Volatile political events can offer great investment opportunities
Buy into firms with attractive valuations and sound corporate governance to avoid high risk, writes Siboniso Nxumalo
The life of an emerging market fund manager is a world filled with political noise. Most of the concerns and questions we receive have something to do with some "political" event that has just occurred.
Over the past few years, Brazil’s president has been impeached, South Korea’s prime minister is undergoing her own impeachment trial, the Turkish prime minister is seeking authoritarian powers after the failed coup attempt, SA’s government has been at war with itself and then there is Russia.
All this political noise creates great investment opportunities for emerging market investors like us. We thrive in environments where markets discount great businesses to highly attractive prices due to perceived uncertainty and risk. Especially when this uncertainty has nothing to do with the underlying fundamentals of the companies in which we invest.
In 2016, we were introduced to the concept of political risk in the developed world. First with Brexit, then with the man who is dominating water cooler conversation or "trending on Twitter", US President Donald Trump. A question we often get asked is what effect Trump’s "America first" policy will have on emerging markets.
With investing, it often helps to look back in history. Trump’s primary rhetoric has been directed against globalisation, with the ambition of bringing jobs back to the US and a particularly keen interest in bringing back manufacturing jobs. Let us look back at the fascinating history of US manufacturing.
Manufacturing as a percentage of GDP and manufacturing employment peaked in 1953. Therefore, manufacturing in the US and its employment have been in decline for 64 years. Trump is trying to reverse the trend in his first few months in office. The world has changed and Trump seems to have failed to acknowledge this. In 1960, the largest companies in the US were in the auto, steel and oil industries. Sixty years on, the same S&P 500 index is dominated by companies that manufacture very little. They are marketplaces, social networks and new-economy companies. You have to work hard to find heavy industry firms or ones that are now thriving in the US, for that matter, anywhere else.
Now take time to refer back to the Wall Street Journal’s headline on Trump on December 7: "When Presidents defy economic gravity, gravity usually wins". We suspect there could be some truth in this. Ultimately, our job is not to speculate on the economics of the murky world of politics.
We firmly believe in buying strong businesses with proven sustainable competitive advantages
We are bottom-up fundamental investors and hence our expertise is in the detailed analysis and understanding of specific companies. For example, Apple is the largest, fastest growing and one of the most loved companies in the world. Trump has spoken extensively about Apple moving some of its production facilities back to the US.
Globalisation has resulted in the global consumer gaining access to better quality products at lower prices. To be able to deliver these products efficiently, firms have developed complex, yet highly efficient, global supply chains that have been engineered over decades to deliver quality at the best price.
In the Old Mutual Emerging Market Fund, our clients’ money is invested in companies that participate in the Apple supply chain. It is thus very important for us to pay close attention to any activity related to this supply chain. One such company is Taiwan Semiconductor (TSMC), the largest independent semiconductor foundry in the world.
One product it exclusively manufactures is the A10 chip, which effectively runs Apple’s latest phone, the iPhone 7.
What’s fascinating about TSMC is that it employs about 45,000 people, about 19,000 of whom have at least a master’s degree or a PhD. A further 12,000 have a bachelor’s degree. TSMC’s highly skilled staff produce chips that operate the products at the leading edge of human innovation. The idea of moving TSMC’s capability to the US should prove to be a little more complicated than simply sending a tweet.
Mind you, at an unemployment rate of 4.8%, the US is pretty much at full employment. Trump’s call for jobs in the US is thus peculiar.
TSMC spends about $10bn annually on enhancing research and development and manufacturing capability. Can you imagine how much a US company would have to spend now to replicate this capability?
We are unable to predict the future. Therefore, we firmly believe in buying strong businesses with proven sustainable competitive advantages at attractive valuations and with sound corporate governance, as they tend to withstand crises and continue growing their earnings in the long run.
Whether Trump adheres to his policies and what that means for emerging markets is thus of far less importance to us than the assessment of the strength and competitive advantages of the companies we invest in.
• Nxumalo is joint manager of the Old Mutual Emerging Markets Fund at Old Mutual Investment Group