Emerging markets funds: betting on countries
Nedgroup and NS Partners are launching a fund covering shares in smaller markets
They say it takes opposing views to make a market. But it is unusual that Nedgroup (Nedbank’s asset manager) is launching a global emerging markets (GEM) fund just at a time when its former parent, Old Mutual, is closing down its equivalent fund.
Old Mutual wasn’t getting the assets it needed to make the business pay. The overheads of an active emerging markets fund are high. Fund managers can’t rely on published information and therefore have to travel extensively, from Shanghai to São Paulo and Mumbai to Mexico City to meet management and, often literally, kick the tyres. At least that is the template established by emerging markets pioneer Mark Mobius, formerly of Franklin Templeton.
Nedgroup’s business model is to outsource fund management and share fees with the sub-adviser. It has chosen NS Partners to run its GEM Equity Fund. The "NS" is an oblique reference to the team’s origins as a part of New Star, a UK fund manager which rose impressively, making its staff rich on listing, and then crashed just as spectacularly. But what’s now the NS team was removed from the centre, mainly running product for Canadian clients. After a few years NS demerged from Henderson, the giant asset manager which had acquired the salvageable parts of New Star.
Each country is ranked one to five, based on politics, governance and structural liquidity
NS co-CIO Ian Beattie says the firm has not had an emerging markets fund, but it has run managed portfolios on that theme. The firm has about $2.1bn under management, so the Nedgroup deal is a significant win. As well as the rand-based feeder fund, there will also be a Dublin-based dollar fund for international investors. Unlike the GEM funds currently accessible to the SA market, such as Coronation and Denker, the fund is not a pure bottom-up stock selector.
Its focus on country selection is more pronounced and each country is ranked one to five, based on politics, governance and structural liquidity. When it comes to sell decisions, deteriorating country conditions override a share’s outlook. It would have been little use to find the best share in Turkey last year with the market down almost 50%.
But SA is no higher than Turkey on the NS ranking table. Both have a four. The worst score is a five, which only Mexico has achieved. Mexico gets a tick for valuation but crosses for earnings, politics (with a new left-wing president), and poor liquidity.
Beattie says he is open to investing into frontier markets, Vietnam being a good example.
"A country focus might not have made sense when emerging markets were primarily commodity exporters, but now they are much more driven by domestic considerations such as the rise of the middle class," he says.
NS’s big holdings certainly play into this theme. The three biggest, making up about 14% of the portfolio, are Chinese tech giants Tencent and Alibaba, and Korean group Samsung. The quirkiest holding is Lemon Tree Hotels in India, a midpriced hotel group similar to City Lodge in SA. Beattie says one strict rule of the fund is not to include developed market shares, even if they have large emerging market footprints. "We would lose our advantage. We are on the ground covering shares in smaller markets which few others are doing, but we have no advantage when it comes to Nestlé or adidas or LVMH."
He says an emerging markets fund has no reason to buy Heineken when it can buy Heineken Malaysia, and Li-Ning in China is a strong competitor to adidas in athletic wear.
This is a very different approach from the Coronation GEM Fund, which has British American Tobacco as one of its top 10 shares; it also owns shares in European aircraft manufacturer Airbus and luxury goods firm LVMH. Even with about a 3% negative return over one year, Coronation is still comfortably ahead of the emerging markets index.
Co-portfolio manager Suhail Suleman says Chinese consumers account for more than 50% of LVMH’s incremental growth, particularly because of the demand for the flagship Louis Vuitton handbags.
Coronation takes an "off-benchmark" approach in other ways, with limited exposure to Taiwan and South Korea. Suleman argues they behave more like developed markets, particularly in the banking sector.
It also prefers the second-tier Chinese tech names such as 58.com and JD.com, though Alibaba is a modest 2% holding. The fund’s largest non-Chinese share (besides Naspers) is India’s Housing Development Finance Corp (HDFC), also held by NS Partners. HDFC is well-placed to benefit from the move of the Indian population from rural to urban areas.
The Denker GEM Fund has had a similar performance to Coronation over three years, but was considerably worse over one year, losing 22% in dollars.
Fund manager Neal Smith says there were three superdogs in the fund: Matahari department stores in Indonesia, which is meeting more competition from online players; the Bim supermarket chain in Turkey, which was hit by a 26% increase in the minimum wage as well as legislation to reduce the sale of supermarket house brands; and Arcos Dorados, the world’s largest McDonald’s franchisee, which is meeting increased competition from new chains and new delivery channels such as Uber Eats.
Old Mutual has found a neat solution to its problem. It is merging its GEM Fund into its MSCI Emerging Markets ESG (socially responsible) tracker, which has no direct competitors.