The managers of Templeton Emerging Markets (TEM ) are confident emerging markets will be a strong performer this year and are hoping to use their untapped debt facility to add exposure as they look to stay ahead of their benchmark or face a tender offer.  

Speaking on a webinar, Franklin Templeton’s Chetan Sehgal and Andrew Ness said that, aside from China, emerging markets did well in 2023 with the MSCI emerging markets excluding China index returning 14%.

By contrast, the EM index including China returned just 4%, according to Morningstar data, while shares in the trust climbed 7%, as shown below.

The managers expect EM to continue to do well and believe there are signs that China will also start to deliver. The bullish pair said that as opportunities start to present themselves the gearing, or borrowing, on the company could be increased from zero to up to 5%. There is no cash in the portfolio, but there is an undrawn £120m debt facility. 

Emerging markets vs the US in 2023

Source: Morningstar

Reasons to be cheerful

The managers pointed to several catalysts for re-rating to back up their claims for a positive year in emerging markets. 

They said the prospect of interest rate cuts in the US as early as March is reducing the pressure on EM currencies, one of the main detractors over the long term. 

While interest rate cuts would create more favourable conditions for US companies, the pair think the damage created by high borrowing rates will take its toll and the long-period of US dominance will come to an end. 

‘The US has had its day in the sun, having outperformed most other markets for a decade,’ Sehgal said, noting that India has kept up performance over that period, while a China rerating should catapult the index ahead of the S&P 500.

‘There is a scenario where retail investors especially in China will come back to their markets. A large part of the foreign community has reduced their exposure to the Chinese market, so I think it is set up for some kind of improvement this year and that is what we are betting on.’

Further triggers for a China rerating include valuations hitting 6%-7% free cash flow yield and local interest rates falling below 2% from their current 2.5%. 

Saba pressure

There is pressure on the pair to deliver five-year underlying returns ahead of the benchmark over the five years to the company’s financial year end on 31 March, or a tender offer for up to 25% of the shares will be arranged.

Currently, net asset value (NAV) total returns of 14% are ahead of the benchmark’s 10% with two months to go. 

At this year’s annual general meeting, shareholders, which includes US bargain hunter Saba, will vote on continuation. 

Over the same timeframe, the shares have returned the same as the benchmark and currently trade at a 14% discount to the NAV of 169.60p per share.

The portfolio is largely focused on Asian emerging markets, with China making up 23% of assets, South Korea, 21%, and Taiwan 16%. 

Top individual positions in the trust include an 11% weighting to semiconductor company TSMC, 6% to Samsung and 5.4% to Indian bank ICICI, according to the latest factsheet. 

By sector, tech makes up 28%, financials constitute 26% and consumer discretionary companies 11%.