Flight to the dollar, inflation and geopolitical risks are making life difficult for emerging markets investors this year, but long term the strength and depth of their companies will prevail, says Carlos Hardenberg of Mobius (MMIT ) investment trust. 

In this 14-minute interview, Hardenberg discusses:

• Mobius’s focus on well-run smaller companies in emerging markets;
• Why EC Healthcare of Hong Kong is his top holding;
• The impact of China’s Covid-19 lockdown policies and tensions with Taiwan;
• Temporary macroeconomic pressures from the strong dollar and inflation;
• His satisfaction in seeing Mobius perform better than Templeton Emerging Markets (TEM ), which he and his business partner Mark Mobius used to run.

Can’t watch now? Read the transcript

Gavin Lumsden: Hello, I’m at the Frostrow Investment Company’s conference in the City of London and with me is Carlos Hardenberg of Mobius Investment Trust.

Carlos, very good to see you. With the name ‘Mobius’, I hardly need to say what you do, but you are an emerging markets investment trust, but you do something a bit different. Over three years since you launched the trust with Mark Mobius, it’s been the best performer in its global emerging markets sector. So, if you invest in smaller companies, do you think you’ve made the case for your approach for investing in smaller companies and picking companies that are-, you incorporate ESG, the environment, social and governance concerns. How does that work and do you feel you’ve made the case for what you’re doing?

Carlos Hardenberg: Yes, thank you and it’s great to see you again, it’s been quite a while. Indeed, what we’re doing is quite different. When we started the firm right from the beginning, we said that there’s an undiscovered opportunity in the market and the reason why we found this to be such a tremendous opportunity is because all the large funds are getting bigger and bigger. They’re all rallying around benchmark names. At the same time, we’ve seen that emerging markets, whether you’re in Asia or Latin America or partially in Africa, are offering more and more new and exciting and innovative business models that haven’t been there before. Beyond the commodities, banks, telecoms and traditional business models.

GL: So, you’re avoiding the emerging markets mainstream?

CH: We are totally avoiding the emerging market mainstream. We are unconstrained so in theory, we can do whatever we think is right, but in terms of defining our sweet spot, we see the most innovative and most exciting business models around the one to seven billion market-cap spectrums. If you consider the fact that EM, as an average, is now 100 billion in the benchmark, we’re diving down into a segment which is really not so well covered, not so well owned and when you have to do a lot of work yourself, if you want to understand these businesses.

GL: Tell us about one or two of the stocks. Let’s take the top two holdings. The top holding, EC Healthcare. What is it and why did you choose it?

CH: So first of all, over the last years we’ve avoided the disasters. We’ve avoided Russia, we’ve avoided China big tech. We’ve avoided the education names there and anything that’s exposing our investors to regulation or other macro-economic risks. So, we’re trying to identify this unique entrepreneurship. We’re trying to identify people that are running businesses that are unique and EC Healthcare is a great example. It’s run by a very inspiring, fairly young gentleman in Hong Kong. He’s been in the healthcare industry from the beginning of his career and he started to represent foreign premium brands in skincare and some other medical areas in Hong Kong. Then he developed a premium, non-hospital healthcare centre in different locations in Hong Kong.

He realised not only the Hong Kong Cantonese are his clients, but also mainland Chinese from the Greater Bay area are travelling all the way to Hong Kong to have their services and procedures done in Hong Kong. So, he used that model, the brand he built. The expertise he built in various medical areas, also dental care and brought this to the mainland and is now offering this in centres in mainland China. The Chinese love premium brands. The Chinese love reliable medical services. They don’t trust their own. They like the fact that in Hong Kong, you have a very clear and tight regulated system, where not everybody can call him or herself a doctor, you actually have to be a doctor.

He’s been doing this, backed by some of the top investors in Hong Kong. Real estate families, Goldman Sachs backing him and he’s now expanding the business further into mainland China. So, a lot of things come together here. Talent, the right people, the right model. An underserved market and right now, we made about 50% over the last two years with this investment. It’s corrected quite a bit now and the zero Covid environment. We utilised this period to build an even larger position because we think ...

GL: You’ve got the conviction there.

CH: Look, zero Covid is not going to last for the rest of your and my life.

GL: So, this is the impact that China’s policy of trying to eradicate, not put up with any Covid whatsoever. It’s hurting the economy and the wider region.

CH: It’s hurting the economy. If you look at the Shanghai region, it accounts for about 35% of Chinese exports. That’s a big number. So, the impact on supply chains is phenomenal and we will feel most of that heat, actually, in the second part of this year. We’re already beginning to feel shortages. Industries are impacted by most of it now. The big question is, how long will this last?  There’s the big party congress in October, November. I think the Chinese administration on the one hand wants to be seen as in charge of the situation, with very clear policies and they don’t want to take a step back. At the same time, they know there has to be an end to it because obviously, it’s hurting Chinese businesses quite significantly. So, I look forward to the next couple of quarters, where this will be gradually lifted. I’ve no doubts about this.

GL: You’re underweight compared to the MSCI Emerging Markets index.

CH: A lot.

GL: You’re underweight in China, quite a lot, but still about 10% from what I could see in the factsheet.

CH: Actually, we’re extremely underweight. We have no exposure to any of the big Chinese tech names or the typical Chinese larger businesses.

GL: So, the Beijing tech crackdown, the regulatory onslaught on the sector last year, you didn’t have any of that?

CH: We had no exposure to this. We had one other healthcare name which was a leading developer of knee and hip implants, which we were actually very happy about and we sold this at four times our initial investment and sold it on time. Other than that, we’re really trying to be very careful about how we invest in China. The better way to get exposure to China is actually, Taiwan.

GL: I was going to say, that makes a lot of sense and a lot of people do that, but of course, there is still a China risk if China ever decides to take control, seize Taiwan.

CH: That of course, is the big question and it’s been there forever, almost. Obviously, we’re trying to have a comprehensive view on the risks. We’re trying to understand them. Nobody is going to give you this unique insight where you get the ultimate answer. However, there are plenty of reasons which make us fundamentally believe that the two countries are both very interested in a more civilised path towards that process. Whether you look at the parliamentary activity between Taiwan and China, there’s a lot of communication links. There are a lot of investments from Taiwan to China, from China to Taiwan, which was not the case 15 years ago. Some of the very sensitive points, how they name certain squares in Taipei, the Taiwanese have addressed in order to accommodate some of the friction that caused in China. So, there are a lot of activities. At the end of the day, you have to remember Taiwan has not a large military, but they’ve got a relatively well-equipped military apparatus, which is one point, but I wouldn’t even go that far.

GL: We don’t want to see a war, do we?

CH: Definitely not. I think it is not in the interest of the Chinese administration to cause a situation which would put the entire Chinese economy into question and the membership of the World Trade Organisation, the establishment of the RMB as a global currency, the pricing of commodity markets in RMB. The recognition of China as reliable trading partner around the world. Will they put all of this into question?

GL: After Russia and Ukraine, they can see, hopefully, the retribution would be-, the cost would be too high.

CH: That’s what I think.

GL: It sounds like there’s plenty of scope in what you’re doing for picking stocks. You’ve talked about one already. So just focusing on the macro risks which inevitably, people do in emerging markets. Just wondering, there’s inflation and the strength of the dollar. Is the strong dollar with the prospect or with US interest rates going up, is that causing the traditional flight from emerging markets or are things different this time?

CH: I would still think that a strengthening dollar, which is already happening, the dollar has strengthened. The RMB actually, it has somewhat not been picked up a lot by the press, but has already depreciated quite significantly. Of course, that’s managed and that’s very much in the interest of China, helping exporters. I think overall, the volatile commodity markets, a stronger dollar, tighter monetary conditions still are bad news for emerging markets as a whole because of the fact that you will have withdrawals of investments there, being attracted into the dollar. Also, this in combination with the expectations that the US economy is growing very fast. Whereas, actually in China, they really have a growth problem.

So, all of this is not necessarily good for emerging markets. I think there is room for further correction in the currency markets. Although, quite a bit of this has already taken place. Is it fatal? Does it mean that we will see a row of bankruptcies or sovereign defaults? There’s no indication or no fundamental reason why you should believe so. Emerging market private sector participants of businesses have deleveraged over the last 15 years. They used the good times to de-lever. The public sector has not assumed an enormous amount of leverage. You are seeing India growing by 8% according to the World Bank. Okay, they’ve lowered from 9.5% to 8.2%, but that’s still very significant growth in a post-Covid environment.

We are seeing that, for the first time, the relationship between emerging markets, as a whole, and developed markets was defined by a couple of rather simple trade factors. If you look at today, the relationship-, comparing today to 20 years ago, it’s completely different. There’s no substitute of that trade in technology. In hardware, software development. Many of the global industries completely depend on the supply of branded and patented components developed in Asia. So that trade will continue, otherwise we can jump back on our horses, for example or we can no longer shoot satellites into the sky or we can no longer install smart home technology into our houses and apartments.

GL: Long-term story remains intact. We haven’t talked about inflation, although of course, it’s linked to the things you’ve just been talking about. How are your companies dealing with-, inflation is high in Asia, in emerging markets as well?

CH: It is high, it is rising, that’s for sure. I would differentiate between those countries. I was in Turkey two weeks ago and it’s a great reminder of my first trips to Latin America, 70% inflation is something which you have to digest in order to understand what it means. The Turks are actually quite pragmatic about managing this. They’re very used to it. It’s not that long ago when they were there. Inflation is hurting them. I personally believe that we are in a new normal now and that higher inflation is there to stay, especially, of course in the next one, two, three years with what’s going on in the commodity markets, etcetera. At the same time, labour markets are also pretty tight. So that’s also another reason.

Although, the participation rate is still relatively low, but I think that will change very quickly. I think the way to deal with this and make it short is to invest in companies that can control their prices and which are not fully exposed to commodity markets, per se. So, we invested in companies which have a strong market position, a unique product and which can actually determine their prices. That’s an inflation hedge. So overall, our-, and you know, many emerging markets are exporters of commodities, which is another hedge to inflation. So, I think there is a way how you can manage that risk.

GL: Sounds like a good formula. Last question, your performance has been good. How much satisfaction do you and Mark Mobius get from outperforming and beating Templeton Emerging Markets which you used to run?

CH: It’s not something which I think about a lot and since it’s run by a very good friend of mine, I don’t have any bad feelings. There will be periods where we will do very well. There will be periods where they will do very well. It’s not something I look at really that much, but of course, it’s nice to beat them.

GL: It’s good to hear and good to get an update, nice to see you again, Carlos.

CH: Thank you very much, great to see you.