Templeton Emerging Markets

TEM has seen a rebound in performance since a change of approach…

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This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. With this commentary, Kepler Partners LLP does not intend to influence your investment firm's behaviour. 

Templeton Emerging Markets

Summary

Templeton Emerging Markets (TEM) invests in stockmarkets of emerging countries with a bottom-up driven, stock-specific approach. It has more of a value tilt than any of its peers in the AIC Global Emerging Markets sector, and the managers tend to take a five-year view on companies’ growth potential.

The trust has outperformed a passive investment in the emerging markets over the past year, and over three- and five-year periods, thanks largely to the themes and stocks brought into the portfolio after a change of manager in 2015. We analyse the performance in detail in the Performance section below.

Chetan Sehgal took over as manager in February 2018, having worked with the previous manager Carlos Hardenberg, who took over in October 2015. He was joined by Andrew Ness as co-manager in 2018. We think the changes in the management team may be one reason the trust trades on a wider discount than the sector average, despite the strong performance. The discount is currently 11.6%.

Although the trust focuses on capital growth, recent policy changes have seen it become more income-friendly, and the payout has increased, as we discuss in the Dividend section.

Kepler View

Templeton Emerging Markets has seen a significant improvement in performance in recent years thanks to changes made to the approach from late 2015 onwards. However, this is yet to be reflected in the discount, which remains wider than the sector average. We think the two manager changes in a short space of time have created uncertainty, despite these changes having so far been positive for relative performance.

On the other hand, we note there are well-known discount players high up on the shareholder register who are likely to sell into any closing discount, and therefore potentially keeping it wider than it might be. Nonetheless, over the longer term we think the current discount could be an interesting opportunity and should the good performance under the current management team continue, we would expect the discount to eventually become tighter.

bull bear
A large and well-resourced team Emerging markets could suffer if the developed world enters recession
A portfolio exposed to the exciting consumer and technology sectors A higher number of holdings can make it harder for a portfolio to add alpha (the trust has 100)
Wide discount in absolute terms and relative to the sector Significant holdings by discount players could keep the discount wide despite good performance

Portfolio

Templeton Emerging Markets (TEM) invests in emerging markets with a bottom-up approach and more of a value tilt than any of its peers in the AIC Global Emerging Markets sector. The trust is well diversified, with around 100 holdings, at the top end of its expected 70 to 100 stock range. The managers, Chetan and Andrew, take a value-based approach to investing, seeking to purchase stocks that they believe have a greater return potential over five years than the market recognises.

Chetan and Andrew draw on the stock research of a large team of analysts at Franklin Templeton based around the emerging markets region. Their work is central to the investment strategy, with the bulk of excess returns expected to come from bottom-up stock selection rather than country or sector positioning. Relative country allocations are mainly a derivative of stock selection, although the manager will tilt the portfolio towards or away from countries or themes if he has strong conviction. That said, the portfolio has been overweight the information technology, consumer discretionary and financial sectors for the past three years following a change in management in 2015. However, financials have come down to a neutral weight in recent months.

This is because the tech and consumer discretionary sectors house many key stocks benefiting from the principal themes in the portfolio: technological development and consumption growth. The managers believe that technology will continue to reshape the global economy and transform industries. Meanwhile, the demographics in the emerging world along with urbanisation are long-term trends driving increasing consumption. E-commerce is a trend that unites both themes.

sector exposure

Source: Franklin Templeton

These trends can be seen in the portfolio’s top holdings, which are largely technology or consumer related, with the exception of one bank (ICICI Bank of India) and one oil company (Lukoil of Russia).

top ten as at 30/09/19


%
Samsung Electronics
7.8
TSMC
7.5
Tencent
6.1
Alibaba
5.5
ICICI Bank
3.9
Unilever
3.2
Brilliance China Automotive
3.1
NAVER
2.7
Lukoil
2.7
Naspers
2.5

Source: Franklin Templeton

Macro analysis clearly affects the portfolio through the themes, despite the focus on stock specifics. The understanding of themes and trends is regularly honed, in meetings of members of the Franklin Templeton Emerging Markets equity team. Other macro factors discussed include the oil price, on which Chetan and Andrew do take a view. Their constructive view on the longer-term price for oil is reflected in the significant weighting to energy stocks.

The portfolio has been significantly underweight China for a number of years, but this does not reflect a macro call on the country, on which the managers are positive. Rather, it reflects their assessment of the right size for their individual stock positions in the country that are overwhelmingly in the financials, consumer-related and tech names. Internet services giants Tencent and Alibaba are the Chinese stocks in the top ten, as well as Brilliance China Automotive. The latter is BMW’s partner for manufacturing and distribution in the country. These stocks were a major contributor to returns in 2018 and a detractor in 2019. Last financial year (2019), the share price fell after Brilliance accepted a reduced stake of 25% in the joint venture. Chetan and Andrew have held on to these companies, in line with their long-term perspective on their companies. However, they have reduced the position in acknowledgement of the increased risk – namely that new rules on foreign ownership in 2022 could see the deal not approved by Chinese regulators.

geographical exposure

Source: Franklin Templeton

Key holdings in South Korea include Samsung Electronics and NAVER, the search engine. Chetan and Andrew believe that the country’s companies are becoming more attractive thanks to improving corporate governance. They also retain overweights to Brazil and Russia. Both countries have been enjoying interest rate cuts, which generally stimulate economic growth and are good news for stockmarkets. That said, both have complicated political situations. So too does China, thanks to the ongoing trade war with the US. In this light we note the gearing on the trust has come down in recent months and the weighting to the economically exposed financials sector has fallen too. In their most recent note, the managers acknowledge the risks on the horizon, and state they are focusing on companies that have sustainable earnings power and resilience against market uncertainty.

Gearing

TEM has a £200m borrowing facility, which the board has given Chetan permission to draw down at will, subject to gearing not rising above 10% of net assets. Fully drawn down, the £200m would be 9.5% of net assets. However, as of the end of September, net gearing stood at just 0.8%, down from 2.4% at the end of the financial year in March.

Returns

The trust has returned 13.8% in NAV total return terms over one year, compared to returns of just 9.1% for an investment in the passive iShares MSCI Emerging Markets ETF. This tracks the performance of the trust’s benchmark, the MSCI Emerging Markets Index, but is investable, unlike that index. Over the past year, stock selection in China has continued to drive returns, as well as picks in the financials, energy, IT and consumer discretionary sectors. These weightings drove returns in 2016 and 2017, which is a validation of the new approach under Carlos, which Chetan continued when he took over in February 2018.

one-year performance

Source: Morningstar

As the graph below shows, the trust is now outperforming the ETF and sector average over five years, which represents a major return to form under the new management team.

five-year performance

Source: Morningstar

The trust had underperformed badly between 2011 and 2015, when Mark Mobius was lead manager, with 2014 being a particularly bad year. Chetan worked with Carlos as he refashioned the portfolio, latterly as deputy portfolio manager. The portfolio suffered mainly by not seeing the potential in stocks in the ‘new economy’, such as tech and new consumer areas, perhaps remaining wedded to an old way of looking at the developing world, which had served the trust well in prior cycles. This was particularly visible in the financial year ending March 2015. Whereas the general trend has been for the vast majority of the difference in returns between the trust and the MSCI Emerging Markets benchmark to come from stock selection, in that year it was sector allocation that hurt, mainly it being overweight energy, materials and financials, and underweight IT. In October 2015, the manager was changed.

returns

Source: Morningstar

Dividend

Chetan’s primary focus in managing the portfolio is generating capital growth. That said, the board recognises the strong appeal of dividends to many investors and to that end implemented a second, interim distribution from the 2019 financial year. This has coincided with a large jump in earnings, which saw the dividend almost double between 2017 and 2018. This was a result of a successful shift in investment strategy by the previous manager, Carlos, which has been continued by Chetan since Carlos departed. It was also aided by a decision by the board to increase the percentage of costs charged to capital to 70%. Earnings per share and dividend growth have continued in the 2019 financial year, and the current dividend yield is 2.1%.

dividends

Source: Franklin Templeton

Management

Chetan Sehgal took over management of the trust in February 2018 following the departure of Carlos Hardenberg to join Mark Mobius, another former manager of the trust, at Mobius Capital Partners. Chetan, who is based in Singapore, has worked at Franklin Templeton for 22 years and has served as director of global emerging markets equity and small cap strategies since 2016. He was Carlos’s deputy prior to his departure in October 2015, and in 2017, he was appointed manager of a number of open-ended emerging market funds. In July 2018, Chetan was joined by portfolio manager Andrew Ness from Martin Currie, who operates out of the UK and has 20 years’ emerging markets investment experience.

In February this year Franklin Templeton created the role of CIO of emerging markets equity for Manraj Sekhon, who joined from Fullerton Fund Management, also based in Singapore. Manraj leads the 80-strong emerging markets equity team at Franklin Templeton, and is based in Singapore along with Chetan.

Discount

TEM’s discount has been wider than the sector average since the start of 2018, and now stands at 11.7% compared to the sector average of 8.2%. We would attribute this to the uncertainty around the high-profile departures from the team and subsequent change of manager, as performance has been strong for most of the period (as discussed in the Performance section). This has weighed on the share price, we believe.

discount

Source: Morningstar

The board has an active buyback policy, and thanks to the stubborn discount has bought back 22% of shares that were in circulation on 31 March 2014 (five years before the last financial year end). Buybacks have continued in the current 2020 financial year. Although there is no stated discount target, we note that the last month TEM didn’t buy back shares was January 2018 when the discount moved narrower than 11% and briefly below 10%.

Shareholders passed a continuation vote at this year’s annual general meeting (AGM). At the 2024 AGM, rather than a continuation vote, the board will propose a tender offer of up to 25% of NAV, if TEM’s NAV total return is below that of the benchmark index (MSCI Emerging Markets) in the interim period.

Charges

The OCF of 1.02% puts TEM below the 1.27% average for trusts in the sector. This includes a management fee of 1% on the first £1bn of net assets and 0.85% on the remainder. At current levels that equates to roughly 0.92%. There is no performance fee. The KID RIY figure is 1.21% – again, below the sector average of 1.81%, although we would caution that calculation methodologies can vary.

ESG

We understand that the Franklin Templeton Emerging Markets equity team incorporates environmental, social and governance (ESG) analysis into its bottom-up stock analysis. It views this as an important dimension of the sustainability of the franchise – i.e. a company’s ability to maintain stable or growing profits over time. The analysts therefore consider a company’s ESG policies and practices, and how they might impact their business model.

Further efforts focus on governance issues and improving practices in the companies they co-own. In the team’s view, good management practices promote long-term earnings growth and sustainability, and it communicates with companies both proactively and reactively to support them. The team will work with companies to help them improve their structures and practices to avoid problems. On the other hand, it will oppose management if it believes it is not acting in the interests of its shareholders. This could include collaborating with other investors or applying pressure through the media or the courts. The company does not report routinely on actions it has taken in its report and accounts, however, so it is hard for investors to assess what has been achieved.

Fund History

Kepler Partners LLP considers this commentary to be a minor non-monetary benefit, as it:

1. Is intended to enhance the quality of service provided to you by us and is generic in nature;

2. Consists of short-term market commentary on the latest economic statistics and/or company results and/or information on upcoming releases or events;

3. Contains a brief summary of the author’s own opinion on such information;

4. Is not substantiated nor does it include any substantive analysis;

5. Reiterates the Kepler Partner LLP’s view on an existing recommendation or substantive research material; and/or

6. Is unlikely to impair your investment firm's compliance duty to act in the best interest of your client.

This report has been issued by Kepler Partners LLP for communication only to eligible counterparties and professional clients as defined by the Financial Conduct Authority.  Its contents may not be suitable for and are not to be communicated to or be relied on by retail clients. It is not an indication as to the suitability or appropriateness of investing in the security or securities discussed.

Past performance is not a reliable indicator of future results. The value of investments can fall as well as rise and you may get back less than you invested when you decide to sell your investments. It is strongly recommended that Independent financial advice should be taken before entering into any financial transaction.

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