March 26, 2020
Addressing the Coronavirus Impact: Emerging Markets Leaders Portfolio
March 26, 2020
Addressing the Coronavirus Impact: Emerging Markets Leaders Portfolio
March 26, 2020
With global markets experiencing unprecedented volatility, we offer some insight into the Emerging Markets Leaders strategy and updates on the portfolio changes. We remain focused on the high quality, long term structural growth companies that we believe will emerge from this bout of volatility and dislocation in a more dominant position.
We have remained disciplined to our investment philosophy and process throughout this unusual period of market swings that has impacted our portfolio as well. We continue to be invested in high quality companies with high return on invested capital and strong balance sheets, and continue to add / rotate capital into positions that we believe will emerge even stronger from this dislocation. Following the first round of impact (and recovery) in China, our portfolio has been impacted by Covid-19 cases spiking in our geographies of exposure. In all these cases, we believe the dislocations are due to extrapolation of near-term cash flow impacts to longer-term trajectories of cash flows (i.e. valuation impacts), or due to undue existential concerns. Alongside, currency devaluations, be it the Indian Rupee or the Brazilian Real, have further exacerbated the near-term pain.
There is, at the moment, a significant uncertainty and fear prevalent in the market about what the end result will look like. However, we have already witnessed China, South Korea, Hong Kong and Singapore taking on the virus head-on via lockdowns, strict social distancing, and international border closures. These measures combined with support from healthcare infrastructure, and natural time for healing has demonstrated a viable path to flattening the case curve, and we hope in near-future disease control, if not eradication, with or without a vaccine. It is encouraging to now see countries from Italy to UK to India taking these steps as well, recognizing the problem and the path to its management. While it will come down to eventual execution, and exact impacts will take time to be revealed, we remain confident that not only will our portfolio weather the storm, but emerge stronger from this.
It is important for investors to recognize that Covid-19 is a very unique event in the history of stock market. Never before has it happened that a number of large global economies have literally shut down simultaneously at the “flick of a switch.” Given the scale and scope of this natural disaster, it is extremely difficult to own a business which would be completely immune to the economic and stock market dislocations arising from it. We are very cognizant that going forward, Covid-19 will have a material impact on the economic and social fabric of our societies. However, our investment process and philosophy of investing into companies with high ROIC, net cash, solid balance sheets, leadership, sustainable competitive advantages, large addressable markets, excellent management, and predictable earnings growth with long future runways, becomes even more relevant.
We believe that our invested companies have strong franchise value with the expected long-term reward outweighing the recent spike in risk. We expect our investments to be well positioned for the recovery phase whenever it comes. These companies will likely emerge more dominant from this period of crisis as many of the less well-equipped competitors will face supply chain disruptions, working capital shortage and inventory adjustments – not to mention, some indebted competitors might simply disappear, or become insignificant. Note that we have seen strong evidence of a number of our companies increasing their focus on customers and vendors alike during this challenging period, supporting the whole chain despite some near-term pain – and this will create critical loyalty ahead.
Our high conviction on the multiyear growth runways of the Chinese Ecosystems has led us to increase our holdings during this time. These companies have already been a significant source of excess returns so far this year, and that should continue. We expect these leaders to strengthen their footholds on the way up, raising penetration followed by take-rates, and launching new areas of growth, spurring positive operating leverage as normalcy ensues. Online Education has performed strongly during this time, seeing increased adoption. To this end, we shifted some capital from a mixed business model company to a pure-play online education company. Being purely online, this business model is massively scalable and has inherently high ROIC. We note that these shifts towards ecosystems and online education aren’t transitory, especially in China, but more a behavioural shift.
On a slightly tepid tone, city closures meant closure of storefronts and curbs on free movement, which hit our Athleisure names badly. While near-term demand has definitely plummeted, however, China has positively surprised us in the speed of storefronts reopening (>85% from latest surveys). Managements and distributors alike have noted that spring inventory clearance is progressing well (~45-50% cleared) with little adverse discounting from last year. If China’s path is any indication of things to come, we remain optimistic for the recovery for the globe as a whole, especially if governments are tackling this head-on. Interestingly, high margin online channels actually saw more traction for our companies during this time, and being leaders in their own rights, we see evidence of market share gains.
Onto the major detractors – India and LatAm. In India, worries over Covid-19 and the subsequent closures of businesses during this time have led to worries of a systematic liquidity crunch. This coupled with the recent Yes Bank fiasco has meant that Indian Financials have taken the brunt of the sell-off. While near-term pain is inevitable, this could be a blessing in disguise, as our investment holdings are all well capitalized and efficiently run private enterprises that will likely gain market share. Our LatAm companies have given up almost all their absolute gains, and then some, in the recent sell-off, further exacerbated by the fall in oil prices. Our thesis of these companies disrupting the financial system and gaining market share remains unchanged. Penetration rates have now reached a level where there is critical mass in our view. In fact, as the situation normalizes, cash aversion and e-money adoption should accelerate. Our companies remain well-funded with strong net-cash balance sheets, and are well positioned on the way up, once markets stabilize.
We believe that the current crisis will sow the seeds for specific new investment opportunities over the next decade. Acceleration in online adoption, increasing AI, and increasing focus on healthcare, are some themes that we are currently researching in depth. We remain true to our investment philosophy, our process, and quite excited looking into the future.
There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline. Accordingly, you can lose money investing. Please be aware that this portfolio may be subject to certain additional risks. In general, equities securities’ values also fluctuate in response to activities specific to a company. Investments in foreign markets entail special risks such as currency, political, economic, market and liquidity risks. The risks of investing in emerging market countries are greater than the risks generally associated with investments in foreign developed countries. Stocks of small- and medium capitalization companies entail special risks, such as limited product lines, markets, and financial resources, and greater market volatility than securities of larger, more established companies. Derivative instruments can be illiquid, may disproportionately increase losses and may have a potentially large negative impact on the Portfolio’s performance. Illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk). Non-diversified portfolios often invest in a more limited number of issuers. As such, changes in the financial condition or market value of a single issuer may cause greater volatility. Privately placed and restricted securities may be subject to resale restrictions as well as a lack of publicly available information, which will increase their illiquidity and could adversely affect the ability to value and sell them (liquidity risk).
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