Templeton Emerging Markets Investment Trust — Fundamentals once again driving outperformance

Templeton Emerging Markets Investment Trust (LSE: TEM)

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Templeton Emerging Markets Investment Trust — Fundamentals once again driving outperformance

Templeton Emerging Markets Investment Trust (TEMIT) has two very experienced managers: Chetan Sehgal (lead manager – based in Singapore) and Andrew Ness (based in Edinburgh). They are encouraged by the trust’s improved absolute and relative performance in recent months as investors are focusing more on company fundamentals rather than macroeconomic developments. The managers seek quality companies with high returns and sustainable business models that are trading at a discount to their intrinsic values and TEMIT’s resulting portfolio is broadly diversified by geography, sector and market cap.

Melanie Jenner

Written by

Mel Jenner

Director, Investment Trusts

Investment Companies

Templeton Emerging Markets IT

Fundamentals once again driving outperformance

Investment trusts
Emerging markets equities

24 February 2023

Price

155.4p

Market cap

£1,805m

Total assets

£2,156m

NAV*

178.3p

Discount to NAV

12.8%

*Including income. At 23 February 2023.

Yield

3.1%

Ordinary shares in issue

1,161.8m

Code/ISIN

TEM/GB00BKPG0S09

Primary exchange

LSE

AIC sector

Global Emerging Markets

Financial year end

31 March

52-week high/low

164.6p

130.6p

NAV* high/low

185.1p

150.3p

*Including income

Net gearing*

0.0%

*At 31 January 2022

Fund objective

Launched in June 1989, Templeton Emerging Markets Investment Trust was one of the first emerging markets funds in the UK. The trust seeks long-term capital appreciation through investment in companies operating in emerging markets or listed on the stock markets of such countries. This may include companies that have a significant amount of their revenues in emerging markets but are listed on stock exchanges in developed countries. Performance is benchmarked against the MSCI Emerging Markets Index.

Bull points

Large, diversified fund run by two experienced managers.

Managers are part of a well-resourced team of more than 70 investment professionals based in 13 countries around the world.

Potential for a narrower discount.

Bear points

Difficult period of relative performance between Q221 and Q222.

Emerging markets can be more volatile than developed markets.

Stable ordinary annual dividends for the past three financial years.

Analyst

Mel Jenner

+44 (0)20 3077 5700

Templeton Emerging Markets Investment Trust is a research client of Edison Investment Research Limited

Templeton Emerging Markets Investment Trust (TEMIT) has two very experienced managers: Chetan Sehgal (lead manager – based in Singapore) and Andrew Ness (based in Edinburgh). They are encouraged by the trust’s improved absolute and relative performance in recent months as investors are focusing more on company fundamentals rather than macroeconomic developments. The managers seek quality companies with high returns and sustainable business models that are trading at a discount to their intrinsic values and TEMIT’s resulting portfolio is broadly diversified by geography, sector and market cap.

Higher growth potential in emerging and developing economies

Source: International Monetary Fund World Economic Outlook January 2023, Edison Investment Research

The analyst’s view

As shown in the chart above, emerging regions have more attractive growth prospects than those in developed markets. This differential is supported by long-term trends including rising middle classes and increased urbanisation in emerging markets. Launched in 1989, TEMIT is a large, well-established emerging market fund. Sehgal and Ness can draw on the significant resources of Franklin Templeton’s emerging markets equity team, which has more than 70 investment professionals based in 13 countries across the globe, thereby offering exposure to a very wide range of investment opportunities. The trust’s managers use gearing tactically; TEMIT currently does not have any net debt given the potential for further downward earnings estimate revisions and stock market volatility during a period of rising interest rates. However, the use of gearing is more likely later in 2023 given Sehgal’s belief in a strong corporate earnings recovery.

Discount in line with one-year average

TEMIT’s 12.8% discount compares with the 9.3–16.4% range of discounts over the last 12 months. Over the last one, three, five and 10 years the trust’s average discounts are 12.8%, 11.1%, 11.2% and 11.3% respectively. There is scope for the trust to be afforded a higher valuation if its relative performance continues to improve or investor sentiment towards emerging market equities becomes more favourable.

The fund managers: Chetan Sehgal and Andrew Ness

The manager’s view: Anticipating a strong earnings recovery

Sehgal says that growth in China is a very important part of overall emerging market growth and following the pivot in its zero-COVID policy, the Chinese economy is normalising. While in December 2022 and January 2023 economic activity continued to be disrupted by COVID-19, sentiment is generally improving within China. The manager suggests that the country is a major global supplier of goods, so when factories increase their production, it should be a deflationary force for most economies. However, he cautions that increased economic activity in China could lead to higher demand and prices for commodities, which could put pressure on manufacturing margins.

In terms of monetary policy, Sehgal comments that most markets are now discounting peak interest rates, although some central banks such as India are behind the curve. While internet stocks were negatively affected by increased Chinese regulation in 2022, the manager says that policies are now in place, so he does not expect further tightening; also, there is a growing understanding in China that the internet is a vital part of the economy and job creation, and plays a useful role in society. The inauguration of the 20th National Congress of the Communist Party of China is in March 2023, which should provide details of Chinese policies over the next five years.

Sehgal says that the 2023 Indian budget illustrated that economic momentum in the country is continuing. He believes that the focus on infrastructure spending will support future economic growth. On a recent trip to India, the manager witnessed high levels of construction projects and that the airports were packed, with passenger volumes exceeding those that he had previously experienced. Sehgal says that there has been a noticeable shift from cars to sport utility vehicles and that demand for electric vehicles is rising, helped by subsidies. He also noted the very high prevalence of digital payments in India; even the smallest grocery shops were unable to give him change as their customers do not use cash.

India-based Adani Group has been in the headlines as there have been fraud allegations by a US short-selling research firm, which has led to billion-dollar losses in the market value of Adani and its subsidiaries and in the personal wealth of the company’s founder and chairman Gautam Adani. The manager confirms that TEMIT has no exposure to Adani Group or its subsidiaries.

Sehgal explains that emerging market shares have performed strongly so far in 2023, including those of Chinese companies, which were weak in 2022, due to depressed sentiment about the closed economy.

Last year, the manager highlighted three factors that were negatively affecting markets: US interest rates, China’s zero-COVID policy and the war in Ukraine. In 2023, investors are considering peak interest rates, China’s economy has now reopened and activity is normalising, and Europe is coming out of a tough winter, while energy prices are moderating. Hence, the macroeconomic backdrop is looking less negative, says the manager. In China, businessmen are reconnecting with their customers and suppliers, business travel is recovering, and restaurants are starting to recoup their lost revenue, which is positive for sentiment within the country. Sehgal also expects a pick-up in global tourism, which would provide additional support for the Chinese economy.

Considering earnings growth, the manager says there is a benefit from a post-COVID-19 recovery, although there are areas of weakness such as semiconductors, which is experiencing a cyclical downturn. While corporate earnings could remain subdued in the early part of 2023, by the end of the year, Sehgal is anticipating a strong earnings recovery.

Current portfolio positioning

At end-December 2022, TEMIT’s top 10 holdings made up 46.1% of the fund, which was a lower concentration compared with 53.7% 12 months earlier; nine positions were common to both periods. The trust’s largest positions tend to be in industry leaders that should be able to navigate difficult economic conditions. TEMIT has a multi-cap portfolio broken down as follows: above $50bn (48.0%); $25–50bn (7.7%); $10–25bn (12.9%); and less than $10bn (31.4%).

Exhibit 1: Top 10 holdings (at 31 December 2022)

Company

Country

Industry

Portfolio weight %

31 Dec 2022

31 Dec 2021*

Taiwan Semiconductor Manuf

Taiwan

Semiconductors & semi equipment

10.1

12.7

ICICI Bank

India

Banks

5.9

5.0

Samsung Electronics

South Korea

Technology hardware & equipment

5.7

11.2

Alibaba

China

Retailing

5.4

5.3

Tencent

China

Media & entertainment

4.4

4.5

MediaTek

Taiwan

Semiconductors & semi equipment

3.3

4.2

Naver Corporation

South Korea

Media & entertainment

3.0

3.7

China Merchants Bank

China

Banks

2.8

2.4

LG Corporation

South Korea

Capital goods

2.8

2.2

Prosus

China

Retailing

2.6

N/A

Top 10 (% of portfolio)

46.1

53.7

Source: TEMIT, Edison Investment Research. Note: *N/A where not in December 2021 top 10.

Over the 12 months to end-December, the notable changes in TEMIT’s sector exposure were a 10.0pp lower technology weighting and a 4.2pp higher exposure to financial stocks. These two sectors were the trust’s largest overweight positions versus the benchmark, with technology at +8.0pp and financials at +4.0pp, while the largest underweight positions were utilities (-2.7pp), and consumer staples and energy (both -2.3pp). The lower technology exposure is a combination of sector share price weakness and active selling, including a reduced weighting in Samsung as its earnings are currently challenged. TEMIT’s Tencent position was reduced following a rally in its share price.

Exhibit 2: Portfolio sector exposure versus benchmark (% unless stated)

Portfolio end-Dec 2022

Portfolio end-Dec 2021

Change
(pp)

Index
weight

Active weight
vs index (pp)

Trust weight/
index weight (x)

Information technology

26.6

36.6

(10.0)

18.6

8.0

1.4

Financials

26.1

21.9

4.2

22.1

4.0

1.2

Consumer discretionary

14.5

11.9

2.6

14.1

0.4

1.0

Communication services

9.8

12.4

(2.6)

9.9

(0.1)

1.0

Materials

8.4

8.2

0.2

8.9

(0.4)

1.0

Industrials

4.5

2.5

2.0

6.0

(1.6)

0.7

Consumer staples

4.2

3.9

0.3

6.4

(2.3)

0.6

Energy

2.6

2.8

(0.2)

4.9

(2.3)

0.5

Healthcare

2.2

1.3

0.9

4.1

(1.8)

0.5

Real estate

0.5

1.1

(0.6)

1.9

(1.5)

0.3

Utilities

0.4

0.0

0.4

3.1

(2.7)

0.1

Other net assets

0.2

(2.6)

2.8

0.0

0.2

N/A

100.0

100.0

100.0

Source: TEMIT, Edison Investment Research. Note: Numbers subject to rounding.

Looking at TEMIT’s geographic exposure, the largest changes over the 12 months to end-December 2022 are higher weightings in China (+4.1pp) and India (+3.1pp) with lower weightings in the rest of the world (-8.4pp, which includes 6.9% held in Russian securities that were subsequently written down to zero), Taiwan (-4.3pp) and South Korea (-3.1pp).

The trust has limited exposure to frontier markets. Sehgal explains that in prior economic cycles, higher interest rates and energy prices have been detrimental to their performance. During this cycle some frontier markets have devalued including Egypt, Pakistan and Sri Lanka; the manager believes that these countries will take time to recover.

Exhibit 3: Portfolio geographic exposure versus benchmark (% unless stated)

Portfolio end-Dec 2022

Portfolio end-Dec 2021

Change
(pp)

Index
weight

Active weight
vs index (pp)

Trust weight/
index weight (x)

China (inc Hong Kong)

30.5

26.4

4.1

32.3

(1.9)

0.9

South Korea

19.4

22.5

(3.1)

11.3

8.1

1.7

Taiwan

14.1

18.4

(4.3)

13.8

0.3

1.0

India

11.9

8.8

3.1

14.4

(2.6)

0.8

Brazil

8.7

6.0

2.7

5.3

3.4

1.6

US

3.2

2.1

1.1

0.0

3.2

N/A

Thailand

2.7

1.6

1.1

2.2

0.5

1.2

Mexico

2.2

1.5

0.7

2.3

(0.1)

0.9

UK

1.7

1.4

0.3

0.0

1.7

N/A

Rest of the world

5.6

13.9

(8.4)

18.3

(12.8)

0.3

Other net assets

0.2

(2.6)

2.8

0.0

0.2

N/A

100.0

100.0

100.0

Source: TEMIT, Edison Investment Research. Note: Numbers subject to rounding.

TEMIT has a new position in One 97 Communications, whose Paytm flagship brand is India’s largest digital goods and mobile commerce platform. The company’s initial public offering (IPO) was in November 2021 and its shares declined in 2022 in a weak stock market environment despite its robust operational performance. Paytm’s high number of active users provides easy access to potential borrowers; it offers small loans, which are a difficult proposition for most other lenders. The company is also expanding its range of services such as working with lending partners that take on the balance sheet risk, and is providing co-branded credit cards.

Another new holding is Empower, which is based in Dubai and is the world’s largest district cooling services provider by capacity. This is a greener solution than individual air conditioning systems. The company has a diverse client base including the Dubai airport. Sehgal participated in Empower’s November 2022 IPO.

There have been additions to TEMIT’s holdings in battery companies including Samsung SDI to increase the trust’s exposure to electric vehicles. Complete disposals in recent months include cement company ACC, whose shares were tendered to Adani Group. Dubai Electricity and Water Authority was sold, with the proceeds used to fund the purchase of its Empower subsidiary. The Longshine Technology Group holding was sold on valuation grounds; the company provides software for the Chinese state electricity grid and electronic vehicle charging points.

Performance: Improvement in recent months

Exhibit 4: Investment trust performance to 31 January 2023

Price, NAV and benchmark total return performance, one-year rebased

Price, NAV and benchmark total return performance (%)

Source: Refinitiv, Edison Investment Research. Note: Three-, five- and 10-year performance figures annualised.

Exhibit 5: Five-year discrete performance data

12 months ending

Share price
(%)

NAV
(%)

MSCI Emerging
Markets (%)

MSCI World
(%)

CBOE UK All Companies (%)

31/01/19

(5.8)

(5.7)

(6.9)

1.6

(3.9)

31/01/20

9.2

9.3

4.0

18.2

10.5

31/01/21

26.0

27.4

23.2

11.4

(8.6)

31/01/22

(8.7)

(10.0)

(4.8)

19.8

19.3

31/01/23

(4.4)

(4.3)

(3.8)

1.4

6.3

Source: Refinitiv. Note: All % on a total return basis in pounds sterling.

Discussing TEMIT’s relative performance in 2022, Sehgal says that on a geographic basis, positive contributors included China (stock selection), Brazil (asset allocation, the trust had an overweight position in a strong market) and India (stock selection). Russia was the largest detractor given these assets were marked down to zero following its invasion of Ukraine. This cost TEMIT just over 3pp in relative performance, which was more than the trust’s 2022 NAV underperformance versus the benchmark. On a sector basis, positive contributors included consumer discretionary and financial stocks, while communication services businesses were the largest detractor; all three were primarily due to stock selection rather than asset allocation.

Turning his attention to individual stocks, the manager reports that the largest positive contributor was India-listed ICICI Bank. In the past, the company had balance sheet issues, but these were resolved and the bank’s management team is executing well. The shares of Brilliance China Automotive were suspended for 18 months, so TEMIT’s holding was marked down. They resumed trading in October 2022 and since then have performed well. Other positive contributors to the trust’s performance were Brazilian bank Itaú Unibanco and Samsung Life, whose margins are benefiting from higher interest rates. Unsurprisingly, two of the largest detractors to TEMIT’s performance in 2022 were Russian stocks, LUKOIL and Sberbank of Russia. Other poorly performing stocks included MediaTek (weak demand for smartphone chips) and Naver (internet stocks came under pressure and there was some e-commerce slowdown).

Exhibit 6: NAV total return performance relative to benchmark over 10 years

Source: Refinitiv, Edison Investment Research

Exhibit 7: Share price and NAV total return performance, relative to indices (%)

 

One month

Three months

Six months

One year

Three years

Five years

10 years

Price relative to MSCI Emerging Markets

3.6

7.9

4.3

(0.6)

(2.5)

3.6

(3.8)

NAV relative to MSCI Emerging Markets

2.3

3.8

4.9

(0.5)

(2.8)

3.5

(3.2)

Price relative to MSCI World

4.4

20.2

7.1

(5.7)

(18.7)

(30.3)

(51.2)

NAV relative to MSCI World

3.1

15.6

7.7

(5.6)

(18.9)

(30.3)

(50.9)

Price relative to CBOE UK All Companies

4.7

11.7

2.6

(10.1)

(5.1)

(8.0)

(14.9)

NAV relative to CBOE UK All Companies

3.4

7.4

3.1

(10.0)

(5.3)

(8.1)

(14.3)

Source: Refinitiv, Edison Investment Research. Note: Data to end-January 2023. Geometric calculation

An improvement in TEMIT’s relative performance over the last few months is having a positive effect on its longer-term record. The trust is now only modestly behind the index over the last year and is ahead over the last five years. Looking at the performance versus other indices, it looks like emerging market stocks have some catching up to do versus global and UK indices. Perhaps there will be a relative improvement in the performance of emerging markets this year given the higher growth prospects, along with recession risks in developed markets as central banks continue to tighten monetary policy in an attempt to combat above-target levels of inflation.

Peer group comparison

TEMIT is by far the largest fund in the 10-strong AIC Global Emerging Markets sector. However, it should be noted that the averages in Exhibit 8 are distorted by the new addition to the sector: JPMorgan Emerging Europe, Middle East & Africa Securities (JEMA), which was formerly JPMorgan Russian Securities.

If this fund is excluded, TEMIT’s NAV total returns are below average over the periods shown, ranking seventh out of nine funds over the last 12 months and the last three years, and sixth out of eight funds over the last five and 10 years. The trust is in the middle of the pack when its returns are compared with the two funds that its managers consider to be its closest peers: Fidelity Emerging Markets and JPMorgan Emerging Markets Investment Trust. Sehgal comments that TEMIT is an actively traded fund and the size of Franklin Templeton’s emerging markets equity team, with its local presence, can provide exposure to many more opportunities compared with its peers. Again, removing JEMA from the table, TEMIT’s discount is wider than the average, ranking eighth out of nine funds. It has a competitive ongoing charge, and no performance fee is payable. In line with most of the funds in the sector, the trust is currently ungeared. TEMIT’s dividend yield is above the mean of the adjusted peer group.

Exhibit 8: Global Emerging Markets peer group at 23 February 2022*

% unless stated

Market cap (£m)

NAV TR
1 year

NAV TR
3 year

NAV TR
5 year

NAV TR
10 year

Discount (cum fair)

Ongoing charge

Perf.
fee

Net gearing

Dividend yield

Templeton Emerging Mkts Inv Trust

1,805.4

(4.2)

2.8

12.2

48.8

(12.8)

1.0

No

100

3.1

Barings Emerging EMEA Opps

60.0

(23.7)

(28.6)

(22.0)

(2.9)

(18.5)

1.6

No

101

3.4

BlackRock Frontiers

265.1

9.1

37.3

15.1

118.2

(5.6)

1.4

Yes

116

3.8

Fidelity Emerging Markets

572.8

(14.0)

(14.2)

(6.0)

29.1

(12.6)

0.6

No

100

2.5

Gulf Investment Fund

64.1

15.1

71.6

133.2

212.5

(4.9)

1.7

No

100

3.7

JPMorgan Em Europe, ME & Africa

42.1

(93.0)

(94.2)

(91.8)

(90.4)

125.5

1.2

No

100

0.0

JPMorgan Emerging Markets

1,329.9

(1.0)

13.7

28.3

99.5

(7.1)

0.8

No

100

1.3

JPMorgan Global Emer Mkts Inc

403.5

(1.1)

20.4

27.3

73.4

(9.5)

0.9

No

109

3.8

Mobius Investment Trust

149.7

(3.2)

37.8

(0.7)

1.5

No

100

0.3

Utilico Emerging Markets

442.0

7.4

7.6

13.8

69.2

(12.7)

1.4

No

104

3.7

Simple average (10 funds)

513.4

(10.8)

5.4

12.2

61.9

4.1

1.2

103

2.6

TEM rank in peer group

1

7

7

6

6

9

4

5=

6

Source: Morningstar, Edison Investment Research. Note: *Performance at 23 February 2022 based on ex-par NAVs. TR = total return. Net gearing is total assets less cash and equivalents as a percentage of net assets.

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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