Welcome to another edition of SOURCE, a publication that shines the spotlight on selected funds and their managers. This time, Columbia Threadneedle Investments presents the Threadneedle Global Emerging Markets Equity Fund. Find out more in our profile and Q&A with manager Dara White plus supporting analysis from Citywire.
Far from derailing the rise of emerging markets, Covid-19 has strengthened their ascent and supercharged powerful structural trends that were already abundantly clear. Dara White, manager of the Threadneedle Global Emerging Markets Equity Fund, has a firm grasp of them.
Themes like the growing middle class, digital innovation, e-commerce penetration, financial penetration and environmental development are chief among the areas where he is finding ‘great’ companies.
When Covid-19 was declared a global pandemic and stock markets sold off sharply in February and March, White was busy capitalising on the opportunity to buy into the quality companies he favours at cheap valuations.‘
Often in times of volatility we witness portfolio turnover increasing materially,’ he said. ‘The pandemic has accelerated trends that we were already participating in within emerging markets. As an active manager, it’s these exact trends that we seek to identify.’
During February, Columbia Threadneedle’s emerging markets (EM) equities team, located across the US and Europe, focused its research on three buckets: companies that would benefit from the pandemic and were likely to see fundamentals improve, such as cloud-related companies; those that faced short-term pain but had the potential to emerge from the crisis stronger, such as payments companies; and those where the road to recovery appeared harder and longer, such as airlines.
White sold Panamanian airline Copa Holdings and Chinese online travel agent Trip.com as lower demand expectations impaired their medium-term investment theses. In a world awash with central bank support, he has reduced the fund’s exposure to financials. Persistently low interest rates, requirements to make higher provisions and provide support to economies during the pandemic are likely to suppress their profitability for the foreseeable future.
The fund is underweight financials as of 30 September 2020. The sector accounted for 15.6% of assets at the end of September, 1.5% less than the MSCI Emerging Markets index.
Holdings include financial institutions that are developing a digital presence and increasing financial penetration, such as Brazilian digital brokerage firm XP, and Indian consumer finance company SBI Cards.
In December 2019, the fund participated in the expectation-topping initial public offering of XP Inc, Brazil’s largest equity brokerage by trading, which has the potential to continue to grow its share of a large, addressable market.
‘Most exciting’ theme
Consumer discretionary stocks are currently the fund’s largest absolute and relative position, commanding 29.3% of assets, 9.1% more than the index weighting. Recent purchases include JD.com, China’s biggest retailer (both online and overall), Hong Kong sports footwear retailer Li-Ning and Detsky Mir, a Russian children’s goods retailer that is growing its online sales and overall market share.
Exposure to consumer stocks is underpinned by what White regards as the ‘most exciting’ theme in emerging markets – the rise of the middle class. ‘EM companies are pioneering the development of new products and services globally thanks to the rise of the middle class and its evolving consumer pattern,’ he said.
The Brookings Institution, a longstanding Washington-based research group, has published several papers that identify Asia as driving growth in the global middle class and household consumption.
The latest, entitled ‘China’s influence on the global middle class’ and published in October of this year1, points to more than 20% of the global middle class living in China. As a point for comparison, in the 1950s, more than 90% lived in Europe and North America.1
‘China is experiencing the fastest expansion of the middle class the world has ever seen, during a period when the global middle class is already expanding at a historically unprecedented rate thanks in part to some of its neighbours like India,’ Homi Kharas and Meagan Dooley, a senior fellow and senior research analyst respectively in Brookings’ global economy and development programme, wrote in the report.2
By 2027, they estimate that 1.2 billion Chinese will be middle class, one quarter of the global total.
While Chinese middle-class consumption initially followed the growth trajectory of the western middle class, with increasing consumer demand for higher-quality products, home ownership and cars, it is now setting its own middle-class trends. ‘Chinese fintech and e-commerce platforms are changing the way consumers and sellers interact, and they are exporting this knowledge to other developing countries,’ said the research duo.
China, the fund’s largest country weighting at 38%, already makes up the largest middle-class consumption market segment in the world.
Such analyses verify White’s conviction in the EM consumer and demand for new products and services that is being driven more by domestic than international growth.
Uncertainty surrounding US-China relations could unsettle markets in the shorter term, but the trade war has potential to cause little longer-term harm to market leaders like Alibaba and Tencent, the fund’s top two holdings.*
While US President Trump recently moved to ban Tencent’s WeChat app in the US, the business is diversified across several structural growth areas – from online gaming and ads to social media, cloud computing and payments – and derives less than 2% of global revenues from the US.3
The fund aims to balance diversification with conviction. Of its 82 positions, the ten largest employ 43.6% of assets.* Stock selection in 8 out of 11 sectors has added to relative performance since the strategy’s inception in 2011.
Fundamental research is the main driver of stock selection. Quantitative and environmental, social and governance tools supplement this.
White has not shortened his time horizon due to the pandemic and remains focused on owning ‘stewards of capital’ – companies that are ‘best positioned to realise the immense growth potential created by the under-penetration of many emerging market industries’ over the long term.
Examples include the electronic components market, which is could benefit from the expansion of 5G networks, and Chinese electric-vehicle manufacturers. With the government‘s focus on EV penetration, 25% by 2025, and their desire to create domestic players, the most dynamic of the EV manufactures with solid technical capabilities and strong management teams will be best positioned.
Astute stock selection has enabled the fund to outperform in different market conditions. An analysis by Trustnet4 identifies it as one of only five funds in the IA Global Emerging Market sector that have produced top decile performance in the benign markets of the first half of 2019 and the turbulence of the first half of 2020.
White attributes consistent outperformance since he started running the fund in July 2019 to his investment process, which is based on the tenet of ‘no unintended bets’. The team creates upside and downside price targets for all stocks in their universe, including those not owned.
His methodical sell discipline corrects the behavioural biases associated with share ownership. A price decline of 20% from the purchase level relative to the market triggers a position cut and 30-day review, after which a decision is made to rebuild the position or sell completely.
How has White found running a global EM fund from Portland, Oregon, during a pandemic? ‘Technological developments have made geographic locations less important,’ he said. ‘Prior to this, our travel schedules were very busy, meeting management teams and getting on the ground to do our investment checks.
‘This year, travel has come to a standstill but the number of meetings has increased as we are able to do more from our home offices. As a global asset manager with sizable assets, access to company management has never been an issue for us. In fact, it’s quite nice being away from the noise of markets and having a healthy work-life balance – key to long-term, sustainable success.’
* As at 30 September, 2020.
2 Source: https://www.brookings.edu/blog/futuredevelopment/
WHAT CHARACTERISTICS DO YOU LOOK FOR IN STOCKS?
We focus our research on identifying what we define as ‘stewards of capital’. These are companies that know how to sustain and accelerate profitable growth. Often characterised by strong management teams that understand how to generate shareholder returns, we look for companies with a competitive advantage that enables them to sustain growth for longer; businesses that have a strong financial position and can grow from their own free cash flow. We pay close attention to return on invested capital (ROIC), focusing on companies with high or improving ROIC. Overall, we seek ‘quality’ stocks.
MANY EM INVESTORS STICK TO LARGER CAP STOCKS BECAUSE THEY SEE SAFETY IN SCALE. IS YOUR APPROACH SIMILAR?
We have consistently added alpha through stock selection across the market capitalisation scale. While we don’t target market capitalisation per se through our investments, our constructive view on the large cap space has been a rewarding area over the last decade, especially since the composition of the universe has changed so dramatically – favouring higher-quality large cap names. Our historically constructive view on some small cap names has been an additional source of alpha generation and differentiated our performance from peers. However, on an absolute basis the fund’s market capitalisation exposure is skewed towards larger cap stocks.
DO YOU GUARD AGAINST BEHAVIOURAL BIASES WHEN INVESTING?
Some investors argue that behavioural biases are inevitable. However, with a well-constructed and repeatable investment process we can seek to mitigate their impact. For example, cognitive errors such as confirmation bias are common within asset management. One of the ways we seek to guard against this is through our robust sell discipline. When a stock falls by more than 20% from its initial purchase price relative to the market, a sale and review is triggered. We immediately cut the position, by between a third and a half. After a 30-day review period we either build the position back or cut it completely. We believe this limits behavioral bias through reducing the affinity to a stock. Our two-gauge scenario tests our analysts’ true level of conviction. We also try to mitigate anchoring and adjustment bias through the systematic inclusion of quantitative and ESG screening tools in our process. These are primarily used to challenge drivers of alpha with the end goal of enhancing fundamental analysis.
TELL US ABOUT YOUR EM EQUITIES TEAM?
With more than 20 years’ average investment experience, stability underpins our team of specialist emerging market investors. Established in 2008, a diverse team was deliberately identified to provide the necessary expertise to manage equities in a universe that we believed would increase in depth and quality. We intentionally hired sector experts given our vision of the evolving nature of the universe, as well as a dedicated China specialist as we envisaged the longer-term importance of this market. Our long-standing, cohesive team provides the foundation for our consistent long-term performance.
YOUR PERFORMANCE HAS BEEN VERY CONSISTENT – WHAT DO YOU THINK IS DRIVING THIS?
Performance is testament to our consistent, repeatable approach to portfolio construction. This is underpinned by research intensity, our tenet of ‘no unintended bets’ and formalised sell discipline.
CAN YOU DESCRIBE THE PORTFOLIO – WHAT DOES IT LOOK LIKE?
Our portfolios are built from the bottom-up. We don’t ignore the top-down macroeconomic picture but rather view its impact through the lens of the company. For the most part, our sector and country positioning is a by-product of stock selection. When we construct portfolios, our key mantra is to align conviction with risk. Conviction is determined by our best fundamental ideas. These boast favourable risk-reward dynamics, which are informed by our upside and downside price targets. Our highest conviction at present are in names across the consumer discretionary, technology, communication services and healthcare sectors.
WHY DOES INVESTING IN GLOBAL EMERGING MARKETS MAKE SENSE RIGHT NOW?
Investing in emerging markets has made sense for some time. With many investors under-allocated to EMs, the diversification benefits to clients, as well as exposure to this rapidly improving asset class provides a compelling investment case. Globally, emerging markets are the drivers of global growth. Furthermore, when thinking about the impact of the Covid-19 pandemic, those countries first affected and with more stringent policy approaches are showing signs of recovery. These include China and South Korea, where we see a continued increase in economic activity. Lastly, we have seen a global trend of central banks providing support through interest rate cuts and liquidity injections. Emerging markets countries have more room to stimulate growth compared to developed markets given their higher interest rates and lower inflation levels.
HOW HAVE GLOBAL EMERGING MARKET EQUITIES CHANGED OVER TIME?
The emerging markets universe has changed dramatically over the last decade. A decade ago, the universe was dominated by sectors such as materials, energy and telecoms. These industries had a large state presence and were synonymous with inefficiency. Today, the universe favours much higher-quality companies, which demand higher valuations. Sectors such as technology, communication services and consumer discretionary now dominate. Businesses tend to be privately run and much more efficient and focused on shareholder returns than the dominant state owned enterprise players of the past. As an active manager with a focus on stock selection, this is an exciting time to be in emerging markets. The breadth of the opportunity set is increasing as new industries continue to develop and domestic markets expand.
WHAT EMERGING MARKET OPPORTUNITIES ARE GETTING YOU EXCITED?
Digital innovation that addresses key bottlenecks, such as fintech, provides a long-term runway for opportunities. For example, in Brazil the backdrop of all-time low interest rates is driving investment in equities. De-regulation and faster technological adoption are creating high-growth opportunities in areas such as payments and digital brokerage.
Structural progress is still ongoing, with reforms seen as key to unlocking growth potential and accelerating secular themes. The reform agenda has slowed somewhat with governments focusing on the pandemic, but the overarching trend will continue across the region. This emphasises domestic demand as a growth driver in the long term, with key reforms progressing in Brazil, Indonesia, India and China.
1. Columbia Management Investments claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Columbia Management Investments has been independently verified for the periods of January 1, 1993 to December 31, 2018. The verification report is available upon request. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm‘s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation. 2. Columbia Management Investment Advisers, LLC, is an SEC-registered investment adviser (formerly known as RiverSource Investments, LLC prior to May 1, 2010). For purposes of compliance with the GIPS standards, Columbia Management Investment Advisers, LLC has defined the Firm as Columbia Management Investments (prior to May 1, 2010 the Firm was known as RiverSource Institutional Advisors; prior to August 1, 2005 the Firm was known as American Express Asset Management), an operating division of Columbia Management Investment Advisers, LLC that offers investment management and related services to institutional clients. As of May 1, 2010, certain long-term assets of Columbia Management Advisors, LLC (“CMA”) were merged into Columbia Management Investments and included in firm assets as of that date. The Firm was redefined in January 2011 to include stable value assets that were previously excluded from the firm. Beginning March 30, 2015, the Columbia and Threadneedle group of companies, which includes multiple separate and distinct GIPS-compliant firms, began using the global offering brand Columbia Threadneedle Investments. As of January 1, 2017, the Firm was redefined to include Columbia Wanger Asset Management, LLC, a wholly-owned subsidiary of Columbia Management Investment Advisers, LLC. 3. The strategy aims to provide long-term capital appreciation by investing in equity securities located in emerging market countries. Emerging market countries are those that major international financial institutions, such as the World Bank, generally consider to be less economically mature than developed nations, such as the United States or most nations in Western Europe. The strategy’s investment process emphasizes bottom-up stock selection with portfolios typically holding 70 to 90 emerging markets stocks. The benchmark is the MSCI Emerging Markets Index Net. The composite was created September 1, 2012. 4. The gross-of-fees returns are time-weighted rates of return net of commissions and other transaction costs. Net-of-fees returns are calculated by deducting from the monthly gross-of-fees composite return one-twelfth of the highest client fee (model fee) in effect for the respective period. Composite returns reflect the reinvestment of dividends and other earnings. 5. Internal dispersion is calculated using the equal-weighted standard deviation of the annual gross returns of those portfolios that were included in the Composite for the entire year. If the composite contains five or fewer accounts for the full year, a measure of dispersion is not statistically representative and is therefore not shown. 6. The three-year annualized standard deviation measures the variability of the gross-of-fees composite and benchmark returns over the preceding 36-month period. It is not required to be presented when a full three years of performance is not yet available. 7. Portfolios are valued and composite returns are calculated and stated in U.S. dollars. Returns are calculated net of non-reclaimable withholding taxes on dividends, interest, and capital gains. Policies for valuing portfolios, calculating performance, and preparing compliant presentations, and the list of composite descriptions, are available upon request. 8. The following fee schedule represents the current representative fee schedule used as the starting point for fee negotiations for institutional clients seeking investment management services in the designated strategy: 0.90% on the first $25 million; 0.70% on the next $50 million; 0.60% on the next $75 million; Negotiable over $150 million. Gross of fee performance information does not reflect the deduction of management fees. The following statement demonstrates, with a hypothetical example, the compound effect fees have on investment return: If a portfolio‘s annual rate of return is 10% for 5 years and the annual management fee is 90 basis points, the gross total 5-year return would be 61.1% and the 5-year return net of fees would be 54.0%. 9. The benchmark is the MSCI Emerging Markets Index Net that is an unmanaged index based on shares prices of a select group of emerging market stocks that are available to global investors, assuming gross dividends are reinvested. 26 countries are included in this index. Index returns reflect the reinvestment of dividends and other earnings and are not covered by the report of the independent verifiers. 10. Past performance is no guarantee of future results and there is the possibility of loss of value. There can be no assurance that an investment objective will be met or that return expectations will be achieved. Care should be used when comparing these results to those published by other investment advisers, other investment vehicles and unmanaged indices due to possible differences in calculation methods. Registration with the SEC as an investment advisor does not imply a certain level of skill or training.
Investment Risk: The value of investments can fall as well as rise and investors might not get back the sum originally invested. Currency Risk: Where investments are made in assets that are denominated in multiple currencies, changes in exchange rates may affect the value of the investments. Derivatives for EPM / Hedging: The investment policy of the fund allows it to invest in derivatives for the purposes of reducing risk or minimising the cost of transactions. Political and Financial Risk: The fund invests in markets where economic and regulatory risk can be significant. These factors can affect liquidity, settlement and asset values. Any such event can have a negative effect on the value of your investment. Liquidity Risk: The fund holds assets which could prove difficult to sell. The fund may have to lower the selling price, sell other investments or forego more appealing investment opportunities. High Volatility Risk: The fund typically carries a risk of high volatility due to its portfolio composition or the portfolio management techniques used. This means that the fund’s value is likely to fall and rise more frequently and pronounced than with other funds. China-Hong Kong Stock Connect The Fund may invest through the China-Hong Kong Stock Connect programmes which have significant operational constraints including quota limits and are subject to regulatory change and increased counterparty risk
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