Global Emerging Markets Fund Quarterly Feedback – Is an EM buying opportunity approaching?

Ian Beattie is a Portfolio Manager at NS Partners, the managers of the Nedgroup Investments Global Emerging Markets Fund.

Ian provides an update of the portfolio’s performance and positioning in Q1 and whether an emerging markets buying opportunity is approaching.

Portfolio performance
The Fund rose 0.69% over Q1, which lagged the Index, which was up 2.29%. Over 1 year, the Fund is still up 63.72% against an Index that’s up only 58.39%. Since inception, the Fund has returned over 18% versus the Index return of just over 13%. Markets have gone through quite a roller coaster over the 12-month period.

Q1 Fund summary
What worked for the Fund was being underweight in China and overweight in Thailand. We had good stock selection in Korea, Taiwan, Thailand and Mexico. What didn't work was our stock selection in China, Russia, Brazil and India. We were underweight in gulf markets and South Africa and overweight in Brazil. Three stocks that worked in Q1 include Minor International, a hotel and restaurant business that benefits from reopening hopes; Kasikorn Bank, a Thai bank and a new holding at the end of 2020 that will benefit from rising rates and rotation trade; Mediatek is a microchip fabless design company with high-end SOC designs addressing 5G and data management systems. They benefitted as China pivoted its supply chains away from the US towards Asia. Three stocks that didn’t work were Dada Nexus, an e-commerce delivery business in China that was hurt by the rotation in Q1; Geely Motors had disappointing earnings as cost squeeze and product cycle issues disappointed investors; Li Ning has been a spectacular winner, but we sold it just before the stock rallied. We reduced our China H shares and Mexico. We took some profits in some stocks in Taiwan. Taiwan has exported its way out of the Covid crisis better than anyone else. We added to financials and opportunistically some consumer staples. We took a bit of profit in some of the industrials.

EM performance
South Africa did pretty well over Q1, which has been a long time coming. Despite outperforming for a long time, Taiwan did ok with their export performance still showing through. Brazil was set back by political woes and a poor Covid 19 response. On the sector performance, materials did very well and we got into materials in 2020, which did well for us. Industrials are still doing ok. Real estate surprised many with most of the world pretty bullish on real estate. There are a few issues in China, which could be a buying opportunity. We could see some support in the real estate sector globally going forward as people can afford to get on the housing ladder for the first time and the high end of the market looks good as well. That’s without the fact that interest rates are low and real interest rates are even lower and will probably remain low. So even though interest rates may be going up in the medium term, that probably still looks good for the real estate sector as real interest rates will probably lag deliberately by the authorities.

Top transactions in Q1
We bought Infosys Ltd, which has been a beneficiary of US recovery and the easing of visa restrictions. We switched into Shinhan Financial Group, which will be a strong beneficiary of the steepening Korean yield curve. We bought into Hindustan Unilever, a high growth, high ROIC consumer staple in India. On the sell side, we sold Taiwan Semiconductor and took profits after Intel announced plans to remain in the fabless semiconductor business. We sold Lg Chem taking profits in a highly cyclical segment. We also sold Grupo Mexico Sab De Cv-Ser to take profits and reduce our cyclical exposure. We sold Li Ning to take profits and reduce China and our consumer discretionary exposure and we switched out of Kb Financial Group into Shinhan Financial. In terms of the country allocation, there hasn’t been much change. We’re still underweight China at 31% and are debating whether we reduce our underweight in China, which will have a big impact on our view on the rest of the universe. Korea is at 10.456%, Taiwan at 13.13% and India at 12.18%.

Macro update
We are cautious for now, but wondering if it’s time to get more bullish for emerging markets. One of the reasons why is that global industrial momentum may be peaking. Global manufacturing PMIs have soared. The new high in the global manufacturing PMI in March is consistent with the peak in money growth last year. The subsequent monetary slowdown suggests a PMI pullback through Q3. The real money and the physical economy gap remains negative. A negative crossover in late 2020 was reflected in bond market weakness in Q1, with equities insulated by US fiscal stimulus. Q2 could be more difficult if industrial momentum slows as expected. Chinese money growth continues to slow, reflecting the Peoples Bank of China’s policy tightening in H2 2020 and suggests that economic growth will surprise negatively. China’s manufacturing PMI relapse is consistent with an imminent global peak. The Chinese manufacturing PMI has fallen significantly and has led turning points in the global PMI since the GFC. Money trends are relatively favourable in Greece, Taiwan and Russia. Russian 6m real narrow money growth is the fastest among BRIC, although Brazil is still in the lead on a 12m comparison. Greece is benefiting from ECB quantitative easing while growth has turned up in Thailand, which could be a beneficiary of a retracement of US yields and economic reopening. China, Mexico and South Africa are lagging.

Portfolio strategy
Global industrial momentum is peaking and is expected to moderate through Q3. The reopening of services will boost GDP and labour markets, but the industrial cycle is more important for earnings and markets.  Inflation is priced in for now and a core pick-up is unlikely until late 2021 / 2022. The excess money backdrop is still cautionary. We will be reducing old economy cyclical sectors and adding to defensives/growth on the expectation of UST yield peak. We are overweight IT, industrials and consumer discretionary. We are underweight China, South Africa, Mexico and GCC and overweight SE Asia. We will continue to focus on quality companies with high, improving ROIC and will look for opportunities in quality and growth again. Buying opportunities could present in 2H.