aren’t protected. And the reason why the 29% level was important is because at 30% the bank would’ve had to offer the same price to all minority shareholders, but it didn’t have to do that so, effectively, minority shareholders are stranded. The new management team they had voted for had only a reason to ask for.

Well, you compare and contrast that with the quantitative measure which shows that according to the World Bank’s doing business rankings in 2018, Russia’s the 35th best place to do business. It ranks immediately below the Netherlands, Switzerland and Japan and so therefore it really shows the contrast of if you look at what’s happening in the real world by kicking the tires versus if you were to just look at a quantitative-based table.

And the reason they do that is because effectively the Russian government has effectively targeted the things that the World Bank looks for and because with its rule of law, it can control very easily and effectively has made those things look better and that very much speaks of “good hearts” law. So when a measure becomes a target, it effectively ceases to be a good measure.

And so I think it just helps hopefully to communicate why we think as an investment team that actually it’s important to look beyond the numbers; with you being out in Taiwan at the moment shows it’s important to go out, travel and actually to have a think and to look what’s behind the numbers, which is very much what our qualitative approach to investing is about and we therefore carry that into thinking about sustainability.

So that really kind of concludes the things that we wanted to discuss with you all today and I suppose now just with a few minutes left just to see whether there are any questions that people would like Stephen or myself to ask or consider. So I would just leave for a bit to see if there’s anybody out there who wants to ask a question.

Marriott: Thanks, Stephen. Thanks, Ian. I can see on the screen that we have had a couple come in, but if anyone else is listening and had any other questions that they’d love to ask, please keep sending those across to us. The first question that we’ve got is, are you concerned about the potential impacts that trade wars and a rising U.S. interest rate could have on emerging markets?

Deane: I’ll take that one, Ian, if that’s OK.

Tabberer: Sure.

Deane: Well, I mean, I think there’s a couple of things to say on this. The first is that we are absolutely not macro investors so, you know, we don’t use this to take a view on anything in the portfolio. Everything that we decide in the portfolio is ultimately, you know, driven bottom up. What I would say, though, is that, you know, the kinds of companies that we own tend not to be taking the sort of risks that would cause extreme pain from something like this.

So, for example, there are a lot of investors certainly focused on the amount of U.S. dollar debt that has been accumulated in emerging markets, but this is something that, you know, is one of the preliminary things that we would look at when we consider a company: is are they taking on foreign currency debt without matching earnings or some sort of offset for it, because that’s surely a sign that at some point they will see pain in the future.

The Asian crisis happened nearly 20 years ago. A lot of the companies that we own, notably the families behind them, remember that crisis very clearly and are not going to make, if they did make the mistake the first time, they’re certainly not going to make it again. And then finally I’d just say in Taiwan now it’s quite interesting obviously because we’re effectively in the middle of a lot of what’s going on at the moment.

And companies here in Taiwan, many of them have manufacturing operations in China, but what’s interesting is again, the good companies think about risks in a very profound and long-term way and so actually we’ve been told today that something we’ve seen in some of the companies that we own, you know, Taiwanese companies have been moving production out of China for five years now. Not necessarily because they anticipated the trade war but because they sense that the level of risk there was rising for a number of reasons; labor, tax and also in some ways perhaps a change in government as well.

And so what we’re seeing as well some of the companies are responding by thinking about whether or not they may or may not need to move production but, again, the good companies don’t have all their production in a single location and so there are ways for them to be able to work around it. And we’ve seen one company we spoke to today was talking about how they were able to compensate for some of the products that they make by having their suppliers actually lend them staff to be able to produce goods in time for an order that they needed to make, so good companies will find a way to work around these thing.

And our ability to predict the future is extremely limited, I would say, so it’s very difficult for us to know what the outcome of the personality dynamics between the leader of the U.S. and the leader of China might result in and so we tend not to get involved in that. We spend much more time just thinking about the individual companies, and the good ones have been through crises before and we can see how they’ve behaved and they’re the ones that we like to own, the ones that have come through strongly.

Marriott: Thank you. And we have one final question that’s come through which I think goes back to your trip to India, Stephen. So what do you think will be a catalyst for India’s consumer-focused companies to fall in value and therefore create more of a buying opportunity?

Deane: It is back to predicting the future again. It’s hard to say. I mean, the one thing that if you spend any time looking at emerging markets the one thing that you see is that the path to riches is not a straight one, and so every company or every country has its own times of stress and I alluded to this earlier that we’ve seen it sometimes in India.

So it’s very hard to know when or even how something might trigger a significant correction in the stock market but we certainly feel things are closer to the end than the beginning in India, if that makes sense, but trying to predict when or how these things happen is just not something that we’re very good at. But we just feel these valuations are too rich for us at the moment and we’re happy just to be patient.

Marriott: Thank you very much. I think that’s all question wise for today. If you are listening to a recorded version of today’s webcast and have any questions, please do get in contact with your local salesperson who will liaise with the team and get back to you with an answer. Thanks, everyone, for dialling in today. Thanks, Stephen. Thanks, Ian. We look forward to seeing you at the next Janus Henderson webcast.

Deane: Thank you, everybody.

Tabberer: Great. Thank you.

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