Templeton EM held back by oil and mining exposure

Investments in materials, energy and financials were major detractors to performance relative to the benchmark. Vale (SAO:VALE3), Kumba Iron Ore (JNB:KIO) and Impala Platinum (JNB:IMP) were the largest detractors, but the trust's managers added to them during its last financial year because of their share price correction.

"It is the Templeton philosophy to invest in companies that are well managed and profitable, but have fallen out of favour due to short-term uncertainties," says the trust's manager Mark Mobius. "We continue to believe in the economic and social development of emerging markets and this has led us over the last five years to continue to hold selective positions in materials stocks which, as a sector, has been the major detractor from performance relative to the benchmark."

Stocks in the energy sector were impacted by lower oil and gas prices, and oversupply concerns. Petrobras (NYS:PBR.A), South Korean energy conglomerate SK Innovation (Korea SE:096770) and PTT Exploration and Production (SET:PTTEP), the oil and gas exploration and production arm of Thailand's state energy company, were key detractors.

"Petrobras is Brazil's main producer, refiner and distributor of oil and gas, and has an exceptional portfolio of production and exploration assets," says Dr Mobius. "The share price rebounded strongly post the period-end, with a 38 per cent return in sterling terms in April, as a rise in oil prices supported the stock and the publication of 2014 accounts removed a significant source of uncertainty for investors.

"Economic growth in emerging markets including Thailand and the wider Asian region should support long term demand growth for oil and gas. Our faith in oil and gas has been a detractor but I expect the oil price to recover to maybe $78 a barrel - it is already up from the bottom."

The trust's managers also like energy as a play on consumer spending, for example petrol stations, while car ownership is growing in emerging markets.

In financials overweight positions in Brazilian commercial banks Itau Unibanco (NYS:ITUB) and Banco Bradesco (NYS:BBD) were the largest detractors, and lack of exposure to Chinese banks also worked against the trust. Its investment team prefer Brazilian, Thai and Indonesian banks due to their higher profitability, attractive fundamentals and long-term growth prospects.

"Banks in these countries can offer an effective means to gain exposure to domestic economic growth in Southeast Asia and Latin America; in particular to access the expansion of consumer spending as rising regional wealth fuels a growing middle class," says Dr Mobius. "Holdings in Kasikornbank (SET:KBANK), Siam Commercial Bank (SET:SCB) and Bank Central Asia (JKT:BBCA) all saw double-digit gains and contributed positively to performance in the past 12 months."

Its managers also favour consumer stocks as a way for an equity fund to tap into gross domestic product (GDP) growth. Examples include consumer staples and soft drinks companies, and cement companies as a play on construction. They also consider global companies which make a high proportion of their revenues in emerging markets such as UK-listed Unilever (ULVR), which the trust added to in its last financial year and accounted for 3.7 per cent of assets at the end of May. "This is a good way to get in via a diversified framework and at a much lower price than some of its listed subsidiaries," says Dr Mobius.

The trust says its contrarian investment approach means it bears little relationship to the benchmark index. Its active share - a measure of how much the portfolio deviates from the index - was 95.7 per cent as at 31 March 2015 and is usually at a similar level. Dr Mobius also says the trust has underperformed in the past when they have held unpopular shares and sectors, but when this has changed performance has turned.

The trust has continued to grow its dividends and is looking to pay 8.25p a share in respect of its last financial year - a 13.8 per cent rise on the previous financial year. It has also cut its management fee from 1.2 to 1.1 per cent as of July last year resulting in a fall in the ongoing charge from 1.3 to 1.2 per cent.

Analyst views

Alan Brierley, director at Canaccord Genuity, maintains his Buy rating but adds that while "there is contrarian value, our inability to construct a solid fundamentals-based and high conviction argument is a concern."

"The fund has a strong long-term track record under manager Mark Mobius," say analysts at Numis. "However, returns have been disappointing in recent years. The best time to buy a manager/asset class is often when it has been out of favour, however, we believe a period of sustained improved performance will be needed for the discount to narrow significantly."

Westhouse Securities suggests switching to Utilico Emerging Markets (UEM) (also an IC Top 100 Fund) as this has outperformed TEM, even though its discount to NAV of 7 per cent is less attractive.

Source: Morningstar, *Templeton Emerging Markets.

Performance

Source: Morningstar as at 15 June 2015

TOP TEN HOLDINGS as at 31 May 2015

Geographic breakdown