A Turnaround in Global Emerging Markets

Transcription

1 January 11, 2013 Topic Paper 11 November 2016 A Turnaround in Global Emerging Markets PERSPECTIVE FROM TEMPLETON EMERGING MARKETS GROUP Mark Mobius, Ph.D. Executive Chairman Stephen Dover, CFA Managing Director, CIO Chetan Sehgal Executive Vice President, Managing Director India, CIO Carlos Hardenberg Senior Vice President, Director of Frontier Markets Strategies, KEY POINTS Markets Fund 1 significantly outperformed its benchmark, the MSCI Emerging Markets, year-to-date, and also outperformed most key competitors over the same period. Apart from the asset class recovery, the fund benefited from significant investments in new economy areas including information technology and health care, fundamental strength of our long-term holdings in Brazil and Thailand, as well as refinements in our investment process. Market Review Emerging-market equities climbed over the first nine months of The recent strong fund flows to emerging markets signal a turnaround in sentiment after investors had grown bearish on the asset class in recent years. As at year-to-date (YTD) ending 30 September 2016, the MSCI Emerging Markets (MSCI EM ) has significantly outperformed the MSCI World and the S&P 500, partially boosted by the recovery in oil prices, signs of stabilization in China, strengthening emergingmarket currencies against the US dollar and beneficial emerging-market structural reforms coming to fruition. Emerging-market equity has experienced a turnaround in sentiment given attractive valuations, superior growth, continued reforms and strong fund flows. Exhibit 1: Markets Fund vs. 3-Month Total Return 3-Month Morningstar Percentile Ranking YTD Total YTD Morningstar Return Percentile Ranking 1-Year Total Return 1-Year Morningstar Percentile Ranking Markets Fund A(Ydis) USD 9.77% % % 7 EAA OE Global Emerging Markets Equity 8.49% 14.91% 16.29% MSCI EM % 17.21% Source: 2016 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is not an indicator or a guarantee of future performance.

2 Exhibit 2: Total Returns 1-Month 3-Months YTD MSCI EM S&P MSCI World Source: Morningstar, in USD Performance Review Over the first nine months of 2016, Markets Fund s performance improved significantly. Not only did it outperform the MSCI EM, but it also outperformed a majority of its peers, ranking in the first quartile in the EAA OE Global Emerging Markets Equity Morningstar category. Apart from the asset class recovery, the strategy benefited from significant investments in new economy areas including information technology (IT) and health care in 2015 to take advantage of both the long-term structural expansion we see in these areas and tactical valuation opportunities. The fundamental strength of our long-term holdings in Brazil and Thailand, as well as refinements in our investment process, also helped performance. Key Contributors Stock Selection in Brazil Brazilian shares rallied strongly this year as speculation rose that a change in leadership would be able to improve the country s finances and help to restore growth. We believe political turbulence is likely to continue to subside in the wake of Dilma Rousseff s 31 August 2016 impeachment. The country also recorded its first current account surplus since 2009 in April and again in May. The current account surplus was US$412 million in April 2016 and US$1.2 billion in May This helped to boost both consumer and business confidence amid a weak economic outlook. Our exposure in Brazilian banks (Banco Bradesco and Itau Unibanco) was a key contributor to portfolio performance. These banks have been recovering from the extremely undervalued levels seen in late 2015 and early 2016, with improved investor sentiment toward the country providing further support. The banks have also implemented a number of organizational initiatives to navigate through the tough economic environment. Itau Unibanco posted good results in the second quarter of 2016, driven by strong fee income, high margins and lower provisioning for bad loans. The bank is strongly capitalized, amply provisioned, has a lot of liquidity, and we believe stands ready to seek to take advantage of the recovery we expect for the Brazilian economy in Meanwhile, we believe Banco Bradesco possesses strong earnings power and product distribution advantages in what is a concentrated banking sector. Its valuations look reasonable to us, and the bank has posted good results, driven by a conservative loan portfolio, cost cutting and additional feebased revenue sources. Outside the banks, Brazilian bakery and confectionary manufacturer M. Dias Banco contributed to the portfolio s outperformance compared to its benchmark index. Stock Selection in Thailand The solid performance of the Thai market through August 2016 reinforces our belief in the long-term advantages of investing in this market. Ongoing government stimulus efforts in the form of infrastructure investment and rural income support have been beneficial, and we expect recent electoral approval of proposed constitutional changes to enhance stability in ensuing quarters. While the passing of the king in mid-october has been accompanied by some market volatility, the structural drivers behind our exposures in Thailand from a macroeconomic perspective as well as the bottom-up stock fundamentals remain attractive to us. Quarterly results at both Siam Commercial Bank and Kasikornbank surprised on the upside, supporting continued rallies. Both stocks have appreciated considerably from the lows of 2015 as at September-end. The underlying fundamentals of their businesses, in terms of loan growth, net interest margins and non-performing loans, have proven relatively resilient despite the macroeconomic driven volatility of last year. Significant Expansion in the IT Sector In recent years, a structural expansion in IT within key global emerging-market benchmarks has occurred. As at end- September 2016, the MSCI EM s IT sector weight is now ahead of energy, materials and industrials combined and is catching up with financials. This increased weighting is a result of both the sector s outperformance, as well as index inclusions (most notably Chinese Internet names in late 2015 and midyear 2016). EM is plainly no longer a commodities-only story. Moreover, the IT sector commands a higher weight in the MSCI EM than the MSCI United States, MSCI Japan and MSCI Europe es. Exhibit 3: Rising IT Prominence in the MSCI EM /96 12/00 12/04 12/08 12/12 9/16 Source: FactSet. Information Technology Financials Energy/Materials/Industrials A Turnaround in Global Emerging Markets 2

3 Exhibit 4: MSCI EM Now One of the Most IT-Driven es Globally September 2016 vs. December Source: FactSet. Within IT, it is also worth noting that there has been a move toward more structural diversification not simply producing hardware for global supply chains, but also world class innovation. In recent times, the MSCI EM has seen a significant increase in software and services companies (including Internet) within the IT sector. Within our investment process, we have been closely tracking the opportunity set in the IT space for some time, coinciding with the structural rise of IT within EM. The sharp correction last year, particularly over the third quarter of 2015, created Exhibit 5: Rising Influence of Information Technology % 9.9% MSCI EM % MSCI United States MSCI Japan 9/16 12/ % MSCI Europe 15.9% 11.2% MSCI All Country World Exhibit 6: P/E Ratio within the IT Sector MSCI EM Sector/Sub- Sector Technology Hardware and Equipment Source: FactSet. attractive valuation opportunities, with the IT sector s aggregate price-to-earnings (P/E) ratio falling to the lower end of its 10- year average in September This move provided us an opportunity to accumulate shares in a number of market leaders with what we view as robust growth prospects, particularly Taiwanese hardware manufacturers/suppliers and Chinese Internet companies whose business models we believe are both sustainable and adaptable. As a result, the IT weight of Markets Fund increased significantly and is now the fund s top sector in terms of allocation on an absolute basis as at 30 September Exhibit 7: Markets Fund vs. MSCI EM IT Sector Weight Changes P/E P/E (10-YEAR HISTORY) 9/15 Low Avg High Information Technology Semiconductors and Semiconductor Equipment Software and Services % % 1.7% 1.7% % % 11.2% 12/14 3/15 6/15 9/15 12/15 3/16 6/16 9/16 Markets Fund MSCI EM Source: FactSet. IT sector industries include communications equipment; electronic equipment, instruments and components; IT services; Internet software and services; semiconductors and semiconductor equipment; software; technology hardware, storage and peripherals. 12/07 12/08 12/09 12/10 12/11 12/12 12/13 12/14 12/15 9/16 Semiconductors and Semiconductor Equipment Software and Services Technology Hardware and Equipment Source: FactSet, MSCI. In Internet companies, our fund s main investments are in Baidu and Tencent. Baidu is an online search engine while Tencent is an Internet services company that provides social networks and instant messaging in China. Each is a leader in its own field with almost full penetration to Internet users. We believe these leading Internet players will continue to benefit from strong A Turnaround in Global Emerging Markets 3

4 online migration and rising consumption in China, with ample monetization opportunities in the future, especially in paid content and social ads. Regarding hardware manufacturers and suppliers, Taiwan Semiconductor Manufacturing Co. (TSMC) and Samsung Electronics have also positively contributed to the fund s overall performance. TSMC has a strong execution track record, and its long-term earnings will likely be driven by the Internet-ofthings, increased use of technology in automobiles and rising silicon content of mobile devices. Samsung has improved its corporate governance, and we believe this is a major change in the context of the South Korean market and has been a key catalyst for performance. Stabilization in China While in the past couple of years fears of doomsday scenarios for the Chinese economy as well as substantial stock market volatility pervaded investment discussions, signs of stability after a sharp slowdown in parts of China s economy have emerged. We believe the government s economic rebalancing efforts in terms of expanding the service sector and spending on infrastructure is coming to fruition. China remains the top country by absolute weight in the portfolio as at 30 September 2016, and we are on the lookout to add more exposure if suitable opportunities arise. At the moment, the good companies in China are generally crowded and this significant investment interest tends to overinflate valuations. Our exposure in China is mainly concentrated in Internet services companies, such as Baidu and Tencent, as discussed earlier. Key Detractors Underweight Resources Exposure As noted above, emerging markets are no longer a commodities-only story and we expect this structural change to continue over the longer term. During the first nine months of the year, however, the portfolio s underweight relative to its benchmark index in the resources sectors of the market materials and energy detracted from relative returns as commodity prices rebounded or stabilized. Notably, a lack of exposure to a number of major energy sector companies in Brazil and Russia detracted. We believe selected commodity shares looked attractivelyvalued at period-end as commodity prices have shown signs of bottoming. Oil prices, for example, are currently significantly higher than their recent lows. Stock Selection in Russia Stock selection in Russia, where the portfolio was underweight relative to its benchmark index, curbed relative performance during the year as the Russian market benefited from recovering oil prices. The Ministry of Economic Development expects gross domestic product (GDP) to contract 0.2% in In comparison, the economy shrank 3.7% in 2015 as measured by GDP. A position in Internet company Mail.ru Group was a detractor as growth has slowed due to declining advertising amid the ongoing economic weakness. Additionally, the lack of exposure to Russian energy stocks and not holding Russian financials holding company Sberbank detracted given the rebound in the domestic market on optimism about oil prices and the country s economic outlook. Select Chinese Consumer Companies While the Chinese economy looks to have stabilized, a handful of consumer discretionary holdings detracted from relative performance over the first nine months of the year, including Brilliance China Automotive and Uni-President China, despite solid fundamentals. Brilliance China Automotive is an investment holding company which manufactures and sells automobiles. Its operations include the production of minibuses, automotive components as well as manufacturing and selling BMW cars for the market in China. Uni-President China is an investment holding company which is primarily involved in producing and marketing beverages and instant noodles. It is one of the largest producers of juice and noodles in China and it also makes tea and coffee products. The company announced first-half results that disappointed market participants. Despite growth in sales of noodles, its beverage revenues were down, with the juice segment particularly weak. The aforementioned Internet search engine Baidu in the IT sector was also a detractor during the period. Investment Process Updates The portfolio shifts and performance recovery in the recent year have been well supported by ongoing investment process refinements. In late 2015 and early 2016, we made several senior leadership announcements including Stephen Dover as chief investment officer; Tek Khoan Ong as director of research; and Chetan Sehgal as director of global emerging-market and small-cap strategies, who provides thought leadership for the global emerging-market strategy along with Carlos Hardenberg. These appointments of long-time seasoned EM investment professionals have provided continued focus and accountability to help our investment strategies build on and elevate the well-established research platform that underlies the team s efforts across emerging markets. In addition to the leadership appointments, we have been working to refine our investment process, including the appointment of dedicated global sector analysts for select sectors including Internet, technology and health care. The sector analyst framework has further reinforced our bottomup idea generation, improved both breadth and depth of our coverage, and enhanced stock research consistencies within the respective sectors, which facilitated the portfolio s significant investments in these areas. A Turnaround in Global Emerging Markets 4

5 Portfolio Positioning Over the past 12 months, we have significantly rebalanced the portfolio to seek to take advantage of both structural shifts in the EM opportunity set, and tactical valuation opportunities due to the weak investor sentiment in previous years. The aggregate weighting difference between the portfolio as at 30 September 2016 and 30 September 2015 was 40.3%. New names: Of the portfolio s current holdings, 48 positions or over half of the current portfolio names were new holdings introduced within the last year. These names comprise a quarter of the current total portfolio weight, and have delivered positive impact in aggregate on portfolio performance YTD. Evolution in Barra risk profile: In terms of the portfolio s active risk profile, the current portfolio has a sharper focus on stock selection, with selection risk comprising 5 of the active risk currently, as compared to 41% a year ago. Exhibit 8: Barra Risk Reports: % Contribution to Active Risk September 2016 vs. December In terms of specific areas of portfolio shifts, in addition to the rise of IT, we increased our exposure in South Korean construction companies, with a view that the market was discounting the potential for a recovery in earnings. Daelim was added to the portfolio in the fourth quarter of 2015 and we expanded our exposure to Hyundai Development in the same period. During 2016, both companies have posted above consensus results, successfully turning around their earnings; in addition, we expect record housing pre-orders in the case of Hyundai, and completion of lossmaking offshore projects for Daelim, to further boost income statements in coming quarters. Health care is another new economy sector to which we have devoted increased resources with a dedicated pharmaceuticals analyst, and where performance attribution has also been strong. While our exposure to the sector has declined over the past 12 months, this is primarily reflective of profit-taking in relatively large long-term holding Dr. Reddy s as well as Bukwang Pharmaceutical and trimming of Biocon, a top contributor. We have opened new positions in Gedeon Richter and Glenmark Pharma, both of which have attractive portfolios spanning the research and development of new drugs as well as production of generics. For both companies, we consider the pipeline of potential new treatments to be attractive, while emerging-market companies lower cost production of generics is advantageous as governments globally more closely scrutinize health care costs, leading to higher risks in terms of pricing for branded drugs. 4 3 Selection Risk Country Industry Currency Risk Style 12/15 9/16 Source: Barra. Summary We believe that the long-term investment case for emerging markets remains positive. In our view, economic growth rates in emerging-market countries are likely to continue to outpace those of many developed-market economies. While emerging markets remain sensitive to macroeconomic indicators and global monetary policy, and volatility is likely to persist for some time, equity markets appear to have begun to readjust as investor confidence returns. Moreover, despite the recent increase in fund flows, many investors remain considerably underweight in emerging markets, which we believe is supportive of further re-rating over the longer term. As we expect emerging-market equity to continue its recovery, accompanied by fundamental improvements and reforms, we continue to refine our approach and aggressively position the portfolio to seek to take advantage of emerging opportunities that are expected to propel the asset class s long-term growth. A Turnaround in Global Emerging Markets 5

6 IMPORTANT LEGAL INFORMATION 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. es 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: Markets Fund is a sub-fund of the Luxembourg-domiciled SICAV Franklin Templeton Investment Funds. 2. There is no assurance that any forecast will be realized. 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. Important data provider notices and terms available at Please visit to be directed to your local Franklin Templeton website. franklintempletoninstitutonal.com Copyright 2016 Franklin Templeton Investments. All rights reserved. 11/16