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Confronting coronavirus

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4 May 2020

How are emerging markets responding to COVID-19?

Whilst there are encouraging signs of a return to normal business activity in some emerging markets, others are still seeing coronavirus cases and deaths rise from day to day. As in developed markets, the long-term impacts on emerging economies remain uncertain.

Investment companies in the Global Emerging Markets sector have reflected these mixed fortunes, with the average company bouncing back 7% in April1, after losses of 15% the previous month2. For investors prepared to take a long-term view, could current valuations provide an attractive entry point?

At a media webinar today hosted by the Association of Investment Companies (AIC), Andrew Ness, Portfolio Manager of Templeton Emerging Markets Investment Trust, Mario Solari, Portfolio Manager of Genesis Emerging Markets Fund, and Ross Teverson, Co-Manager of Jupiter Emerging & Frontier Income Trust, discussed how they are dealing with the impact of coronavirus and their outlook for emerging and frontier markets.

Their views have been collated alongside comments from Michael O’Brien, Manager of Fundsmith Emerging Equities Trust and Austin Forey, Manager of JPMorgan Emerging Markets Investment Trust.

COVID-19 – China holding up better

Ross Teverson, Co-Manager of Jupiter Emerging & Frontier Income, said: “Going into 2020, we remained focussed on identifying those companies which in our view are exposed to specific or structural positive change that is underappreciated by the market. As a result of our fundamental stock picking process, we have consistently been underweight China, favouring higher conviction ideas in overlooked markets, including Turkey, Mexico and Russia.  

“Though the COVID-19 outbreak originated in China, the Chinese market has surprisingly held up better than the rest of emerging markets and our underweight position has acted as a headwind for us, as has our higher allocation to smaller companies.  We have not significantly altered positions within the portfolio, as we believe that the long-term investment case for our holdings remains intact and that the companies in which we invest are well positioned to weather the economic impact of coronavirus.”

Mario Solari, Portfolio Manager of Genesis Emerging Markets, said: “Our China domestic A-share investments have been among the most resilient year-to-date. There seem to be several reasons for this. One is fundamental; China appears to have successfully controlled the number of new COVID-19 infections, even while releasing restrictive measures. Buoyed by this containment success, many management teams we have spoken to are optimistic about a ‘V-shaped’ recovery, especially in the second half of the year.

“That said, a key next question is the degree to which falling global demand for manufactured exports will undermine hopes for a rapid economic rebound in countries like China, Korea and Taiwan.”

Andrew Ness, Portfolio Manager of Templeton Emerging Markets, said: “At a time when coronavirus-driven country shutdowns have exacerbated investor concerns, the crisis hasn’t altered our investment philosophy towards emerging market stocks. We continue to favour competitive, well-managed companies with long-term sustainable earnings power and attractive valuations. Our approach has been calm and rational, without panic. Hence, we have not made significant changes to our portfolios on account of the crisis. However, we have reduced or exited some investments in companies where we believe there is a longer-term negative impact on the business or where share prices have not corrected in line with the expected negative impact on the business.”

Opportunities and risks

Mario Solari, Portfolio Manager of Genesis Emerging Markets, said: “We have been busy reassessing the range of outcomes for our portfolio holdings. Some portfolio holdings have benefitted from social distancing. NetEase, for example, a leader in the Chinese video game market, has seen a boost in user engagement, as social distancing and the temporary closure of schools has increased the consumption of digital entertainment. Recent data indicates 60% to 70% of Chinese gamers increased playing time during the outbreak. By contrast, the impact on our Indian bank holdings has been more negative. India has a young population, but a weak public healthcare system, and the country is in near lockdown in most areas. This exacerbates the economic slowdown we have seen in the last couple of years.

“During this period of extreme volatility we have been assessing dislocations between share price moves and underlying fundamentals, taking the opportunity to upgrade the quality profile of the portfolio.”

Austin Forey, Manager of JPMorgan Emerging Markets, said: “At the industry level, e-commerce companies, media content companies including mobile games developers, food retailers and pharmacies are net beneficiaries of the nature of this downturn. On the other side, businesses associated with travel and those reliant on physical stores – restaurants, fashion retail – are under pressure. The sell-off has been pretty indiscriminate; it’s created some opportunities in companies we liked fundamentally but which previously looked expensive, especially in areas like IT services, e-commerce and mobile gaming.”

Ross Teverson, Co-Manager of Jupiter Emerging & Frontier Income, said: “We certainly see longer-term opportunities being created in companies that offer a combination of low valuations and very strong balance sheets – around a third of the portfolio is in companies with net cash on their balance sheets. We see these qualities in companies across a diverse range of sectors and markets, including our holdings within Taiwanese tech, Chinese pharma, Indonesian property and Pakistani autos. Beyond the risks presented by coronavirus, we would highlight political risks in emerging and frontier markets as being significant, yet difficult to forecast.” 

Outlook for emerging and frontier markets

Michael O’Brien, Manager of Fundsmith Emerging Equities Trust (FEET), said: “The vast majority of companies in FEET’s portfolio have net cash and resilient business models based on repeat, low-ticket transactions and backed by high barriers to entry. We believe that the businesses in our portfolio are going to continue to benefit from the rise of the emerging market consumer and trends such as formalisation and consolidation. This is something which the crisis will likely accelerate even before economic recovery takes hold at some point later on this year or next year. We would not be surprised if there is greater investor interest in emerging markets once recovery becomes visible given their stronger long-term growth trajectories.”

Mario Solari, Portfolio Manager of Genesis Emerging Markets, said: “Countries that are likely to be relatively better off are those that combine high levels of testing with relatively robust economies and this includes Taiwan and Korea. At the other end are Brazil and South Africa where testing is low and existing budget and current account deficits make it harder to turn on the fiscal taps. We remain bullish on the long-term opportunity in emerging markets. The long-term growth outlook is compelling considering the demographics and income convergence opportunities, and our markets are often inefficiently priced. We believe this is particularly the case today. We seek to identify a diverse group of quality companies and combine them into an attractive portfolio offering good long-term returns.” 

Ross Teverson, Co-Manager of Jupiter Emerging & Frontier Income, said: “The current environment presents significant challenges to many emerging and frontier market companies. However, it is also important to recognise that valuations are very low relative to history for many companies and sectors within the asset class. These low valuation levels only ever tend to be reached during periods of greater uncertainty, but it is also the case that they have typically created compelling long-term buying opportunities in emerging and frontier market equities.”

Austin Forey, Manager of JPMorgan Emerging Markets, said: “Current market conditions reinforce that the way we have always invested, focusing on strong balance sheets and large competitive moats, is the right philosophy. We have been careful through this time to re-evaluate all our investments to try to ensure that they meet these high standards, and sales have reflected where we had doubts in this regard. The corporate world is rapidly changing and there will be big winners and losers; for investors in emerging markets, we believe the opportunity set is bigger and more diverse than ever before, particularly in China.”

Andrew Ness, Portfolio Manager of Templeton Emerging Markets, said: “In our view, domestic recovery in north Asia as well as lower oil prices are supportive of a number of emerging markets, but the extent to which stimulus policies can offset demand destruction remains to be seen. Valuations relative to developed markets also look more appealing than they have for some time, although there will be significant volatility in earnings forecasts over coming months. There will be a hit to earnings in Q1 for most businesses and most likely Q2 due to supply shocks and weaker demand activity globally. Although we expect some normalisation in the second half of 2020, we can’t rule out a delayed recovery should there be a more prolonged and severe global recession.”

-Ends-

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Notes

  1. Data is share price total return 01/04/2020-30/04/2020. Source AIC/Morningstar.
  2. Data is share price total return 01/03/2020-31/03/2020. Source AIC/Morningstar.
  3. The Association of Investment Companies (AIC) was founded in 1932 to represent the interests of the investment trust industry – the oldest form of collective investment. Today, the AIC represents a broad range of closed-ended investment companies, incorporating investment trusts and other closed-ended investment companies and VCTs. The AIC’s members believe that the industry is best served if it is united and speaks with one voice. The AIC’s mission statement is to help members add value for shareholders over the longer term. As at the end of March, the AIC had 363 members and the industry had total assets of approximately £184 billion.
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