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Brandes Investment Partners Emerging Markets Equity Strategy Notes First Quarter 2019 (January 1 – March 31, 2019)
The Timothy Plan Mutual Fund Emerging Markets Fund returned 8.3% (gross of fees) in the first quarter, underperforming its benchmark, the MSCI Emerging Markets Index, which increased 9.9%.
Holdings in real estate and communication services drove performance.
Mexico-based Fideicomiso PLA Administradora Industrial (known as Terrafina), Fibra Uno and Fibra Macquarie Mexico lifted returns as these income-oriented securities benefited from the U.S. Federal Reserve’s hints that there may be no further interest rate hikes in 2019.
Among our communication services holdings, notable contributors included Indonesian XL Axiata and Chilean Empresa Nacional de Telecomunicaciones (Entel). Investors welcomed XL’s encouraging earnings growth and favorable outlook. Similarly, Entel’s shares rose on strong 2018 results driven by improved profitability and margins in Chile and Peru.
Select financial holdings also aided performance, namely Panama-based Banco Latinoamericano, Russian Sberbank, Colombia’s Grupo Aval and information technology services provider Chinasoft International.
Positive sentiment shift regarding trade negotiations between China and the United States boosted Chinese stocks in general. Consequently, while the majority of our China-based holdings appreciated in the quarter, our underweight allocation to companies in the country hurt relative returns.
Meanwhile, tightening financial conditions combined with heightened uncertainty surrounding local elections weighed on our holdings in Turkey. Our allocation there remains measured to three companies: banks Akbank and Garanti Bankasi, as well as real estate firm Emlak Konut.
Other detractors included India-based electric utility Reliance Infrastructure, Slovenian bank Nova Ljubljanska Banka, which gave back some of its strong returns from the fourth quarter of 2018, Mexican cement producer Cemex, and Brazil-based regional jet manufacturer Embraer.
Embraer has received sign-off for its deal with Boeing from most of the required stakeholders, including the Brazilian government and shareholders. The deal is expected to close by the end of this year, assuming anti-trust regulators approve it. In the quarter, Embraer’s shares declined as the company missed revenue and net income forecasts. Nevertheless, our valuation thesis remains positive. As we have shared in the past, we view the deal favorably as it crystalizes the value of Embraer’s commercial segment ahead of any need for regional jet volume recovery, partially mitigating the risks related to the capital expenditure cycle of airlines (Embraer’s customers). The deal also offsets the competitive threat from Airbus/Bombardier and provides a closer relationship with Boeing, which we believe creates an upside potential for both Embraer’s defense and business jet segments.
Select Activity in the First Quarter
The Emerging Markets Investment Committee initiated new positions in companies that we know very well as we have owned them in the past, namely Latin American airline Copa Holdings and Austria-domiciled Erste Group Bank, which operates mainly in emerging European countries.
The investment committee exited the strategy’s positions in Russian Lukoil and India-based Reliance Infrastructure.
A number of recent developments led to a reconsideration of our investment thesis for Reliance Infrastructure and our eventual divestment. Most notably, during the second half of 2018, Reliance sold its Mumbai utility to Adani Transmission. The utility had been Reliance’s main earnings contributor and was sold to pay down debt. Prior to the sale, our investment case for Reliance Infrastructure was supported by the valuation of its electricity assets, including its stake in publicly listed Reliance Power. We also anticipated some upside potential from its significant balance of financial assets. However, the disposal of the Mumbai utility meaningfully reduced Reliance’s earnings power and led to a deterioration in the quality of its net asset value (NAV), which now consists primarily of financial holdings and contingent assets.
Furthermore, the company went into a technical default on a small portion of its debt for a few weeks until it received the proceeds from the utility sale, raising immediate concerns about the liquidity and recoverability of its remaining financial assets. Our loss of confidence in the company, combined with its poor transparency, triggered our decision to exit the position.
Continuing the trend from the second half of 2018, we trimmed a number of our positions in Brazil given their strong performance. For the first time in over five years, Brazilian companies did not represent the strategy’s largest country weighting at quarter end, with South Korea taking over the position. The strategy maintained major underweights in China, Taiwan and India.
Changes to the Global Industry Classification Standards (GICS) undertaken by MSCI in the fourth quarter of 2018 affected our relative weightings from a sector/industry basis. As has been the case for a number of years, we remained underweight the information technology sector as of March 31, although our underweight was not as significant as before, due to the reclassification of large technology companies (e.g., Alibaba, Tencent, Baidu) into the communication services sector. Our allocations to the consumer discretionary and real estate sectors continued to represent notable overweights.
At quarter end, the strategy’s largest sector weighting was in financials, although we were underweight the benchmark because of our lower exposure to banks in China, Brazil and India.
As a firm, we continue to see significant value potential in emerging markets equities, as we believe valuations remain appealing from both an absolute and a relative standpoint. Our enthusiasm for the asset class is highlighted by our allocation to emerging markets businesses in our Brandes global strategies, which—as of March 31—was at or near the peak levels achieved over the past decade.
Thank you for your continued trust.
Net Asset Value: A company’s total assets minus its liabilities, divided by the number of outstanding shares.
The MSCI Emerging Markets Index with net dividends captures large and mid cap representation of emerging market countries. Data prior to 2001 is gross dividend and linked to the net dividend returns.
MSCI has not approved, reviewed or produced this report, makes no express or implied warranties or representations and is not liable whatsoever for any data in the report. You may not redistribute the MSCI data or use it as a basis for other indices or investment products.
The foregoing Quarterly Commentary reflects the thoughts and opinions of Brandes Investment Partners® exclusively and is subject to change without notice. The information provided in the commentary should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any security transactions, holdings or sectors discussed were or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance discussed herein. International and emerging markets investing is subject to certain risks such as currency fluctuation and social and political changes; such risks may result in greater share price volatility. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that the securities sold have not been repurchased. The actual characteristics with respect to any particular account will vary based on a number of factors including but not limited to: (i) the size of the account; (ii) investment restrictions applicable to the account, if any; and (iii) market exigencies at the time of investment. Unlike bonds issued or guaranteed by the U.S. government or its agencies, stocks and other bonds are not backed by the full faith and credit of the United States. Stock and bond prices will experience market fluctuations. Please note that the value of government securities and bonds in general have an inverse relationship to interest rates. Bonds carry the risk of default, or the risk that an issuer will be unable to make income or principal payment. There is no assurance that private guarantors or insurers will meet their obligations. The credit quality of the investments in the portfolio is not a guarantee of the safety or stability of the portfolio. Investments in Asset Backed and Mortgage Backed Securities include additional risks that investors should be aware of such as credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments. Securities of small companies generally experience more volatility than mid and large sized companies. Although the statements of fact and data in this report have been obtained from, and are based upon, sources that are believed to be reliable, we cannot guarantee their accuracy, and any such information may be incomplete or condensed. Strategies discussed are subject to change at any time by the investment manager in its discretion due to market conditions or opportunities. The Brandes investment approach tends to result in portfolios that are materially different than their benchmarks with regard to characteristics such as risk, volatility, diversification, and concentration. Please note that all indices are unmanaged and are not available for direct investment. Past performance is not a guarantee of future results. No investment strategy can assure a profit or protect against loss. Market conditions may impact performance. The performance results presented were achieved in particular market conditions which may not be repeated. Moreover, the current market volatility and uncertain regulatory environment may have a negative impact on future performance. The margin of safety for any security is defined as the discount of its market price to what the firm believes is the intrinsic value of that security. The declaration and payment of shareholder dividends are solely at the discretion of the issuer and are subject to change at any time.
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