Glen Finegan, Head of Emerging Market Equities, provides a detailed update on the Henderson Emerging Markets Strategy, covering performance, investment activity, portfolio positioning and his outlook for the asset class.
Q4 2016 performance and investment activity
The strategy underperformed the MSCI Emerging Markets benchmark index over the quarter.
During the quarter we added new holdings in Nampak, a South African listed company, and LG Household & Health Care, which is listed in South Korea.
Nampak
Nampak is Africa's leading packaging company and trades at an attractive valuation. The company currently faces some inflationary headwinds but the long-term outlook for volume growth in African markets is good. With an impressive new management team at the helm, we are optimistic this company's returns will improve.
LG Household & Health Care
Despite a small fall in the valuation of some good-quality companies towards the end of 2016 many of Asia's best domestic businesses remain too expensive for our taste. That said, the correction did provide us with an opportunity to purchase a stake in LG Household & Health Care, an extremely well run and leading consumer business in South Korea, at what appears to be a reasonable valuation. We have been investors in the parent company LG Corporation for some time and, unusually for a Korean conglomerate, are comfortable with the governance at the LG group thanks to its transparent corporate structure.
Company research
Team members visited companies in India and Eastern Europe during the fourth quarter. En route to Eastern Europe we stopped in Stuttgart where we met with Mahle Gmbh, parent company of our large Brazilian investment Mahle Metal Leve, as well as a founder of Merida's European business. Merida is a leading bicycle manufacturer based in Taiwan and a significant holding within the strategy.
Understand the people behind the business
We believe it is vital to try and understand the people behind companies in which we invest and take every opportunity to meet representatives other than just top managers and investor relations departments. These meetings almost always generate useful insights, expand our network of industry contacts and sometimes highlight new ideas for team members to research. The Stuttgart meetings strengthened our confidence in Mahle's governance structures and in the case of Merida we were impressed by the quality of its divisional management and corporate culture.
Portfolio positioning
The portfolio has a bias towards companies listed in markets that bore the brunt of commodity price declines such as Brazil, Chile and South Africa. The resulting economic shock resulted in weaker currencies, more attractive valuations and the tantalising possibility of improving national governance. During 2016 emerging middle class voters in South Africa delivered a message to the ruling ANC demanding less corruption and more focus on improving living standards. Similarly, in Brazil it is possible to frame the fall of the Rousseff administration as a demand for less corrupt government. While far from certain that peoples' demands will be met, better standards of governance may lead to higher valuations in the medium to long term.
Less positively, some emerging markets that have come to be seen as relatively stable may not be insulated from the populist wave sweeping the developed world. During 2016 we witnessed the Polish government adopt a more interventionist stance and in Chile left-wing politicians recently proposed changes to the regulation of water utilities. Both of these developments negatively affected the strategy. In the absence of an improvement in broad-based economic growth this type of populist risk to investment returns is likely to increase.
Market drivers
Following a prolonged period of poor returns, appetite for emerging market risk increased substantially over the course of 2016. As a result the asset class delivered a strong absolute return.
While a portion of this return came from good-quality businesses recovering from oversold valuations, the latter part of the year saw lower-quality emerging market assets outperform. In our opinion, lower-quality assets include many state-controlled enterprises and companies listed in countries with little or no respect for property rights. The fact this followed a period of strong returns from the asset class suggests to us it may be based more on momentum than fundamentals.
An area of particular concern is the very large and highly opaque Chinese banking system. In response to slowing economic growth in 2016, we were alarmed to see regulators there encourage banks to stop recognising bad loans as a tool to stimulate loan growth. What was perhaps more alarming though was the many sell-side analysts and shorter-term investors who viewed this as a reason to buy Chinese banks, given lower reported bad loans would mean higher (artificial) profits. The strategy has limited exposure to Chinese equities but a severe banking crisis in China would likely have global ramifications.
Our strict valuation discipline and focus on only the highest-quality companies aims to provide downside protection over and above seeking exposure to the long-term opportunity of rising living standards in some parts of the developing world. In line with our more cautious view the strategy's cash level increased over the course of 2016.
For more information on the Henderson Emerging Markets Opportunities Fund, please click here.
Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
Issued in the UK by Henderson Global Investors. Henderson Global Investors is the name under which Henderson Global Investors Limited (reg. no. 906355), Henderson Fund Management Limited (reg. no. 2607112), Henderson Investment Funds Limited (reg. no. 2678531), Henderson Investment Management Limited (reg. no. 1795354), AlphaGen Capital Limited (reg. no. 962757), Henderson Equity Partners Limited (reg. no.2606646), Gartmore Investment Limited (reg. no. 1508030), (each incorporated and registered in England and Wales with registered office at 201 Bishopsgate, London EC2M 3AE) are authorised and regulated by the Financial Conduct Authority to provide investment products and services.
