Templeton Emerging Markets' tech transformation

A look at Templeton’s top 10 holdings two years ago would have revealed a host of miners and natural resources companies. Today, Samsung Electronics (SMSD) makes up 7.1 per cent of assets, Chinese ecommerce giant Alibaba (BABA:NYQ) accounts for 3.4 per cent and Taiwanese electronics company Hon Hai Precision Industry (2317:TAI) and Chinese internet giant Tencent (700:HKG) features too. 

Technology stocks are responsible for much of the recent emerging markets renaissance. The MSCI Emerging Markets index is up 23 per cent in the year to date and rose by 32.6 per cent in the 2016 calendar year, due in large part to the stellar performance of the technology sector, which now accounts for 26.6 per cent of the index.

But Mr Hardenberg says it is his investments in disruptive smaller companies, introduced since he took over in October 2015, and his contrarian picks, that have driven the fund’s outperformance against the index. In 2016 Templeton delivered a share price total return of 47.9 per cent and it has already generated a 30.2 per cent return in the year to date.  

"The reason we performed so well was because we picked a lot of good stocks, including consumer-orientated businesses such as the BMW subsidiary in China, which has doubled in value over the past 12 months. We also have two banks in Brazil, including Itau Unibanco (ITUB4:SAO), a noodle and cookie producer in Brazil (M Dias Branco (MDIA3:SAO)) and our holdings in the Philippines, such as Banco de Oro (BDO:PHS), did well, too.

"We have an active share of around 80 per cent and this is still a truly contrarian portfolio which is not in any way close to the index even though some of the bigger names are well-known index names," he says.

But the tech theme is key to his vision too. When Mr Hardenberg took over in October 2015 he pledged to reduce the concentration in blue-chip emerging markets stocks in traditional industries and open the trust’s doors to exciting, nascent technological disrupters from across the emerging world.

His portfolio holdings have doubled in number since he took over and now contains 90 stocks, of which the majority of new additions have been mid and small caps. Around 32 per cent of the portfolio is now invested in stocks with a market capitalisation of under $50bn (£38.6bn). And he is dedicated to unearthing companies that are set to disrupt traditional industries. In order to do that he has recruited two teams of analysts solely to work on the information technology and healthcare sectors.

In Latin America he has bought ecommerce companies such as B2W Companhia Digital (BTOW3:SAO). "This is an Amazon-like business in Brazil backed by the family that owns the Ambev brewery company. This business just didn’t exist seven years ago and it is being backed by traditional local conservative money now," he says. In Kenya he added three companies, a brewery and two banks. "Kenya Commercial Bank (KCBK:NAI) is one of the main partners of [mobile payment company] M-PESA. Local banks give you exposure to all parts of the economy – they give loans to start-ups and alternative energy providers, which is why we buy them," he says.

He has also introduced Saudi Arabia to the portfolio for the first time and a new investment in Brazil, as well as a raft of healthcare-focused investments.

The nature of emerging markets stocks has changed, he says. "Emerging markets have now overtaken the west in terms of patent registration. And research and development has increased hugely too. Fintech is huge in emerging markets, healthcare is a business in its own right, as is technology. China is now the largest automotive maker in the world and that’s totally new."

That brings with it different risks and a very different approach to valuation.

"Technology changes fast," says Mr Hardenberg. "For example, in the battery space it’s totally unclear which battery technology will be the winner. This is a very different universe which requires us to have a different approach, learn a different language and use new tools to analyse these stocks.

"In the past we very much focused purely on cash flows and earnings multiples and it’s still the case that discounted cash-flow analysis plays a very big role, but for some of the technology companies it’s more important to quantify the ability of a management team to monetise an existing group of consumers and clients.

"In many cases they can be loss-making for many quarters and years, and overnight they start charging for something and the company just begins to print money. You cannot find that in a number, so it’s more about understanding the ability of management to turn existing businesses into more profitable businesses and you need to be able to understand the mindset of management."

Technology companies such as Alibaba, which currently trades on a price-earnings (PE) ratio of 56.94 times trailing 12-month earnings, are certainly not cheap on any number. How does that sit with a manager running a dedicated value-focused fund? Does Mr Hardenberg consider himself a value manager?

"Is that a trick question?” he asks. "I’ve trained my entire life as a value manager and I think the DNA of Templeton (where he has worked 17 years) is to value companies. But does that mean that I only buy low PE ratio stocks? No, I’m an opportunistic manager who tries to understand the real value of companies and my passion is to uncover situations where we think the market is mispricing an asset.

"I respect value principles but we’ve invested a lot of further resources and thinking to expand our understanding of value in emerging markets. We don’t want to be stagnating and focusing on just a few companies and wait for them to fall to a low PE ratio. That’s not going to give you much of a sexy portfolio."

TEMPLETON EMERGING MARKETS (TEM) 

Performance 

Source: FE Analytics, as at 1.09.17

Top 10 holdings as at 31.07.17 (%)  

Source: Templeton, as at 31.07.17

Sector breakdown as at 31.07.17 (%)  

Source: Templeton, as at 31.07.17