A toxic triple whammy of China, Russia and Ukraine has cost Templeton Emerging Markets (TEM ) dear, wiping out the outperformance fund managers Chetan Sehgal and Andrew Ness have achieved since taking on the £1.7bn investment trust four years ago.

Annual results this month showed the Asia-weighted portfolio of around 80 stocks suffered a 17.3% drop in underlying net asset value (NAV) in the year to 31 March, with shareholders suffering a 21.2% slump with dividends included, underperforming the MSCI Emerging Markets index which fell 6.8%.

Adjusted for last year’s five-for-one share split, earnings per share slipped slightly to 3.44p but a final dividend of 2.8p held the total payout to 3.8p, with the board using a small amount of revenue reserves to make up the difference. The shares yield 2.6% and stand at a discount of 12.6% below NAV, a gap the board is seeking to reduce through buybacks.

The decline in the financial year - primarily caused by slumps in Alibaba and Tencent during the China tech crackdown, and the writedown to zero of holdings in Russia after the invasion of Ukraine in February such as Lukoil, Sberbank and search engine Yandex - was a sharp reversal of the previous 12 months when NAV soared 54.5%. 

A year ago, the trust was riding high, with the investment team earning the praise of the chairman Paul Manduca as it led its sector with five-year total investment and shareholder returns of 127% and 156% that were well ahead of the MSCI benchmark’s 91%.

However, by the end of March, according to Numis Securities, Templeton’s growth in NAV since Sehgal (above) succeeded Carlos Hardenberg in February 2018 had been slashed to 4.8%, below the 7.4% of the index, further weighed down by the writedown of BMW’s China joint venture Brilliance, a former top 10 holding, after its shares were suspended last year, and a lack of exposure to Saudi Arabia whose oil companies boomed after a spike in crude prices caused by the conflict in Ukraine.

Latest Morningstar data at 17 June shows the trust’s NAV and shareholder returns now lag the MSCI Emerging Markets over three, five and 10 years. Over five years, NAV including dividends is up just 17.3%, underpinning shareholder returns of 18.6% that basically match the index but trail rivals JPMorgan Emerging Markets (JMG ) and JPMorgan Global Emerging Markets Income (JEMI ) which have returned 39.6% and 23.2%.  

Over three years, a 2% shareholder return has embarrassingly fallen behind the 20.8% achieved by Mobius (MMIT ), the smaller company emerging market rival founded by Hardenberg with Templeton’s founding fund manager Mark Mobius.

All that Templeton’s value-style managers, who have weighted the portfolio to consumption, premiumisation and digitalisation themes with overweights in IT and financials, can really say about this reversal is that their markets have become cheaper, providing buying opportunities with which to get the trust back to its long-term outperformance

Since April last year their stocks have on average de-rated from 15.7 times earnings to a multiple of just 10.6 a year later, compared to a slightly more expensive index where the valuation multiples fell from 18 to 12.1 times.

They can also point to some winners in the past year, such as Indian bank ICICI, which gained 26.6% over the 12-month period, and Brazilian bank Itaú Unibanco, which leaped 50.5% on the back of improved sentiment and prospects towards the commodity-rich Latin American economy.

Back to square one

‘It’s difficult to be bullish in the short-term,’ Ness (above) admitted to Investment Trust Insider last week. ‘There are significant challenges to the global economy, which emerging markets are not immune to, including the war in Ukraine, and the impact that’s having on certain parts of the commodity complex, and the Fed rate hikes we’re going through as they address high inflation,’ said the co-manager, who joined Franklin from Martin Currie a few months after Sehgal took up the lead on the trust.

‘The challenge of China’s “Zero Covid” policy remains a difficult one to navigate because we don’t know the extent to which they’re going to maintain it. At the background of everything there’s the climate challenge where companies and governments are charged with attempting to decarbonise their respective economies. That comes with additional costs and challenges for businesses to reduce the emissions’ footprint of their operating activities.’

Despite the downbeat tone, the managers are sticking to their process of finding companies generating sustainable profits and trading below their intrinsic values. ‘Whilst the immediate outlook may be volatile, this approach should help us best navigate the ongoing pandemic and geopolitical instability. Over time, we expect the long-term fundamentals of our holdings to remain intact and to produce attractive returns for investors,’ they concluded in their outlook statement.

And for the time being the managers have the support of their board. ‘While we are concerned by recent performance, the board is reassured by both the quantity of resources and the quality of the insights that the team produces and is confident that performance will turn around in due course,’ said Manduca.

Since launch under Mobius in June 1989 to 31 March, Templeton’s total underlying investment return of 3,814% compared to the MSCI Emerging Markets’ total return of 1,792% shows the long-term power of investing in the world’s fastest growing economies, the board and managers believe.