Emerging markets may not seem like natural territory for investors who prioritise environmental, social and governance (ESG) factors. But Mobius Investment Trust's (MMIT) six-strong investment team, which includes well regarded emerging markets investors Mark Mobius and Carlos Hardenberg, works with companies to improve both ESG credentials and financial returns.
“In emerging markets people haven’t really been doing this - activism isn’t a big thing,” says Fergus Argyle, partner at Mobius Capital Partners and member of the trust's investment team. “All the companies we have sat down with say that we are the first investors who have done this with them."
The trust, which launched in October 2018, mainly invests in mid-caps listed in emerging and frontier markets that its managers think are undervalued, have strong growth potential and with which they can engage with to boost financial performance.
While the trust's managers are doing due diligence on potential investments they put together a list of things that they hope to improve or change. And when they have invested in a company they present their ideas to its management, typically three or four points.
“It’s free consultancy for them, but we stand to benefit if they adopt it,” explains Mr Argyle. “All our engagements are constructive – we are not aggressive activists in the mould of [some] of our peers."
An example of a company they are engaging with is Yum China (YUMC:NYQ), a quick-service restaurant brand that owns the KFC, Pizza Hut and Taco Bell franchises in China. Kunal Desai, partner at Mobius and member of the trust's investment team, says that Yum China's balance sheet is “essentially a gold mine” because it has a “huge amount of cash” and owns 85 per cent of its stores. In the US, by contrast, restaurant chains typically own about 20 per cent of their stores.
“We are working with Yum China to [reduce the percentage of stores it owns to around] 50 per cent, which will create a huge amount of cash, meaning that it can increase the dividend and share buybacks,” he says.
Mr Desai admits that the company's business will be negatively impacted by the coronavirus outbreak in the short term because it has had to close 30 per cent of its stores and the ones that remain open will experience a decline in revenues. But he also says that Yum China was quick to implement a ‘contactless’ delivery service to help reduce the risk of person-to-person transmission of the coronavirus and this should boost revenue from deliveries, which currently accounts for about 23 per cent of the total.
"We were very positive about China and felt like a lot of the headwinds were clearing before the outbreak of coronavirus," adds Mr Argyle. "Although the impact on China's gross domestic product (GDP) will be significant we remain constructive on China."
He also says that weakness in the market could provide opportunities to buy shares in good businesses at lower prices.
Mobius Investment Trust's managers also like to invest in family-run, listed businesses that could benefit from governance changes. Mr Desai says that India is a “very fertile market” as there are many family-owned businesses with second-generation heirs who have returned after studying abroad, and are looking to improve board structure, share option plans and capital allocation. Mobius Investment Trust currently holds four such companies including APL Apollo Tubes (APLAPOLLO:NSI) and Polycab (POLYCAB:NSI).
Mobius Investment Trust has a bias to consumer discretionary, consumer staples, technology and healthcare stocks as these are areas in which its managers believe they can add value. “We are willing to ignore large parts of the market," says Mr Argyle. "There is no point in us engaging with companies if they can’t control their prices or profitability very easily, so we [avoid] highly regulated or commodity-exposed industries."
Although governance is Mobius Investment Trust's managers' main focus they are also working with companies on environmental and social issues.
For example, they have presented polish grocer Eurocash (EUR:WSE) with a plan to improve its energy efficiency via initiatives such as the installation of light-emitting diode (LED) lights, solar panels, and more efficient fridges and freezers. And they have persuaded Russian internet company Mail.Ru (MAIL), which derives 30 per cent of revenues from online gaming, to add more warnings on its website about the dangers of gaming for prolonged periods.
“We’ve been really impressed by the receptiveness of Mail.Ru,” says Mr Argyle. “Its chief executive officer Boris Dobrodeyev, who never used to talk to investors, is now making more frequent trips and calls.”
Over one year to 7 February the trust made a net asset value (NAV) total return of 0 per cent, behind MSCI Emerging Markets index's return of 8 per cent, according to broker Winterflood. However, over, one, three and six months the trust is well ahead of this index with positive returns, and its managers are optimistic that the changes they have implemented in a number of companies are starting to bear fruit.
“We typically favour businesses that are unloved or out of favour, and that we believe are trading at very sharp discounts to what their franchises' strengths should imply,” explains Mr Desai.
He adds that as these companies' operational plans have started to have an impact their share price performance has improved, although it has taken time for their turnaround plans to result in earnings upgrades and operational improvements.
