Face-Off: Terry Smith versus Carlos Hardenberg

A year ago, no-one gave emerging markets much of a fighting chance in a world led by Donald Trump’s America. A strengthening dollar, the repatriation of US manufacturing and a president long on rhetoric and short on empathy made for an unedifying backdrop, and few were predicting the start of an impressive bull run.

Yet that is exactly what has happened. The MSCI Emerging Markets index is up 25 per cent over one year, while some specialist emerging market trusts have gained even more. However, it has mattered where global emerging markets fund managers have been invested. Those invested in China or Brazil have fared particularly well, while Russia and India have been comparatively lacklustre. Equally, sector allocation has been important. Consumer, materials and technology stocks have been strong, while utilities have lost money in local currency terms.

These strengths and weaknesses have been reflected in the performance of individual trusts, and the extremes are perhaps no clearer than in the two trusts under consideration. The Templeton Emerging Markets trust (TEM) is up 31.6 per cent, while the Fundsmith Emerging Equities trust (FEET) is down 0.6 per cent.

There are a number of reasons why this bald comparison between the two companies is not quite fair, however. First, in the last emerging markets rout in 2015, the Templeton trust lost 24 per cent and the Fundsmith trust just 10.9 per cent. The trusts aim to do quite different things, one aiming for punchy, high-octane returns, while the other aims to deliver a steadier, if less exciting, path for investors.

Gavin Haynes, investment director at Whitechurch Securities, says: ‘These two trusts have quite opposing styles. FEET is all about quality businesses, and takes a similar approach to that taken on the Fundsmith Equity fund, while TEM is value-based, looking for out-of-favour areas. It has been a difficult time for the value philosophy since the advent of quantitative easing and markets have favoured high-quality defensive, noncyclical businesses. However, there has been a cyclical recovery in emerging markets since 2015 and value has returned to favour.’

Fundsmith emerging equities

When he launched Fundsmith Equity in 2010, Terry Smith believed the fund management industry had over-complicated itself. The key to success, he argued, was to buy companies that make their money by a large number of everyday, repeated, relatively predictable transactions, not to overpay, and then to do as little dealing as possible to keep costs low.

It is a strategy that has worked fantastically well. Funsmith Equity is now over £11 billion in size, feeding into an appetite for high-quality, predictable businesses in the wake of the financial crisis. But FEET's success in emerging markets has been mixed. While it successfully defended capital in its first year compared to the rest of the sector, it has not kept pace with the cyclical recovery.

It is also relatively concentrated. Smith says: ‘Indian companies constituted 38 per cent of the portfolio as at the end of August. We regard India as the largest repository of high-quality listed consumer goods companies of the sort we seek. In addition, we believe it is likely that the implementation of the Goods and Services Tax (GST) on 1 July will become another plank in the economic transformation of what seems destined to become the world’s largest country by population. If this proves to be the case then FEET should be well positioned to benefit.’ More than 75 per cent of the trust is invested in consumer staples stocks.

In contrast, Smith holds only 6 per cent of the portfolio in China compared with the country’s 29 per cent weighting in the MSCI Emerging Markets index. He adds: ‘We find it much harder to find quality consumer companies in China or to believe in a rosy macro outlook following the surge in credit, which has been used to prop up growth.’ It is not deliberately a low-volatility approach, even if that is the ultimate outcome. ‘In the end we are investors in companies and seek the long-term compounding which they can derive from the rise of the consumer in emerging markets,’ says Smith.

‘Whilst that does not make them immune from either economic or market volatility, we endeavour to identify good companies and hold their shares for the long term to derive the benefit of this compounding. ‘When our nerves are strong enough and we have the funds to do so, we use some of the volatility to purchase more of the companies we like,’ he adds.

The trust’s share price discount to net asset value has been remarkably stable compared with the rest of the sector, possibly a function of a loyal band of Terry Smith evangelists who have been sold on his message. He says: ‘It’s hard to see how we could have done more to inform our investors about the long-term view we propose to take. We always stress that if you are not a long-term investor, FEET is not the right investment for you.’

Templeton Emerging Markets

Templeton Emerging Markets trust has a long history, not all of it illustrious. Managed in a deep value style by emerging markets veteran Mark Mobius, it had a tricky run of form leading up to a change of lead manager in 2015. Partly, this was a reflection of markets that could not summon any enthusiasm for value stocks, but there were also questions over how the trust was being run.

New manager Carlos Hardenberg has reinvigorated the trust in startling style since the start of his tenure. It is top of the sector over one year, outpacing its nearest rival (Aberdeen Emerging Markets) by 9 per cent. It is also 13 per cent ahead of the wider sector over the three years to 27 September.

Hardenberg says that while he has remained true to the trust’s value investing heritage, there have been some considerable changes. ‘Value investing – the traditional way, looking at discounted cash flow models and market multiples – is in our DNA,’ he says. ‘However, we have taken the concept of value investing to a new level, recognising that market multiples are only one side of the story.

‘We need to understand the quality of the management, how they are going to grow market share, how they are going to secure payment to shareholders. There are many other factors that drive value.’ As part of this approach, the portfolio has changed considerably. Out were a number of large, mature conglomerates, and some materials and commodities companies. Stateowned companies were also consigned to the investment dustbin, and the portfolio shifted to the private sector.

A notable addition has been holdings in the technology sector. For Hardenberg, there is a quiet technology revolution taking place across emerging markets, which don’t have the legacy issues of developed markets and can bypass a whole layer of development.

He says: ‘In Vietnam, for example, there has been an entire evolution. It used to be bricks and mortar, but there has been an aggressive move to digital banking. Banks are now moving into the countryside areas, but without a physical presence. It is evidence of how emerging markets have changed. They are at the forefront of innovation and ideas generation – and I’m not sure the world has realised.’

The trust has also shifted into the smaller and more rapidly growing frontier markets. It has investments in East Africa, Cambodia and Peru, for example. It is now firmly ‘new emerging’ rather than ‘old emerging’.

The group values having people on the ground and can call on a vast bank of analysts in the individual markets, who provide local intelligence and insight. Hardenberg is clear that this gives a real advantage in terms of weeding out poor corporate governance.

Conclusion

Investors woke up to the stronger performance of TEM in June of this year, and the discount started to narrow from below 15 per cent to its current level of 11 per cent. With hindsight, that might have been the time to buy, but the discount still doesn’t appear to have caught up with performance. In contrast, FEET’s discount has little scope to narrow.

This would seem to prefer TEMIT, but the choice may come down to whether investors in emerging markets are really looking for stability and predictability, or whether they have decided – having taken the leap – that they want all the rock ‘n’ roll that goes with an investment in new and developing economies. 

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