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Brandes Investment Partners Emerging Markets Equity Strategy Notes Second Quarter 2019 (April 1 – June 30, 2019)
The Timothy Plan Mutual Fund Emerging Markets returned 5.7% (gross of fees), outperforming its benchmark, the MSCI Emerging Markets Index, which increased 0.6% in the second quarter.
All of the strategy’s holdings in Russia performed well, led by food retailer X5 Retail Group and Sberbank.
X5’s shares rose on margin improvement, helped by continued food inflation in Russia. We have trimmed our position following the strong performance, maintaining a measured allocation.
Much like its peers in Russia, Argentina-based oil and gas company YPF saw its shares advance despite political risks and tightening financial conditions in Argentina.
Holdings in Brazil also lifted performance. Higher education services provider Estacio Participacoes saw enrollment increase over 12%. The company’s distance-learning segment grew over 25%, while enrollment for in-person courses remained stable even as tuition prices for that segment climbed nearly 4%. Another notable contributor among our Brazilian holdings was health care services provider Hapvida Participacoes e Investimentos. The market responded positively to Hapvida’s agreement to buy a local competitor, Grupo Sao Francisco, in a bid to expand in Sao Paulo.
Other contributors included South Korean autos Kia Motors and Hyundai Mobis.. Additionally, our underweight to China helped relative performance.
The Chinese equity market struggled amid heightened tension and complexity surrounding the U.S.-China trade dispute. While our underweight to the country aided relative returns, our holdings there weighed on absolute performance. One notable detractor was information technology services firm Chinasoft International.
Other poor performers included Turkish real estate investment trust (REIT) Emlak Konut and Mexican cement company Cemex.
Emlak’s shares fell due to disappointing 2019 results to date, specifically with regard to unit sales, operating margins and EBITDA (earnings before interest, taxes, depreciation and amortization). We maintain a measured allocation to the company knowing that its stock performance is highly dependent on the macroeconomic situation in Turkey, particularly inflation and homebuyers’ confidence, as well as the health of the construction sector.
Meanwhile, Cemex continued to face a variety of concerns. These include a sharp drop in Mexico’s construction activity this year, fears of a recession in the United States (its biggest market), and a lack of confidence in management’s capital allocation prowess. We believe these issues have been more than accounted for in Cemex’s current share price. Trading at less than 70% of book value and 9x forward earnings at quarter end, the company represents what we see as an attractive value opportunity.
Select Activity in the Quarter
The Emerging Markets Investment Committee initiated a new position in made-to-order chipmaker Taiwan Semiconductor Manufacturing Company (TSMC).
TSMC is the world’s dominant semiconductor foundry, controlling approximately 54% of this secularly growing end market.
Unlike integrated device manufacturers such as Intel and Samsung, which design, manufacture and sell semiconductors, pure-play foundries such as TSMC focus solely on manufacturing semiconductor products for their customers. With Intel’s foundry efforts struggling and GlobalFoundries (second-largest pure-play foundry after TMSC, with approximately 9%
market share) ceasing its production of leading-edge semiconductors, TSMC and Samsung will likely be the only two foundries capable of supplying leading-edge technologies.
TSMC’s smartphone segment, with clients such as Apple and Huawei, has consistently accounted for a significant portion of the firm’s revenue (over 50%) and largely driven its revenue growth over the past seven years. As the smartphone market slows down, however, management expects future revenue growth to increasingly come from its high-performance computing (HPC) business, where the development of its leading-edge technologies resides. As of 2018, HPC represented 30% of TSMC’s revenue.
While we believe TSMC is well positioned to achieve its growth objective in the HPC business, weaker demand in the smartphone market and intensifying competition in other non-leading edge segments present headwinds. Nonetheless, even after considering these challenges, our analysis shows that TSMC offers upside potential. In our view, the company is one of the most attractively valued and sustainable franchises in the global semiconductor industry, and should continue to generate appealing returns on capital and free cash flow going forward.
The Timothy Plan Mutual Fund Emerging Markets returned 14.5%, outperforming the MSCI Emerging Markets Index, which gained 10.6% for the six months ended June 30, 2019.
As was the case for the second quarter, strong performance was driven by holdings in Russia, Brazil and South Korea (specifically auto companies). From an industry standpoint, holdings in oil and gas helped returns significantly. Other notable contributors included Indonesian telecom XL Axiata, Panamanian bank Banco Latinoamericano de Exportaciones y Importaciones (BLADEX) and our Mexican REIT holdings.
Our underweight to China was a leading detractor to relative returns. At the company level, Brazil-based regional jet manufacturer Embraer, Cemex, Emlak Konut, Nishat Mills and Indian electric utility Reliance Infrastructure hurt performance.
Continuing the trend from the first quarter, we trimmed a number of our positions in Russia given their strong performance and ended the quarter with an approximately 8% allocation.
As of June 30, we held our largest country weights to Brazil and South Korea, while remaining materially underweight to Taiwan and China, even with the recent additions of TSMC and PetroChina. On a sector basis, our largest overweights were to real estate, consumer discretionary and communication services companies. The financial sector continued to represent a significant underweight position, due to our lower exposure to banks in China, Brazil and India. Additionally, we maintained a lower allocation to information technology than the benchmark.
Amid the constant stream of macroeconomic and geopolitical news, it is important to remember that volatility is not unusual in emerging markets investing and has often created attractive yet overlooked opportunities. We believe our investments in Russia are good examples of such opportunities. Only a few years ago, market participants seemed to view investing in Russia as a binary decision, with no regard for individual company merits or valuations. Over the past 18 months, however, shifting investor sentiment, combined with material free-cash-flow generation and strong returns on invested capital, has driven up the share prices of many of our holdings there and led us to trim our allocation.
Moreover, with the diversity of emerging market companies and their varying fundamental strengths, simply “being there” may not be the best way to access opportunities within the asset class. Rather, we believe investors can be best served by applying a selective approach that an actively managed strategy such as the Brandes Emerging Markets Equity offers.
Thank you for your continued trust.
Book Value: Assets minus liabilities. Also known as shareholders’ equity.
Forward Earnings: Sell-side analysts’ consensus earnings estimates for the next fiscal year.
Forward Price/Earnings: Price per share divided by earnings per share expected over the next 12 months.
Free Cash Flow: Total cash flow from operations less capital expenditures.
Price/Book: Price per share divided by book value per share.
Return on Capital/Return on Invested Capital: Net income minus dividends divided by total capital; used to assess a company’s efficiency at allocating the capital under its control to profitable investments.
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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