Templeton Emerging Markets Investment Trust — Managers keeping the faith with quality portfolio

The managers comment that the improvement in TEMIT’s relative performance is most welcome. They say that 12 months ago, they were experiencing the toughest performance periods of their careers; however, they had huge confidence in the trust’s portfolio, which is once again bearing fruit. The managers describe TEMIT as a quality growth fund, but growth is not ‘at any price’ and the fund is made up of world-class, well-managed businesses. The portfolio yield is around 4% and 20% of the fund has a dividend yield greater than 5%. Companies are also returning cash to shareholders via share repurchases, which the managers find reassuring given the uncertain economic environment.

TEMIT’s valuation multiples (P/E, price to cash flow and price to book) are less than the benchmark’s so ‘quality value’ may be another way to describe the trust, which has the potential to outperform in a range of market environments. TEMIT can be considered a core emerging market fund or as part of a multi-manager strategy, as a balance to high-growth emerging market strategies. Some of the trust’s competitors had a large weighting in highly valued growth stocks so, as these have de-rated in a higher interest rate environment, it has been beneficial to TEMIT’s relative performance.

The managers are bullish on the outlook for emerging markets, considering them to be under-owned and undervalued. The region’s c 12x forward P/E valuation multiple is in line with the 15-year average but, relative to developed markets, especially the US, the managers consider there is a compelling investment case on both a P/E and price-to-book basis. They believe that positive emerging market attributes are underappreciated, such as well-capitalised banking systems and, compared with the western regions, underlevered sovereign, corporate and household balance sheets. During the global pandemic, there was less fiscal support in emerging markets compared with developed regions, meaning that as economies have reopened, the bounceback in activity has been greater in developed versus emerging markets.

Stocks are selected on a bottom-up basis and so the trust’s sector and geographic weightings are a by-product of this process. As shown in Exhibit 3, over the 12 months to end-May 2023, the largest sector changes were a 4.2pp higher exposure to industrials and a 7.9pp lower allocation to technology stocks, although this remains TEMIT’s largest overweight versus the benchmark (+5.8pp). The largest sector underweight position was consumer staples (-3.2pp).

As shown in Exhibit 5, over the 12 months to end May the weighting to Indian stocks increased by 3.5pp, although it remained underweight versus the benchmark (-1.9pp). Recent additions to the fund include ACC (cement manufacturing) and Hindalco (aluminium production). Notable deviations from the benchmark allocations were overweight positions in South Korea (+8.3pp, which is towards the high end of the three-year historical range), Brazil (+3.1pp) and the US (+2.9pp), due to two holdings that are listed in this developed market but have significant operations in emerging markets. TEMIT has a below-index exposure to China (-3.5pp) and has a meaningful lower allocation to the rest of the world (-11.8pp) compared with the benchmark.

At end May 2023, TEMIT’s top 10 holdings, which represent a range of countries and sectors, made up 45.8% of the portfolio, which was a lower concentration compared with 52.6% 12 months earlier; eight positions were common to both periods.

The trust has a multi-cap portfolio broken down as follows: above $50bn (46.1%); $25–50bn (11.9%); $10–25bn (12.9%); $5–10bn (14.5%); and less than $5bn (14.6%).

In Exhibit 7, we show the constituents of the AIC Global Emerging Markets sector. However, we have excluded JPMorgan Emerging Europe, Middle East & Africa Securities (JEMA), which was formerly JPMorgan Russian Securities, as its inclusion heavily distorts the peer-group averages.

TEMIT is the largest fund by a wide margin. Its NAV total return is modestly above average over the last 12 months, ranking fifth out of nine funds, and below average over the other periods shown, ranking seventh out of nine funds over the last three years, and sixth out of eight funds over the last five and 10 years. The standout performer over the last three, five and 10 years is specialist investor Gulf Investment Fund, which has benefited from rising energy prices and robust growth prospects in the Gulf region. Compared to the two funds that TEMIT’s managers consider to be trust’s closest peers, Fidelity Emerging Markets and JPMorgan Emerging Markets Investment Trust, TEMIT’s total returns rank first over the last 12 months and second over the last three, five and 10 years. The trust’s managers highlight the benefits of Franklin Templeton’s large and globally diversified emerging markets equity team, which can help identify local opportunities that may not be covered by its peers.

TEMIT’s discount is currently wider than the average of the selected peer group, ranking sixth out of nine funds; only one of which is trading at a premium. The trust has a competitive ongoing charge, and no performance fee is payable. In line with most of the funds in the sector, TEMIT is currently ungeared. Its dividend yield is above the average of the adjusted peer group.

Looking over the long term, from its launch in June 1989 to end March 2023, TEMIT’s NAV +3,845.7% total return is substantially higher than the benchmark’s +1,707.2% total return.

In FY23 (ending 31 March), TEMIT’s NAV and share price total returns of +0.8% and +0.5% respectively were ahead of the benchmark’s -4.5% total return. The largest positive contributors to the trust’s relative performance were ICICI Bank (India, +1.3pp, consistently good fundamentals helped by a robust balance sheet and a strong franchise), Prosus (China, +1.1pp, investment company and Tencent’s largest shareholder; this company benefited from easier restrictions in the Chinese internet industry) and Brilliance China Automotive (China, +0.9pp, a car manufacturer whose shares resumed trading after an 18-month suspension; it paid a special dividend from the proceeds of its partial sale of a joint venture with BMW).

On the other side of the ledger, the largest detractors were NAVER (South Korea, -1.1pp, the leading internet and advertising company in the country experienced slower post-COVID growth, there were concerns about expansion into unprofitable new businesses and earnings missed consensus expectations), Americanas (Brazil, -0.7pp, disappointing Q322 results, accounting irregularities and the departure of a new leadership team – the position was sold) and Banco Bradesco (Brazil, -0.5pp, weak Q422 results and exposure to Americanas).

TEMIT’s relative performance at end-June 2023 is shown in Exhibits 10 and 11. The trust has experienced a notable improvement since late April 2022, which is starting to feed through into TEMIT’s longer-term record. The trust’s NAV is now ahead of the benchmark over the last one and five years and also modestly ahead over the last 10 years.

TEMIT pays regular dividends twice a year, an interim in January and a final distribution in July. In FY23, the trust’s revenue earnings were 5.72p per share, which was a 66.3% increase year-on-year. The proposed total dividend of 5.00p per share is c 1.1x covered and is 31.6% higher than the 3.80p per share distribution in FY22. At-end FY23, TEMIT had revenue reserves of c 11.1p per share, which is equivalent to c 2.2x the FY23 annual dividend.

TEMIT’s shares are trading at a 12.8% discount to cum-income NAV, which is towards the wider end of the of the 10.1–15.4% range of discounts over the last 12 months. It is wider than the 11.3–11.5% range of average discounts over the last three, five and 10 years. The company regularly repurchases shares with the aim of reducing the volatility of the discount. During FY23, c 19.8m shares were bought back (c 1.7% of the share base) at a cost of c £29.2m; this added 0.23% to TEMIT’s NAV.

A higher level of investor risk aversion has led to wider discounts across the investment trust sector. If sentiment improves, coupled with TEMIT’s improving relative performance, it could mean that the trust is afforded a higher valuation.

TEMIT is the UK’s largest emerging markets investment trust and was launched in June 1989. Its shares are quoted on both the London and New Zealand stock exchanges. The trust is managed by FTEME, a pioneer in emerging markets investing with c $30bn of assets under management.

Chetan Sehgal has been TEMIT’s lead manager since 1 February 2018; he is based in Singapore and has more than 30 years’ investment experience. He was joined in September 2018 by Edinburgh-based Andrew Ness, who has 29 years’ investment experience. The managers aim to generate long-term capital growth by investing in companies listed in emerging markets, or those listed in developed markets that earn a significant amount of their revenues in emerging markets. TEMIT’s performance is measured against the MSCI Emerging Markets Index. There are no specific restrictions on the fund’s geographic or sector exposure but, to mitigate risk, at the time of investment, a maximum 12% of assets may be held in a single issuer, and up to 10% of assets may be invested in unlisted securities (a maximum 2% in a single issuer). Gearing of up to 20% of NAV is permitted.

TEMIT is subject to a five-yearly continuation vote, with the next due at the July 2024 AGM (the July 2019 vote was passed with a 99.95% majority). In May 2019, the board announced a five-year, performance-related conditional tender offer, subject to the next continuation vote being passed. If the trust’s NAV performance lags its benchmark in the five years ending 31 March 2024, the board, at its discretion, will undertake a tender offer for up to 25% of TEMIT’s shares in issue, at a price equivalent to the prevailing NAV minus 2% and the costs of the offer.

Sehgal and Ness, who are assisted by portfolio analyst Manish Agarwal, are able to draw on the considerable resources of FTEME’s investment team. In recent years, the levels of collaboration and communication within the team have continued to be enhanced; there are regular meetings, both formal and informal, and all analysts and portfolio managers are expected to contribute to investment returns.

The managers employ a long-term approach driven by ‘3S’s’: seeking structural growth opportunities, investing in businesses with sustainable earnings power that are trading at a discount to their estimated intrinsic value, and they believe in responsible stewardship of client capital. TEMIT has a three-step investment process:

At the end of May 2023, TEMIT had a higher dividend yield than the benchmark, and lower trailing P/E, price-to-cash flow and price-to-book multiples. In aggregate, the trust’s portfolio companies are less indebted compared with benchmark companies.

Risk management is also a very important part of the process, with scenario analysis undertaken to ensure the managers are not taking unintentional risks. TEMIT has a diversified portfolio of 60–80 positions invested across the market cap spectrum. All holdings are regularly reviewed to ensure analysts’ recommendations are up to date and reflect any changes in a company’s fundamentals. Sehgal and Ness believe that given the wide dispersion of returns between shares in emerging markets, they can generate alpha via stock selection, which is deemed more important than sector and geographic allocation. The trust’s active share typically ranges from 70% to 85% (this is a measure of how a fund differs from its benchmark, with 0% representing full index replication and 100% indicating no commonality); at end-March 2023 it was 73%.

ESG factors are an integral part of TEMIT’s research process. Its managers employ FTEME’s three-pillar framework aiming to be an emerging market leader in sustainable investing:

Where material, climate change/carbon analysis is integrated into the bottom-up research process, focusing on assessing the impact on long-term business values. This is part of the holistic approach of integrating ESG analysis with traditional analysis to gain valuable insights into the quality and risks of investee and potential investee companies. For more information, please see TEMIT’s latest stewardship report.

On 31 January 2020, TEMIT entered into a £100m, five-year, 2.089% sterling-denominated, fixed-rate loan with Scotiabank Europe. With effect from 28 September 2022, the term loan was transferred by novation to the Bank of Nova Scotia, London Branch. It also has a £120m, three-year, unsecured, multi-currency revolving credit facility with the Bank of Nova Scotia, which can be drawn down in sterling, US dollars or Chinese renminbi (RMB) at the prevailing market rates at the time of drawdown. The maximum amount of RMB permitted is 45% of the combined £220m debt facility. TEMIT’s managers continue to take a cautious view on borrowing in difficult markets; at end-May 2023 the fund was ungeared.

Effective from 1 July 2022, TEMIT’s management fee is 1.00% of net assets up to £1bn, 0.75% between £1bn and £2bn and 0.50% above £2bn (previously 1.00% of net assets up to £1bn and 0.80% above £1bn); no performance fee is payable. Despite the lower management fee, in FY23 the trust’s ongoing charges increased by 1bp year-on-year to 0.98%; this was due to a reduction in average net assets during the year offsetting the management fee reduction, which came into effect on 1 July 2022.

TEMIT is a conventional investment trust with one class of share; there are c 1.2bn ordinary shares in issue with a further c 103.8m shares held in treasury. Its average daily trading volume over the last 12 months was c 1.5m shares.

TEMIT’s newest non-executive director is Abigail Rotheroe, who joined the board on 1 November 2022. She has more than 20 years of investment experience, most recently as the investment director at Snowball Impact Management, a sustainable and impact-focused asset manager. Rotheroe previously managed retail and institutional Asia-Pacific portfolios in Hong Kong and London for Schroders, HSBC Asset Management and Columbia Threadneedle Investments. She has experience in manager selection, sustainability and impact measurement.

Paul Manduca will complete his nine-year tenure as one of TEMIT’s directors on 1 August 2024, so the board is undertaking a search for a new chairman; an announcement will be made in due course.

Shareholders will vote at the July 2023 AGM on the proposed increase in the directors’ annual fees in respect of FY24: chairman +£2.0k to £73.0k; chairman of the audit and risk committee and senior independent director +£2.5k to £58.5k; and independent directors +£1.0k to £41k.