Templeton Emerging Markets Investment Trust — Broader investment remit and positive outlook

When discussing the backdrop in emerging markets over the past few months, Sehgal highlights the tougher regulatory environment, especially in China, and while Q221 saw a resurgence in COVID-19 cases, stock markets proved to be resilient even in countries that have been particularly negatively affected by the pandemic such as Brazil and India. The MSCI Emerging Markets Index ended the first half of 2021 in positive territory helped by firming commodity prices; economies that are reliant on the energy and materials sectors have prospered.

The manager suggests that investors underappreciate the value of emerging markets, as they consistently trade at a valuation discount to developed markets. Emerging markets are home to the lowest-cost global commodity producers, higher consumption trends are beneficial for economic growth and the region is home to many leading technology companies. Sehgal says that there is a suite of attractive investment opportunities available, while companies are adopting higher levels of corporate governance and there is an increased focus on environmental, social and governance (ESG) issues as a whole. He comments that despite emerging markets’ positive attributes, valuations in the region remain depressed. Sehgal believes that over time there is potential for a re-rating as investors will not ignore the strong earnings growth trends in the region forever, which should lead to improved sentiment. He notes that despite economic crises due to COVID-19, unlike in prior downturns most emerging market banking systems have been resilient. The manager comments that back in the 1990s, for example, there tended to be banking crises every two to three years, but the sector is now more robust, which should be reflected in higher valuations.

Sehgal does not make macroeconomic forecasts, but he observes that the Chinese economy is very competitive, and he believes that global trade dependence on the country has increased during the pandemic. The manager says that China is now a global leader in many more businesses, such as its 70–80% market share across the solar value chain; this sector is deemed critical in helping to fight climate change. Within the automotive industry, Europe and developed markets have dominated the production of internal combustion engines; however, China is now one of the leading manufacturers of batteries and other inputs for electric vehicles. The country is allocating more resources to its electronics and semiconductors industries, and while these businesses lag the market leaders in South Korea, Taiwan and developed markets, with capex rising, China is becoming increasingly competitive and is a magnet for growth companies.

The MSCI Emerging Markets Index rallied by c 11.5% from the end of 2020 to mid-February 2021, before pulling back, and there has been a considerable amount of sector rotation. Sehgal explains that those leading the market this year are areas that have typically lagged such as energy and materials, while internet stocks have retreated following very strong performances last year. Looking at individual markets, Brazil and Russia have performed well, while China has lagged, and in terms of market cap, small companies have performed better than large firms. The manager comments that market rotation emphasises the importance of running a fund that is diversified by geography, sector and market cap. He notes that there has been a very strong emerging markets earnings recovery across the board and, for the first time in several years, estimate revisions are generally positive. Sehgal considers that it is ‘as good a time as any’ to invest in emerging markets.

At 30 June 2021, there were 76 holdings in the portfolio (none of which were unlisted). The top 10 made up 58.9% of the portfolio, which was a higher concentration versus 53.8% a year earlier; seven positions were common to both periods. In terms of market cap, 52.7% of the fund was invested in companies above $50bn, 28.5% between $10bn and $50bn and 18.8% below $10bn.

Over the 12 months to the end of June 2021, TEMIT has a higher technology exposure (+7.5pp) and this continues to be the trust’s largest overweight compared with the benchmark (+10.5pp). There is a lower communication services exposure (-4.4pp), although this sector retains an above benchmark weighting (+6.0pp).

TEMIT has notable higher exposures to Taiwan (+5.1pp) and South Korea (+4.9pp), and a lower weighting to Hong Kong/China/Macao (-3.0pp) and this is the largest underweight versus the benchmark (7.1pp). The largest overweight exposure is South Korea (+9.9pp).

Sehgal highlights important portfolio activity this year including the following new positions:

There have also been several complete disposals from the fund in 2021. Flat Glass Group is a Chinese company providing glass for solar panels; its sale proceeds were used to fund the position in Daqo New Energy. The manager explains this was undertaken on the basis of relative valuation and he considers that industry demand/supply dynamics for silicon are more attractive than those for glass. US-listed IMAX Corporation was sold as the manager believes that its business recovery as economies reopen is already reflected in the company’s share price. Prosus, which owns part of Tencent Holdings, has also exited the portfolio. Proceeds of this sale were used to increase TEMIT’s positions in Tencent and Naspers. Sehgal explains that while Coal India is working to reduce its carbon emissions, from an ESG perspective, TEMIT no longer has any direct exposure to coal miners. Catcher Technology is a Taiwanese electronics casing manufacturer whose customers include Apple. The company sold some of its assets to a Chinese company and the manager prefers TEMIT’s holding in Hon Hai Precision Industry (also known as Foxconn). Sehgal sold the trust’s position in Kuaishou Technology, which was a successful February 2021 IPO. He locked in significant profits in this leading short-form video company in China, which is mainly engaged in the operation of content communities and social platforms. LG Corp spun off five of its businesses into a new company called LX Holdings. The manager saw a lack of value in the new entity, so the position was sold. Several smaller positions have also exited the portfolio including Thai banks such as Siam Commercial Bank as the pickup in tourism in Thailand has been delayed due to the increase in COVID-19 infections.

The holdings in two large Chinese companies were sold (China Mobile and China National Offshore Oil Company, also known as CNOOC) following an executive order prohibiting all US institutional and retail investors from purchasing or investing in securities of companies identified by the US government as ‘communist Chinese military companies’ – TEMIT has a number of US shareholders and is managed by US company Franklin Templeton.

In Exhibit 6, we highlight TEMIT’s relative performance. It is ahead of its benchmark in both NAV and share price terms over three and five years. The trust’s relative performance was negatively affected in Q221 by its exposure to large Chinese internet companies, whose share prices fell due to a tightened regulatory environment and increased competition. Sehgal explains that transactions undertaken so far this year have been accretive to the trust’s performance, although some high-conviction positions in the portfolio have not performed well despite continued positive earnings revisions, such as Samsung Electronics and Taiwan Semiconductor Manufacturing Company, whose share prices have suffered from sector rotation; the manager notes that small caps have outperformed large caps so far this year.

In H121, TEMIT’s performance was modestly ahead of its benchmark in NAV and share price terms. Positive contributors included NAVER, Guangzhou Tinci Materials Technology, Lukoil, POSCO, Gazprom, Vale, Bajaj Holdings & Investment, MediaTek and Infosys. Detractors included Alibaba, Naspers, China Resources Cement and Brilliance China Automotive.

In Exhibit 8, we show the nine largest funds in the AIC Global Emerging Markets sector; with a market cap of c £2.2bn, TEMIT is by far the biggest. Its NAV total returns are above average over three and five years, ranking second in both periods (out of eight funds) and are below average over the past 12 months and 10 years. Sehgal suggests that ‘looking at the batting average, TEMIT has outperformed its peers in terms of upside/downside capture’. In the three years to the end of March 2021, the trust had an upside capture ratio (outperformance in months of a rising market) of 124.4% and a lower downside capture ratio (underperformance in months of a falling market) of 105.2%. As at 4 August 2021, the trust’s discount was wider than the selected peer group average; just one fund was trading at a premium. TEMIT actively repurchases shares (more regularly when they are trading at a wider-than-average discount), which is accretive to NAV performance. It has the second-lowest ongoing charge, a below-average level of gearing and a dividend yield that is modestly above the mean.

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