Templeton Emerging Markets Strategy: Year-End Review

Transcription

1 Topic Paper 15 February 2018 Templeton Emerging Markets Strategy: Year-End Review PERSPECTIVE FROM FRANKLIN TEMPLETON EMERGING MARKETS EQUITY KEY POINTS Emerging markets (EMs) continued their rally and sustained strong outperformance compared to developed markets (DMs) in We believe this momentum will continue into 2018 despite potential economic and political headwinds in the year ahead. Likewise, FTIF Templeton Emerging Markets Fund 1 continued to outperform its index and key peers, primarily driven by our stock selection in banks, automobiles and information technology (IT). Core themes of technology and consumption remain, with new sub-themes identified: e-commerce, new mobility vehicles, fintech, penetration, premiumization and health care. Stephen Dover, CFA EVP, Head of Equities, Franklin Templeton Investments Chetan Sehgal Senior Managing Director, Director of Portfolio Management Franklin Templeton Emerging Markets Equity EM Review in 2017 In 2017, emerging markets improved from a low point in 2016 and sustained strong outperformance compared to developed markets, with the MSCI EM Index up 37.8% versus the MSCI World Index return of 23.1%. The asset class saw a record inflow of US$80 billion in 2017, and we believe the stock market recovery in emerging markets, which has been underway since 2016, is showing little signs of abating. US trade protectionism was seen as the main 2017 tail risk for emerging markets, but it appears to have been less confrontational relative to Trump s rhetoric-filled election campaign. Emerging markets are at the forefront of a changing world, and old economic models are undergoing a transformation, paving the way for new and exciting investment opportunities. This is evident as many industries are newly exposed to Asian emerging markets, such as technology and autos, which bodes well for the region. Exhibit 1: Emerging Markets Are at the Forefront of a Changing World Macroeconomic Transformation Fundamentals in EMs have improved over the years, especially post 1997 financial crisis Economic and policy reforms are seen across Asia, Latin America and Africa EMs are increasingly selfsufficient and no longer dependent on DMs for exports Microeconomic Evolution EM businesses and populations are adapting to technological advancements Economic shift from a low-cost manufacturing hub for DMs to high tech, high value chain economy Improving earnings of EM companies Investment Case Remains Compelling Given the strong rally witnessed in 2017, many investors may wonder if emerging-market (EM) equities have further room to run in Emerging markets valuations are currently at a seven-year high since 2010, at 14.68x price-to-earnings, and

2 1.78x price-to-book ratio as at end December We believe these valuations are fundamentally supported by earnings growth. After EM corporate earnings reached an inflection point in 2016, the return on equity (ROE) of EM companies continued to outpace developed markets, as seen in Exhibit 2. We see better visibility in EM corporate earnings forecasts and believe earnings still have further upside. Moreover, many EM economies are in the expansion phase, with select countries such as Russia and Brazil coming out of recession, and new policy reforms paving way for stronger economic fundamentals. The tailwinds of commodity prices also benefit many economies. Despite a narrower valuation gap, EM companies continue to trade at a discount relative to developed markets. Emerging markets are growing in economic significance globally, and we believe this momentum will continue into 2018 despite potential economic and political headwinds in the year ahead. Exhibit 2: ROE: MSCI EM Index vs. MSCI World Index January 2007 December MSCI EM Index MSCI World Index Source: FactSet, MSCI, IBES estimates. There is no assurance that any estimate will be realized. Performance Review In 2017, FTIF Templeton Emerging Markets Fund continued to outperform against its benchmark MSCI EM Index, returning 38.0% versus 37.8% respectively, in USD. The fund s trailing one two years performance results continued to generate strong alpha (top decile/quartile), illustrating a balanced portfolio and improved risk management, with returns driven by stock selection. Key Drivers of 2017 Performance Bank and Insurance Bank and insurance holdings in the financials sector outperformed, supported by positive tailwinds for emerging markets including higher structural growth. We generally favor banks with strong market positions, attractive spreads or that demonstrate turnaround potential. We look for names that are market leaders (Sberbank, Banco Bradesco, Itau Unibanco), names in the midst of restructuring (ICICI) or names that stand to benefit from the underpenetration story. Additionally, Kasikornbank is among the best-managed banks in Thailand. Historically, we have been underweight Chinese banks, mainly because their spreads are very low compared to other banks in the EM asset class. In China, we hold Ping An Bank and Ping An Insurance, which we believe have strong turnaround potential. Automobiles Luxury vehicles, in particular Brilliance China, a BMV JV partner in China, performed strongly in 2017, and expectations for 2018 look positive, supported by both stock-specific and industry growth. Brilliance China has entered a strong product cycle since the launch of the seventh generation of 5 series models in June We expect the product mix to improve with the launch of more competitive models in 2018, including the locally produced X3 in mid-2018, and the new 3-series and X2 models in The company also improved operating efficiency due to a product mix upgrade and cost savings from the localization of engines, and may see improvement in the light commercial Exhibit 3: FTIF Templeton Emerging Markets Fund Performance vs. Index As at 31 December 2017 Discrete Annual Performance (%) 12/16 12/17 12/15 12/16 12/14 12/15 12/13 12/14 12/12 12/13 Templeton Emerging Markets Fund A (Ydis) USD MSCI EM Index (USD) Name Total Return 1-Yr Total Return % Rank Category 1-Yr Total Total Return Return % Rank 2-Yr Category 2-Yr Total Total Return % Return Rank Category 3-Yr 3-Yr Total Total Return Return % Rank 5-Yr Category 5-Yr Templeton Emerging Markets Fund A (Ydis) USD Morningstar EAA Fund Global Emerging Markets Equity Category MSCI EM Index (USD) Source: Morningstar, in USD. Periods greater than one year are shown as average annual total returns. The Morningstar EAA Fund Global Emerging Markets Equity Category consisted of 595 funds for the one-year period, 570 for the two-year period, 513 funds for the three-year period and 438 for the five-year period. Past performance does not guarantee future results. Templeton Emerging Markets Strategy: Year-End Review 2

3 vehicle business following its JV with Renault. Brilliance China outperformed its peers with 18% volume growth compared to the 3% volume growth registered by the auto industry last year. Information Technology The top contributor in the IT sector, Samsung Electronics, remains a key beneficiary of the continuing memory cycle: Industry consolidation, stabilization in ASPs and disciplined capex spending will be some of the company s growth drivers, in our opinion. Despite being a well-known consumer brand, the company is also a strong player in semiconductors, which helped drive earnings in Looking ahead, Samsung s organic light-emitting diode (OLED) business is expected to grow on the back of the surge in flexible OLED displays. The company has also taken noticeable steps to improve its corporate governance from the chaebol-related political scandal it faced in the first half of Recent company announcements to align shareholder interests with management interests have been viewed positively by investors. The company also plans to enhance long-term value by returning more free cash flow to shareholders for the period. Portfolio Positioning/Opportunities in EMs Looking ahead in 2018, as fundamental stockpickers, we continue to remain positive on emerging markets. Core themes of technology and consumerism remain, and we have further identified areas of opportunities within these themes in 2018, as noted in Exhibit 4. Technology Is Reshaping the Global Economy Despite the correction seen in technology names after the third quarter of 2017, we remain convinced in this sector and in the portfolio names. Opportunities for efficiencies, cost savings and ease of doing business are supported by emerging markets accelerating internet usage and penetration. The MSCI EM Information Technology Sector Index rose 60.91% in 2017 as investors were drawn by the secular trends including e- commerce, gaming and cloud computing. The semiconductor industry has gained strong prominence over the years, catering to the increased demand for automotive chips, wireless infrastructure, sophisticated electronic devices, and other major applications. Aside from Samsung Electronics (South Korea), we are well positioned with our exposure in Taiwan Semiconductor Manufacturing Company (TSMC), the world s largest independent integrated circuit (IC) foundry with over 50% market share. The company has a strong execution track record, and its longterm earnings will likely be driven by high-performance computing, driverless cars, the Internet-of-Things and the rising silicon content of mobile devices. Moreover, its development of both 10 nanometer (nm) and 7nm processes are on track, and its solid leadership in technology advancement will likely help secure future market position and earnings growth. E-Commerce Continues to Accelerate E-commerce is still very much a penetration growth story, resonating in several markets as consumers increasingly use multiple devices for online shopping. Traditional ways of doing business are losing ground to the digital revolution, which introduces new innovative ways to personalize a shopper s experience. To illustrate, Alibaba started employing big data to its algorithm since September 2016, which enhances personalized and real-time recommendations to improve clickthrough rates and monetization. The high growth rate of digital commerce has caught the attention of many, including social media companies. Russian internet search giant Yandex recently announced an online retail joint venture with Russia s largest bank (Sberbank), with hopes to tap into Sberbank s enormous customer base. Our team favors leading e-commerce firms over social media companies, as the former have the capability of achieving a high market share. The social media industry has evolved rapidly over the past decade, but its commercialization is capped by the number of waking hours, and e-commerce platforms are likely to have business models that have dominant market share. New Mobility Is Disrupting Industries Technology is also shaping the automobile industry, introducing new trends such as electric vehicles (EVs) and automated driving systems. There have been several partnerships over the past few years, such as BAIC collaborating with both Baidu and Alibaba on autonomous driving software. Component manufacturers have also jumped on the bandwagon, including South Korean tire producer Hankook. Although our exposure is derivative at this moment, we are closely monitoring this trend as we see this as a long-term theme. Fintech Is Driving Financial Institutions Inclusion Over the past year, there has been greater adoption of fintech solutions globally, driven by emerging markets, including China, India, South Africa, Brazil and Mexico. Fintech firms in these markets have become successful at tapping into the tech literate but financially underpenetrated populations. Our banking investments have recognized the importance of this potential and have increased investments into their fintech arms (Itau Unibanco, Ping An Insurance). Sberbank also introduced more online services and closed branches, and this has helped to improve margins. Tech names have also explored into this field, with Alibaba and Tencent introducing Alipay and Tenpay, respectively Consumerism, a Play on Demographics The structural case for emerging markets continues to center around demographics, a rising middle class and domestic consumption. Penetration We believe the demand for goods and services is set to skyrocket as EM household income continues to grow. We have pivoted the portfolio toward direct and indirect consumer Templeton Emerging Markets Strategy: Year-End Review 3

4 Exhibit 4: Relative Valuations: MSCI EM Index vs. MSCI World Index January 2007 June 2017 Top Themes E-Commerce Continues to Accelerate Investment Ideas E-commerce is still very much a penetration growth story, resonating in several markets including Russia (Yandex) and South Korea (NAVER). Technology Is Reshaping the Global Economy New Mobility Is Disrupting Industries Fintech Is Driving Financial Institutions Inclusion Penetration Many EM companies have stepped up to play a dominant role in producing automobile solutions not only in terms of software (Baidu), but also in terms of components including batteries (Samsung Electronics) and tires (Hanook Tire). Banks are increasing investments into their fintech arms (Itau Unibanco, Ping An Insurance). Favorable demographics of young and growing middle class populations bring opportunities to untapped consumer spending potential. Consumerism, a Play on Demographics Premiumization Shifting Health Care Landscape Looking beyond the penetration story, premiumization is the next natural transition as income rises. Examples include higher-end automobiles (Brilliance China) and leisure (entertainment, resorts, movie theatres, gaming and travel). Demographic shifts and societal changes are intensifying pressures on health care systems, and more hospitals and pharmaceuticals are taking steps to cater to this market (Biocon, Glenmark Pharma). plays, such as internet services (Yandex, Mail.Ru), apparel (Fila Korea) and food retailers (Uni-President China), all of which are able to benefit from the demographics of young and growing populations and untapped consumer spending potential. Premiumization As the working class attain their basic necessities of life, higher disposable incomes help drive aspirational demand for higherend consumer items a phenomenon known as premiumization. Consumers are demanding better quality not just for goods, but also, increasingly, for services, including entertainment, resorts, movie theatres, gaming and travel. From an investment perspective, we are particularly interested in companies that cater to this need, including higher-end automobiles (Brilliance China), movie theatres (IMAX), liquor producers (Hite Jinro) and resort casinos (MGM China, Sands China). Shifting Health Care Landscape Demographic shifts and societal changes have intensified pressures on health care systems, and more hospitals and physicians are taking steps to improve the services provided to patients. Increasingly affluent consumers also increase the demand of aesthetic plastic surgery and weight management. There is also a push toward preventive care, including a focus on nutritional products. Perhaps the most pressing issue for health care in developing countries is the rise of aging populations. According to the October 2011 Global Health and Aging Report presented by the World Health Organization, the number of people aged 65 or older is projected to grow from an estimated 524 million in 2010 to nearly 1.5 billion in 2050, with most of the increase in developing countries. Aging populations have created a higher demand for niche drugs, which are produced by biopharmaceutical companies, such as Biocon. The company developed recombinant human insulin that could be used to treat diabetic patients. Large-cap opportunities are often centered in biopharmaceutical companies, but we believe a wider spectrum of health care opportunities can be found in the small-cap space. Summary/Risks Ahead As we expect EM equity to continue its positive run, we continue to refine our approach and aggressively position the portfolio to seek to take advantage of emerging opportunities that are expected to propel long-term growth in the asset class. Key areas of risk include uncertainty about the US administration s policies, as well as the ability of China to continue its growth while making structural adjustments. US monetary policy shifts also remain a source of apprehension for many market participants. Recent market volatility was triggered after concerns over rising US inflation, creating investor worries that it could prompt the US Federal Reserve to hike interest rates, resulting in a broad equity sell-off with investors moving into gold and other perceived safe-haven assets. During such periods, emerging-market equities generally display heightened risk aversion and indiscriminate selling, often at the expense of solid fundamentals. However, the stronger correction in emerging markets has been quitemild. And there is a good reason for the higher resilience of emerging markets in this correction we are in a recovery phase, valuations are relatively cheap and, in general, most investors are still underweight emerging markets. It s also important to note that many emerging markets have stronger foreign reserve positions and lower external debt today than they ve had historically, which makes them potentially less vulnerable to external shocks. Moreover, each emerging country has its own idiosyncratic domestic drivers, hence they are less correlated to one another and the global market as a whole. In a post-correction recovery period, emerging markets could be good for a surprise. In our view, we are still in the early innings of the EM earnings growth upturn, and valuations and sentiment continue to be conducive to further gains in the asset class. Emerging markets are increasingly taking the global stage, and it is an opportune time to be at the forefront of a changing world. Templeton Emerging Markets Strategy: Year-End Review 4

5 WHAT ARE THE KEY RISKS? The value of shares in the Fund and income received from it can go down as well as up and investors may not get back the full amount invested. Performance may also be affected by currency fluctuations. Currency fluctuations may affect the value of overseas investments. The Fund invests mainly in the equity securities of emerging markets around the world, which have historically been subject to significant price movements, frequently to a greater extent than equity markets globally. As a result, the performance of the Fund can fluctuate considerably over time. Other significant risks include: emerging markets risk, currency risk, liquidity risk, operational risk, Shanghai-Hong Kong Stock Connect risk. For full details of all of the risks applicable to this Fund, please refer to the Risk Considerations section of the Fund in the current prospectus of Franklin Templeton Investment Funds. IMPORTANT LEGAL INFORMATION Templeton Emerging Markets Fund is a sub-fund of the Luxembourg-domiciled SICAV Franklin Templeton Investment Funds. This document is intended to be of general interest only and does not constitute legal or tax advice nor is it an offer for shares or invitation to apply for shares of the Luxembourgdomiciled SICAV Franklin Templeton Investment Funds ( FTIF ). Nothing in this document should be construed as investment advice. Opinions expressed are the author s at publication date and they are subject to change without prior notice. Subscriptions to shares of the FTIF can only be made on the basis of the current prospectus of the FTIF and, where available, the relevant Key Investor Information Document, accompanied by the latest available audited annual report and the latest semi-annual report if published thereafter. The value of shares in the FTIF and income received from it can go down as well as up, and investors may not get back the full amount invested. Past performance is not an indicator or a guarantee of future performance. Currency fluctuations may affect the value of overseas investments. When investing in a fund denominated in a foreign currency, your performance may also be affected by currency fluctuations. An investment in the FTIF entails risks which are described in the FTIF s prospectus and, where available, the relevant Key Investor Information Document. In emerging markets, the risks can be greater than in developed markets. Investments in derivative instruments entail specific risks that may increase the risk profile of the FTIF and are more fully described in the FTIF s prospectus and, where available, the relevant Key Investor Information Document. No shares of the FTIF may be directly or indirectly offered or sold to residents of the United States of America. Shares of the FTIF are not available for distribution in all jurisdictions and prospective investors should confirm availability with their local Franklin Templeton Investments representative before making any plans to invest. Any research and analysis contained in this document has been procured by Franklin Templeton Investments for its own purposes and is provided to you only incidentally. References to particular industries, sectors or companies are for general information and are not necessarily indicative of a FTIF s holding at any one time. Given the rapidly changing market environment, we disclaim responsibility for updating this document. References to indices are made for comparative purposes only and are provided to represent the investment environment existing during the time periods shown. Indexes are unmanaged and one cannot invest directly in an index. They do not reflect any fees, expenses or sales charges. Please consult your financial advisor before deciding to invest. A copy of the latest prospectus, and if available for this product the Key Investor Information Document, the annual report and semi-annual report, if published thereafter can be found, on our website or can be obtained, free of charge, from Franklin Templeton International Services S.à r.l. Supervised by the Commission de Surveillance du Secteur Financier 8A, rue Albert Borschette, L-1246 Luxembourg Tel: Fax: Templeton Emerging Markets Fund is a sub-fund of the Luxembourg-domiciled SICAV Franklin Templeton Investment Funds. MSCI makes no warranties and shall have no liability with respect to any MSCI data reproduced herein. No further redistribution or use is permitted. This report is not prepared or endorsed by MSCI. CFA and Chartered Financial Analyst are trademarks owned by CFA Institute. Important data provider notices and terms available at franklintempletoninstitutonal.com For Institutional Investor and Consultant Use Only. Not For Distribution To The General Public. Copyright 2018 Franklin Templeton Investments Corp. All rights reserved. 2/18