Genesis Emerging Markets Fund — ESG uncovered

Genesis’s investment team is enthusiastic about the economic recovery in EMs and the resulting investment opportunities. The portfolio manager Karen Roydon points out that the global recovery will benefit most EM countries, particularly those with large exposures to commodities, as they will be able to monetise commodity revenues to accelerate the recovery and growth of their economies.

The biggest increases in country weightings were China and Taiwan, by 3.4pp and 2.3pp, respectively (see Exhibit 1). This was despite the team taking profits in a number of Chinese and Taiwanese companies on the back of strong performance and very high valuations. For example, Jiangsu Yanghe Brewery (0.67% of the portfolio at end-April 2021), the premium alcohol producer in China, has seen strong demand for its products during the year and its valuation has surged as a result. Given the team’s valuation discipline, it reduced its holdings in the sector by 250bp in 2020 and another 75bp in 2021, after the share prices of Jiangsu Yanghe Brewery and Wuliangye more than tripled between March 2020 and January 2021. The trust is significantly underweight China, Taiwan and South Korea. This reflects the team’s view that there are many attractive investment opportunities in the broader EM universe where valuations are also less stretched.

The global acceleration of digitalisation in 2020 has been of interest to the team. The social impact of the COVID-19 pandemic lockdowns has been significant. The increase in online activity, such as purchases and entertainment, resulted in the growth of internet businesses broadly across EMs, including China and North Asia, where there is already a highly developed digital footprint. Roydon points out the pandemic has accelerated the growth of digital consumer applications, particularly outside China and North Asia, creating businesses with much more scale. This has made the industry more settled and it is now much easier to see who the winners will be in these less developed markets (see the below paragraph for some examples), which was not the case 18 months ago.

The team has been taking advantage of this trend in portfolio activity. Despite having a relatively large exposure to internet businesses outside China historically, it has continued to increase exposure to internet businesses outside China in particular. For example, it initiated a holding in Delivery Hero (1.4%), an online food delivery company with business across different EM countries, which has a third of its business in the Middle East, where e-commerce also picked up considerably in 2020. It also added Yandex (1.64%), the largest Russian internet search engine. According to Roydon, e-commerce sales growth in Latin America were running at less than 15% annually but accelerated to 50% in 2020. Genesis is also seeing a boom in e-commerce in Russia, particularly at one of the leaders, Ozon (0.35%), a multi-category e-commerce platform and a public company in which the fund invests.

Long-term, consumption-led EM themes continue to shape the portfolio’s sector exposure with consumer discretionary & staples and financials accounting for c 60% of the portfolio (Exhibit 2). The repositioning for the post-COVID-19 pandemic recovery is illustrated by the shift towards cyclical consumer discretionary businesses (+5.0pp over the past 12 months to end-April 2021) and a reduction in consumer staples (-2.4pp). The portfolio had 112 holdings at the end of April 2021.

The 21st century market consensus view is that understanding ESG considerations is critical for investors to generate long-term returns. Genesis believes ESG is particularly important for investors in EMs, as regulatory institutions in these regions are often weak. In EMs, the law often provides only weak protection for the interests of stakeholders. As long-term active investors, the Genesis team prefers not to be at the mercy of poorly governed companies, so investing in companies with strong and improving governance is very important. The impact of environmental and social factors can be more subtle in EMs and the team has developed proprietary industry frameworks to inform its analysis.

ESG considerations have always been an integral part of Genesis’s investment process. There are three key points to the process:

There are 11 PMs at Genesis who manage the fund jointly. Each PM is responsible for integrating ESG risks and opportunities into their investment thinking – it is not the responsibility of a separate team, highlighting the importance of ESG in the process. PMs create a stakeholder analysis, which identifies the most material ESG factors facing a company and sets out an engagement plan to attempt to address the issues that can be improved. This stakeholder analysis forms part of the company’s quality rating, which is a sizing factor; a material risk that affects a PM’s assessment of long-term sustainability will result in a lower quality rating, and hence a lower weight in the portfolio.

Engagement priorities (for the top 10 engagement priorities see exhibit 3) are identified by PMs and recorded and tracked regularly. Genesis believes that the most effective way to influence management behaviour and create change is for the PMs – who have the closest relationship with the company – to lead the discussion. Engagement is important as it helps companies improve and to reduce some of the risks that their business, and by extension, their shareholders may face.

PMs have ample access to ESG research materials. They liaise with industry specialists, invite expert speakers to educate the team on material ESG matters, such as primary energy usage, water management & security and labour standards, as well as more niche topics like antibiotic usage by protein businesses. Genesis’s team members use ESG ratings providers like MSCI as a reference to inform their decisions, as well as information from many of the ESG-related groups they support, such as the Asian Corporate Governance Association and the CDP (previously the Carbon Disclosure Project), but draw their own conclusions.

Managing over $20bn, Genesis is a sizeable investor in EMs and, given the team’s long-term investment horizon, it is a valued shareholder. Investee companies tend to take Genesis’s views seriously, as it is typically a material shareholder in a company.

Genesis’s PMs engage with companies individually, and also collaboratively with other shareholders. For example, Genesis collaboratively engages with portfolio companies on climate-related issues. Recently it acted as lead investor for three high-priority companies identified by the CDP to encourage disclosure on climate change, water security and forest-related risks. Genesis promotes the industry accepted standards set by the CDP, a governing body for blue-chip organisations. The CDP governs information on companies regarding climate change issues and engages with them to improve disclosure.

Exhibit 4 shows three examples that illustrate the outcomes of the team’s engagement with portfolio holdings.

Genesis’s Annual Stewardship Report 2020 is a detailed account of its ESG process.

Over the past 12 months, GSS’s NAV has been almost in line with the benchmark on a total return basis, despite the portfolio’s defensive stance (see Exhibits 5 and 6). Strongly performing Chinese and Russian companies, such as such as Wuliangye, Jiangsu Yanghe Brewery and Yandex, helped GSS to achieve competitive performance. Indeed, GSS’s Chinese exposure has added a lot of value over the last year. The share price of several portfolio holdings more than doubling, particularly the positions in A-share holdings where the fund has a 6–7% combined weighting. As discussed above, the team has subsequently taken profits where outperformance has led to high valuations. It should be noted the fund remains underweight in China, Taiwan and South Korea, reflecting attractive opportunities found elsewhere in emerging and frontier markets.

Longer-term performance remains robust, with the trust outperforming its benchmark over 10 years.

GSS’s defensive tilt and focus on the consumer sector may sometimes result in a performance lag versus the diverse peer group (Exhibit 7). In particular, GSS typically lags the more concentrated, aggressive growth mandates when markets are led by a narrow group of technology stocks, such as in 2020. The peer group contains aggressive growth, income and specialist (such as frontier markets) mandates. GSS outperformed the sector average over three and five years. The trust does not have an income focus and ranks fifth for dividend yield. The trust’s ongoing charge also ranks fifth and it does not charge a performance fee. The fund was ungeared at end-April 2021.