149. Finding multi-baggers in emerging markets

2 September 2021 (pre-recorded 31 August 2021)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION]

Chris Salih (CS): Hello and welcome to the Investing on the go podcast. I’m Chris Salih and today we’re joined by John Citron, one of the managers on the Elite Rated JP Morgan Emerging Markets Trust. Thank you for joining us today John.

John Citron (JC): Thanks, great to be here.  

[INTERVIEW]

[0:15]

CS: Let’s start with the trust, it’s 30 years old this year, obviously you haven’t been managing the trust for the entire tenure but could you maybe tell us about some of the biggest changes to investing in emerging markets over the past few decades? You know, the likes of the countries, the sectors or any other changes that you may have seen.

JC: Yeah, it’s a great question. The short answer is that the opportunity set has expanded a lot over the past decade. And the two biggest changes are that includes a lot more in the technology sector and a lot more in China. And the easiest way to see that is if you look at the 10 largest companies in the MSCI Emerging Markets Index, which is the index for the fund, and you look today versus a decade ago, well firstly only three of the names are the same: Samsung, TSMC and Vale On. That in itself tells you, I guess a lot has happened that only three names managed to survive in the top 10 for a decade.

And then if you look at where we are today versus then, 10 years ago, you had four commodity stocks, two telecom stocks and today there’s no telecom stocks and only one commodity stock, Vale On. And instead you have a lot of internet stocks really. You have you know, the likes of Tencent, Meituan, Alibaba and so on. You have other tech type stocks like Infosys. And so it’s a lot more technology and a lot less commodities. And like I say, there’s been a lot of churn. And if you look at the country composition of the index, you kind of see a similar tale. So China and Hong Kong have doubled their weight from 20% to nearly 40%, while Latin America and emerging Europe have halved their weight from kind of close to half the index down, down closer to 20%.

So things keep changing, and I think when we look forward, we see more changes from here. You see quite a powerful healthcare sector starting to emerge within both India, China and other places too. We’re seeing a new breed of financial technology companies start to appear, and so on. So I think there’s quite a few, if you could kind of put it back to the trust that the portfolio has shifted over time to reflect some of these trends and I’m sure we’ll get to it later, but I would also like to say that, although it reflects these trends, we also find a lot of idiosyncratic opportunities that reflect the bottom up opportunities that we see. And so we have had important investments in places like Argentina and Belarus and Indonesia and so on and so forth. So the universe shifts and more China, more technology, and we shifted to some extent, but also kind of always keeping an eye out for any gems we can find looking more broadly.

[2:48]

CS: You mentioned tech there, the sort of the rise of tech at the expensive of maybe commodities, for example, segues into my next question because obviously the team does believe that emerging markets are becoming more like developed markets. Could you maybe expand a bit more on that and are the opportunities the same and, you know, could they even become a point where there are no emerging markets?

JC: Well more like developed? I think that’s, that’s kind of partly true. I would draw a contrast, I guess, between country through the prism of the corporate sector and investment and country through the prism of the macroeconomic standpoint.

So I think, you know, when it comes to investment, we’ve always held the view that investing in emerging markets doesn’t require a different skill set to investing in developed markets. The things that you need to succeed, you know, calmness, patience, forensic analysis are the same, and the things that cause you to make mistakes, behavioral biases, over-optimism they’re also the same too. I mean, investing in sense is just investing.

But when you look to the corporate sector, I think what has changed is that the best companies in emerging markets are now clearly comparable to the best companies in developed markets from a corporate quality perspective in a way, which wasn’t necessarily always true. I guess if you went back further in time. In some cases that’s because they are genuinely global businesses. So let’s take an obvious example that the biggest one of the biggest holdings in our fund and a big part of the emerging markets world is Taiwan Semiconductor, which is now the world’s largest manufacturer of semiconductor chips. And in terms of technology and productivity, it’s kind of moved ahead of Intel to take the lead in the global semiconductor industry.

But even for domestic businesses, I think we see equivalent to high quality in some areas. So the best banks in emerging markets like Capitec, Bank Central Asia, HDFC Bank, they offer a customer experience, you know, a set of technologies and also financial metrics return on assets and so on, which are better than most or many develop market banks. And then I think if you look at the tech world again, in the internet side, companies like Tencent and Sea limited, you know, they, they’re driven by our sort of artificial intelligence algorithms that are again, kind of equal to ahead of what’s going on in Silicon Valley.

So in other words, you, I think, you know, we think that you don’t have to sacrifice corporate quality when investing in emerging market companies. But when it comes to the economies themselves, I think our view is that many of these are going to be emerging markets for a long time in the sense that incomes will remain low, government and legal systems are, you know, in some cases are more developed, but in other cases, the less developed, and in some cases we’ll never reach kind of Western developed norms. And so, I think that’s that slow evolution at the macro level is something we understand, but it’s something we think creates a lot of corporate level opportunity. And so, you know, where you are able to mix these kind of best in class management teams and corporate quality with some of these very long duration kind of income growth and slow development opportunities, that’s the kind of great standpoint from which we can succeed.

[5:48]

CS: Okay. Just looking at the portfolio itself, I mean the average company held in the portfolio has been there for like 10 years, and that’s obviously, you know, in a world where maybe market cycles are perceived in different sort of lengths and, you know, perhaps companies are held for less time than they were in the past. Could you, could you maybe talk us through that and also what was the longest standing stock in the portfolio and why has it been such a good investment for so long?

JC: Yeah. So, you know, as you mentioned, I’ve been a more recent addition to managing the trust and it’s been managed since 1994 I think by Austin Forey who I guess is a really unique investor in terms of how long he does hold companies and how low the turnover of the product is, and I think that’s been a really core part of the success.

And so if you look at the longest standing holdings, you have a number of stocks that have been continuously held in the fund since the 1990s. And those would include names like a Walmex, HDFC and TSMC. So I think of these the longest standing is Walmex, which has been owned continuously since 1994. And in that time that the stock’s up more than 10 times in Sterling terms, which is more than double the return delivered by the index. And I think Walmex, just as basic facts is Walmart’s Mexican subsidiary. And I think in a way it typifies what makes a successful long-term investment because on the one hand, the investment cases is really entirely unchanged versus 30 years ago. So the basics of it are that you have a food retail industry in Mexico, that back then was almost entirely informal, but today is still relatively informal. And so there’s this opportunity to consolidate market share. And the key to capturing the opportunity remains the same, which is about offering, you know, everyday low prices to customers on a wide variety of goods.

So the set up hasn’t really changed yet, the company’s obviously had to evolve and the way it delivers its value proposition to the customer has evolved along with that. So, you know, while the setup and the basic principles are unchanged, you now have e-commerce being the fastest area of growth for the company. Walmex is, you know, culturally changed a lot and has now become one of the kind of global leaders on issues like environmental, social and governance which obviously, again, back in 1994 was less of a priority. And it has a, you know, an incredibly robust sets of targets on its supply chain in terms of sustainable sourcing, which we really benchmark a lot of other companies, both in emerging markets and globally by.

So, yeah, that’s probably the longest standing one. And I think we still see a pretty good outlook there in terms of, you know, the industry growth and the company’s ability to take advantage of it over the next few years.

[8:33]

CS: And at the other end of the scale, what’s your most recent investment, and what’s the attraction of that specifically?

JC: Well, as you noted turnover’s pretty low, but I think you are in luck, so we did add one name this year, I think. So there was a new name added in May which was a Taiwanese stock called Advantech. Probably worth noting, but I think it’s a good example of the kind business we would like to own, particularly in the trust, because it is a smaller and less liquid name. And obviously that having the closed-end structure enables us to invest in that kind of business. It’s not necessarily a small business, it’s not hyper illiquid. It’s just kind of maybe, it allows for a slightly different profile of investments. And this is a great example because what does Advantech do? Well, it’s the world’s leading manufacturer of industrial PCs. So an industrial PC is any computer that’s used in a non-consumer or office application. So it’s everything from medical devices to factory equipment, to points of sale kiosks in shops, all the computers needed to control smart traffic lights or street lighting system, all this kind of stuff.

And what do we like about the business? Well it’s a clear leader. Its market share is multiples that of the next largest player and it spends more than half of the whole industry’s research and development budget. It has exceptional returns on capital above 20%, has a consistent net cash balance sheet, and it has a long track record of paying out very large amounts of earnings as dividends. And so you have this kind of great financial model, great management track record. And the industry it’s in is really, you know, got a very long runway, long duration ahead of it given you only really see more compute power being added to devices around the world and computers appearing in all sorts of applications where they didn’t appear before. So we view a good outlook there. And it’s a business we’ve been interested in, and there was a small sell-off in the market, unrelated to the business itself, that provided a good opportunity to start a position.

[10:35]

CS: And just moving on, you sort of touched on this a bit earlier – many emerging market funds and are dominated by Asian companies and, you know, essentially is Asia now the only real story in town or other opportunities elsewhere? You mentioned the likes of LatAm [Latin America] and a few of those other regions. Could you maybe talk us through that as well, please?

JC: Yeah, it’s a great question. I think the greatest proof that there’s more than just Asia in emerging markets has really been our performance over the last decade of the trust when a number of the biggest contributors have come from Latin America and emerging Europe. And although the overall universe outside Asia, you know, the number of companies it contains might be a bit smaller, but there’s still a lot of them. And, you know, one mantra we always have is it only takes one idea to make a difference, because if you can find that great business, then it can, you know, some of the better businesses we’ve had, and I’ll talk about some of them now, have been real multi-baggers and those can drive a lot of performance for a product, and you only need one or two of them.

So let me talk you through some of those briefly, so two of our largest contributors, which remain large and important holdings are headquartered in Argentina. One is Globant which is an IT services company, which takes the best technical and creative talent in Latin America and uses it to build products for Western companies. So, for example, their breakthrough client, when we were first investing in the company, was Disney and they were very involved in building out the digital experiences in Disneyland parks. So there were these bracelets that visitors wear when they when they go into Disneyland to avoid queues and another things and they were instrumental in building that product. These days you know, there’s grown a lot of that help is helping businesses in all sorts of different industries solve problems. And maybe worth saying as well, one of the big positions we also have in the trust is a business called EPAM, not a Latin American business –  founded in Belarus, which has a very similar model, it’s based on taking the best technical talent – in this case from Eastern Europe – and taking it to developed market companies who are desperately short of high quality technology developers.

The other Argentinian name is Mercado Libre, is leading e-commerce and FinTech company in Latin America. It’s number one in e-commerce in Brazil, in Mexico and Argentina. And it has a PayPal type digital payments platform, which has been built on top of the e-commerce business. So, yeah, these are huge opportunities. And I mean, we don’t, I guess we’re not talking about performance of a specific stocks, but I mean, in the case of Globant, you know, that that’s a business that’s up well over 10 times since we first invested in it. And I think it’s just a great example of how, if you can find these exceptional businesses, you only need a few of them, and there certainly are a few of them across Latin America, across Eastern Europe, and so they remain very important kind of hunting grounds for us when we’re looking for new ideas.

[13:26]

CS: We’ve almost got to the end without mentioning China too much, but just before we do, obviously there’s a lot of news coming out with these recent crackdowns on investments, in the likes of the afterschool tutoring and other areas. Could you maybe talk us through the impact of what’s happening there and what you’re seeing and your perception of it, please?

JC: Yeah, I mean, you’re definitely correct with the increased regulatory pressure in China has been the kind of major issue in our lives and in emerging markets over the past few months. So maybe for those less familiar, I can give like a sentence or two of background and then talk about how it impacts our portfolio specifically.

So for much of the time or certainly for some time now, the Chinese government has been looking to increase regulation, particularly of the tech industry maybe before talking about education and the tech industry regulation has been ramping up this year, but frankly, I guess a lot of the issues are quite similar to those we’ve seen in the West. So they’re looking to tighten standards around worker rights, they’re looking to ensure customer data isn’t being shared too broadly when it comes to the targeting of online advertisements and so on. I think we’ve always had the view that this kind of regulation makes sense, the bigger companies, which constitute our investment universe, are kind of pretty well positioned to deal with it. And we’ve been willing to own these companies through that noise. Which I guess mirrors how, you know, you may see US investors own Facebook or Google through antitrust noise and so on. It’s kind of, it’s some analogy there albeit, with kind of local specifics.

The afterschool tutoring thing, obviously was a different thing and was much more worrisome from our perspective. So in China you have this one exam that students take, which determines which university they go to and obviously parents and students take incredibly seriously. And this huge tutoring industry has developed around that with companies that in total had over a $100 billion of market capitalisation. And earlier this year, the Chinese government effectively outlawed that industry at a stroke of a pen and the market cap of these companies fell kind of 80% to 90% in a few days.

You know, the rationale from the government’s side was the burden, the stress and the cost of tutoring was stopping families having more than one child, and this was causing long-term demographic issues. And it’s always worth reminding that China moved away from its one child policy some time ago, and now is trying to encourage larger families. But, you know, regardless of the rationale, to see the government willing to destroy this kind of very large area of economic activity and stock market value was quite shocking.

We had a very small investment in the space which we sold and you know, it is a concern. So I think where we are now is that from a portfolio perspective, we’ve kind of always had a kind of mild underweight position to Chinese internet, and some of the areas that are being more regulated and that has benefited our relative performance this year. We do have some holdings nonetheless which are in mostly in the internet area. And I think our belief is that there, as I discussed, the other regulatory issues are probably manageable in the long run.

In the end, you know, government regulation is always somewhat unknown. It is always something that you worry about and it’s something we certainly discuss a lot with our team on the ground in China. I think, you know, ultimately, I can say we run a diversified portfolio and our best protection in China specifically is when we try and find businesses that operate a long way from the government.

So for example, we own a business, which is a producer of soy sauce, which it sells to consumers and to restaurants. And you would think selling soy sauce, hopefully is an industry where regulators have little interest, it typifies one of those idiosyncratic opportunities that we’re hoping to find. So I think, yeah, it’s a balance. You know, I think we are more concerned than we were particularly given what happened in the afterschool tutoring sector. But when we look at our exposures, firstly, they’re not so high overall and particularly not in relative terms, and when we look at the businesses we hold, we view, sensible, well-managed businesses we think can navigate this pool. So a lot of businesses which hopefully aren’t too exposed to regulation.

CS: That’s great John, thank you very much for joining us today.

JC: Thank you very much, it’s been a pleasure.

CS: And if you’d like to learn more about the JP Morgan Emerging Markets Trust, please visit fundcalibre.com and while you’re there remember to subscribe to the Investing on the go podcast.