A number of important themes are providing attractive opportunities in Emerging Markets. Charles Walsh, portfolio manager, talks about some of those themes below.
Technology leadership & 5G – the rise of Asia
This year we have witnessed a further shift in technology leadership from the west to the east, which is most apparent in semiconductors and the 5G hardware supply chain. Take Intel, for example, which has recently announced a move away from manufacturing its own chips due to its inability to produce at the leading edge nodes. Over the past few years they’ve experienced numerous problems and delays, which have ultimately led to them losing Apple as a client. Intel will shift production of its chips to TSMC of Taiwan and Samsung Electronics in Korea, both of whom are already producing at 5nm and 7nm, whilst Intel still hasn’t mastered the 10nm process.*
Another good example of this trend, is Taiwan-based semiconductor manufacturer Mediatek. The company has created a strong market in Asia for mid-priced 5G smartphones with the introduction of its competitively priced 5G chips. It has taken market share from US-based Qualcomm, which produces similar technology but which can’t compete on price and efficiency.
Mediatek has also benefitted in recent months from the US ban on Huawei. As companies became restricted on supplying US-derived technology to Huawei, the company turned to Mediatek to supply chips. President Trump’s ban appears to have increased the reliance on Asian technology. And, looking at the bigger picture, this is likely to accelerate the pace at which Asian companies develop their own intellectual property in order to be less reliant on the US.
Financial inclusion – lifting the masses
Another strong theme for us and one which is typically only accessible in emerging markets is financial inclusion - providing financial services to the un-banked, typically rural poor, population.
A good example in the portfolio is Indonesian ultra-micro finance company BTPN Syariah. This is an exciting company providing loans typically of $100-500 to women in rural communities looking to set up their own businesses. It also provides them with training on issues like best business practices and bookkeeping. BTPN Syariah is there for people with no access to formal banking – some clients don’t even have government ID - who want to provide for themselves.
Another example is Indian microfinancing business M&M Financial Services, which is among our top contributors to returns year to date. Their main focus is on providing loans to small farmers for vehicles, machinery and working capital.
Key issues
The rise in Covid-19 infections
Rising infection rates and new restrictions could trigger further bouts of market volatility, once again hurting some sectors more than others. For example, a number of real-estate positions feature among our detractors year-to-date, including China-based property developer Sunac and Indian housing-finance business HDFC. The latter is India’s leading mortgage provider, which has seen its business and share price affected by the pandemic.
We, however, believe HDFC’s share price will recover. The company should benefit from demographic transformation in India – a long-term structural change that is only being delayed by Covid-19. There are 1.3 billion people in the country and roughly 200 million homes, over half of which are either slums or contain just one or two bedrooms**. Housing construction is vital for employment, is a key government policy and the demand from consumers is there. External events have taken over in recent months, but we still think HDFC has a bright future in a changing India.
China-US tensions and the upcoming US election
As we discussed above, the US ban on Huawei has not hurt our holdings. On the contrary, we have seen some of the benefits of technology leadership moving east. US-China tensions, however, will continue to create volatility, especially as we move closer to the US election in November.
Both Republicans and Democrats have adopted a hawkish stance on China, but that does not mean China will be treated the same whoever wins. A Democrat win would, at least, mean a more predictable policy stance. And President Biden would likely employ a more multi-lateral foreign policy and reach out more to other Asian countries, which would be a positive for the wider Asia ex-Japan market.
Portfolio Outlook
Given the upcoming US election and the direction of the Covid-19 pandemic over the coming months, uncertainty is likely to remain.
For our part, we are maintaining what we believe to be a balanced, high-conviction portfolio, which tends to hold less than 30 stocks. These are companies with strong balance sheets benefitting from key themes in the region, such as the dominance of Asia technology, the growth of micro financing and demographic change – as discussed in this update - as well as companies that we believe will do particularly well when economic activity recovers more broadly.
We don’t believe the tensions between China and the US or the pandemic have irreversibly changed the fundamentals of the companies in the portfolio – for those business that have been adversely affected by recent events, we think it’s a case of when, not if, performance recovers.
*Source: Reuters, July 2020
**Source: CLSA
