Templeton Emerging Markets underperforms

The trust had a difficult time over its last financial year to 31 March 2014, with net asset value total return down 14.6 per cent and share price total return down 16.8 per cent, against the benchmark down 9.9 per cent.

It trades on a discount to NAV of 10.23 per cent and over the past year this has been as wide as 11.8 per cent.

As well as difficult markets, the trust says it was impacted negatively by the strength of sterling against emerging markets currencies because it does not hedge against exchange rates. For example, over the year to 31 March in local currency its benchmark would have gained 3.8 per cent rather than fallen 9.9 per cent.

The fund's sector breakdown is significantly different to its benchmark because it picks shares according to their individual merits rather than by sector or geographic weighting. This means its performance can diverge significantly from the index.

For example, at the end of March the fund had 20.3 per cent of its assets in energy against 10.8 per cent for its index, and 16.2 in consumer discretionary against 9.2 per cent. Its manager, Mark Mobius, believes the emergence of emerging markets consumers should increase demand for commodities and consumer goods. The trust's largest sector exposure is financials which account for 26.7 per cent of assets as it holds a number of banks to play growing domestic consumption.

But its holdings in Turkey's Akbank and Indonesia's Bank Danamon, together with Peruvian miner Buenaventura, detracted most from performance, though the trust's managers are confident on the longer-term prospects for these companies. For example, Turkish banks including Akbank came under particular pressure after the chief executive of a leading competitor bank was arrested. "However, Akbank is well positioned to benefit from growing demand for financial and banking services in Turkey," say its managers. "The bank's prudent and experienced management, high asset quality, and strong equity and deposit base lead us to maintain a positive view. Moreover, the bank’s valuation remains attractive at current levels."

The trust's overall holdings in Turkey fell 39.3 per cent and its Indonesian holdings fell 31.5 per cent.

But its managers say an evaluation of existing holdings in the portfolio led to additional purchases in 10 companies as price falls during the period provided an opportunity to increase positions that remained attractive. Purchases were made in four key sectors: materials, consumer staples, energy, and information technology.

New additions include Pakistan's Oil and Gas Development, which accounts respectively for 60 per cent and 30 per cent of that country's oil and gas production.

Templeton Emerging Markets also increased holdings in companies including Buenaventura, South Africa's Impala Platinum and Anglo American, Brazil's Vale, and Russia's Gazprom.

"Right now the commodity sector looks particularly good value but there are bargains in many sectors," say its managers.

They add that performance has now turned and the trust is outperforming the indices - its NAV has beaten the benchmark over one, three and six months. "Having lots of bargains in the portfolio we are well positioned to take advantage of future opportunities in consumer, commodity and financial sectors," they add. "Despite weakness in the last 12 months, we believe that emerging markets in general and our stock holdings in particular stand to benefit from attractively low valuations and improving global growth prospects."

The trust proposes increasing its dividend for the year by 16 per cent to 7.25p and will cut its fees from 1.2 per cent to 1.1 per cent a year from 1 July. It currently has an ongoing charge of 1.31 per cent which could fall because of this reduction, and no performance fee unlike some of its sector peers.

Templeton Emerging Markets is also the largest and most liquid trust in the Global Emerging Markets sector with almost £2bn in assets.

It must seek shareholder approval for its continuation every five years and a vote is due this year at the annual general meeting on 18 July. Its directors expect it to pass this and continue.

Analyst views

"Templeton Emerging Markets is downgraded to 'negative' as the performance has disappointed over recent years and its concentrated portfolio creates significant company risk," say analysts at Oriel. "Furthermore, we worry that there is no clear succession plan for when Dr Mobius decides to step down."

Dr Mobius is now 77 and has managed the trust since it started in 1989. However, Templeton says the trust is managed on a team basis.

The investment team value and buy stocks based on their five-year investment outlook, resulting in a portfolio that can appear fully valued on first appearances but has holdings which are considered to be below intrinsic value once future earnings are factored in. "We worry that this approach combined with the low turnover of the portfolio leaves it exposed to growth shocks and reduces the margin of safety the management thought they had embedded in an investment, especially if economic or company growth rates do not match initial expectations," continues Oriel.

But they add: "Should markets recover, the fund's focus on growth and its concentrated portfolio could lead to strong performance."

Analysts at Numis argue that "the best time to buy a manager/asset class is often when it has been out of favour, and now is an attractive time for investors to consider raising their exposure to emerging markets equities."

Analysts at Winterflood say: "There will be periods when the fund's performance diverges (from its benchmark), as has been the case more recently. However the fund benefits from a well resourced and highly experienced management team. Discount risk is also largely mitigated by the fund's reasonably active buy-back programme."

Source: Morningstar, *Franklin Templeton.

Source: Morningstar as at 20 June

TOP TEN HOLDINGS as at 31 May 2014

Geographic exposure