'Stock Take' (Part 2) - The EM Edition
The Blind Squirrel's 'Monday' Morning Notes. Year 3; Week 24.
Big changes coming to Blind Squirrel Macro at the end of June. If you missed the earlier emails, details can be found in the post linked below.
During June, before Blind Squirrel Macro moves completely behind the paywall, we are going through the process of re-underwriting all of the live Acorn trades and revisiting the 'bull pen' of themes that we have closed out the trade but continue to monitor. This week we tackle emerging markets.
'Stock Take' (Part 2) - EM Edition
The 🐿️ has always been a fan of emerging markets. My chief reason for wanting a job at Barings at the outset of my career was because of the bank’s EM footprint and legacy. This was not just an early 1990s passing fad for the venerable London merchant bank. Barings had been in the business of deal making in new markets since the 18th Century.
I remember hugely enjoying my time spent with John Orbell, the Barings in house historian and archivist (yes, those were very different times!). His pre-war chronicle of Baring Brothers includes the story of how the bank was once a trusted adviser to that promising early 19th Century emerging market, the United States of America.
“In 1802 it became known that Spain had ceded the one million square miles of the Territory of Louisiana to France… Alexander Baring accompanied United States officials, Monroe and Livingstone, to Paris where he acted as their financial adviser, and, in bargaining with the French, was largely instrumental in scaling down their demands from 100 million to 60 million francs. The deal was mostly financed through the issue of $11.25 million United States government bonds to the French Government which sold them to Barings and Hopes who placed them in the London and Amsterdam markets.” ‘Baring Brothers & Co., Limited. A History to 1939’ - John Orbell.
I remember John showing me documents containing global investment portfolios from the 19th Century and I spent a few hours of the past week trying to see if I could track down images of them online for this note. Down that particular rabbit hole, I stumbled upon the next best thing - a fascinating 2012 paper by economic historians David Chambers and Rui Esteves - The First Global Emerging Markets Investor: Foreign & Colonial Investment Trust (1880-1913).
In 1868, the Foreign & Colonial Government Trust (now known as the F&C Investment Trust (‘FCIT’) and still listed on the London Stock Exchange) was founded as the first collective investment scheme specifically designed to bring ‘stock market investing’ to those of ‘moderate means’. FCIT was famously the only investment trust share which John Maynard Keynes included in the portfolio he managed for his father in the run up to World War 1.
FCIT’s initial portfolio consisted of 18 foreign government bonds (it later allocated to equities), diversified across Austria, Egypt, Italy, Latin America, New South Wales (Australia), Nova Scotia (Canada), Portugal, Russia, Spain, Turkey, and the United States. The intention was to buy and hold these bonds to maturity, providing investors a yield pick-up over the paltry returns available on British government bonds at the time.
The paper tracks FCIT’s portfolio over the 33-year period leading up to 1913. FCIT only established a meaningful overweight in US financial assets in the mid 1890s during the Grover Cleveland presidency.
The 🐿️’s first boss in emerging markets always told me to focus on the ‘3 B’s’ when it came to opening up new markets - banks, brewers and building materials (basically cement companies). In the late 19th / early 20th Centuries it was the US railroad stonks that seduced FCIT’s investment committee away from their Latin American overweight positions.
The railroads were the large cap tech stock of 130 years ago and FCIT leaned into the frenzy hard. It wore a punchy drawdown in 1890 (Sherman Act) but looks to have weathered the big bust of 1894/5 (when 25% of US railroad stocks went bankrupt) remarkably well. 10 years later, you can see how the railroads handed over the growth baton to the electric companies. There is always a new ‘new thing’ in investing.
EEM - The EM ‘Trading Sardine’
Fast forward to today, and the US overweight in global equity portfolios has extended to the point at which US equities represent 64% of the MSCI All World index (ACWI). The emerging markets of Asia are large enough to capture a mere (relative to population and GDP) 5.3% weighting in the index. The rest of the emerging world is concealed within that 3.8% ‘other’ bucket.
This rodent has never believed in a ‘one size fits all’ strategy for investing in emerging markets. However, I doubt that many owners of the popular ($18bn AUM) EEM 0.00%↑ ETF know that this gives them a bigger exposure to Saudi Aramco than it does to the entire South African or Mexican stock markets!
Do the owners of ($14bn AUM) EMXC 0.00%↑ (because “China is completely un-investable bro”) know that they have a 26% exposure to Taiwan (whose ‘imminent’ annexation by China is the chief cause of their China angst)?
I get that many investors now have mandates that prohibit them from investment in Chinese equities or fear an Executive Order out of the White House that might prevent them in the future. However, these markets have been breaking out for well over a year and are yet to see meaningful fund flows.
With respect to China specifically, when the 🐿️ suggested to folk on Forward Guidance in April ‘24 that Chinese equities might offer value and last August that they were long China anyway, he received no shortage of hate mail. By the time Dave Tepper persuaded everyone to reach for BABA 0.00%↑ call options in late September, the positive earnings revisions that I had suggested might be on the cards were already fully out in the open.
Within emerging markets more broadly, you have “the next China” (India) trading at a premium to US equities while markets elsewhere in Asia, Africa and Latin America offer, in this rodent’s opinion, incredible value sitting at the lows of their historical multiple ranges.
Within our BUSHY™ beta portfolio, the 🐿️ captures his bullishness around emerging market equities with positions diversified emerging market tech (via EMQQ 0.00%↑), Latin America (via ILF 0.00%↑) and Africa (via AFK 0.00%↑). However, the largest EM equity position in the portfolio is DVYE 0.00%↑, iShares’ EM High Dividend ETF. Write up here 👇.
Also, here is the 🐿️ explaining BUSHY™’s low beta, short duration approach to international equities to the wonderful Matt Zeigler on his Excess Returns show:
DVYE has comprehensively outperformed broad-based emerging markets equities over the past 2.5 years and continues to trade at around 50% of the forward PE multiple of the EM index and comes with a 10.75% indicated dividend yield. I expect DVYE to be a key building block of my beta portfolio for many years to come.
Time to drill down into the regions:
China and Southeast Asia
The DVYE weighting in Chinese and Taiwanese stocks is over 30%. Elsewhere, my direct exposure to Chinese equities has a strong emphasis on avoiding the obvious China Tech ADR names that are often subject to the vagaries of hot money flows.
So far in 2025, I have added 2 baskets (‘Guochao’ and ‘Ganbei’) focused on Chinese consumption. So far, the performance of these baskets has been carried by the Labubu dolls of Pop Mart - you may need a ‘Gen Z’ or ‘Gen Alpha’ member of your household to explain!
I am hoping that the beer, Baiju, restaurant and white goods stocks will follow the Labubu lead in due course! In the meantime, I want to focus on the 2 HK-listed Asian conglomerate calls from last summer:
Swire Pacific (19 HK) Update
Last August, a series of coincidences triggered a deep dive on Swire Pacific (19.HK), the Hong Kong conglomerate with assets spanning real estate, aviation and beverages. I saw a business trading at a 55% discount to my fair value. That is the kind of margin of error that allows you to stay in a name confidently through multiple market cycles.
This week I updated my sum-of-parts valuation for the business (using the same methodology as last summer). Since last August, the base (pre 🐿️ adjustment) net asset value is up by 20%. My total return has been a less exciting 10.2% (mainly from dividends). Outstanding performances by all of the main underlying group businesses have been rewarded with a widening of the NAV discount.
Swire Properties is two-thirds of the way into their HK$100bn investment program; just announced a sellout of their first luxury residential project in Shanghai; and has repurchased almost 100m shares in the current financial year. It continues to trade at over a 60% discount to NAV (versus a long-term average pre-Covid of 35% to 40%).
Cathay Pacific’s passenger and cargo volume (and profit) recovery continues yet is still trading at a 53% discount to Singapore Airlines on a forward PE basis. HAECO, Swire’s MRO business saw 45% growth in recurring profits. HAECO alone is a $2.5bn business if valued in line with ST Engineering (S63:SGX).
Swire Beverages (the Coca Cola bottler) grew it mainland China profits by 11% and is expanding its Southeast Asian footprint with acquisitions in Thailand and Laos.
On the capital allocation front, Swire Pac has reduced its A share count buy over 9% since last August and just announced a 5% dividend increase.
As Swire Properties and Cathay make further progress in closing their post-Covid drawdown, I feel comfortable that the market will start to focus on the clear value on offer at the group level. In the meantime, this is the 🐿️’s favorite ‘low beta China’ exposure.
First Pacific (142 HK) Update
Mr. Market has been kinder in terms of rewarding progress at our other Asian conglomerate, ASEAN-focused First Pacific.
The stock is up 37% since last August (pre dividends). Notwithstanding an 18% drop in the market cap of PLDT (the largest Philippines telco in which First Pac has a 25.6% economic interest), I have increased the 🐿️ NAV for the group by 30%.
Understandably Philex (their gold miner) has had a very good year. Also, now that Singapore-based FPM Power / PacificLight is generating meaningful EBITDA (SGD412m in FY24), it is time to put a (modest) multiple on those cashflows rather than value it at book cost (most 3rd party brokers are starting to do this too).
I have upgraded my valuation of First Pac’s stake in MetroPacific subsidiary (‘MP’) to $3.5bn (in line with (conservative) estimates from brokers Citi and CLSA). 74% of that value is covered by MP’s listed stake in Manila Electric alone and there are a number of near-term catalysts coming that will expose value in other parts of MP such as the imminent IPO in July of Maynilard (water utility) with an estimated market cap of $2bn.
PLDT’s EBITDA multiple has contracted further in line with falling cash flows in the core telecoms business. However, I do think that the market will soon start to assign value to PLDT’s 38% stake in the digital bank Maya (where Tencent, KKR and the IFC are now also on the register. Maya is the #2 fintech in the Philippines behind GCash but, unlike its larger competitor, has a full banking license. GCash is currently preparing for an IPO that could value the business at $5bn.
First Pac’s ownership in Indofood CPB, the world’s largest maker of wheat-based instant noodles, is via its controlling stake in PT Indofood Sukses Makmur (INDF:IDX). INDF trades at major discount to the value of its 80.1% stake in Indofood CBP (ICBP:IDX), giving negative value for its other (profitable!) agribusiness activities. The 🐿️’s NAV looks through that double discount.
I see pockets of hidden value in First Pacific everywhere I look!
Moving on to Latin America
As mentioned above, BUSHY™’s exposure to Latin America is via ILF 0.00%↑, iShares Latin America 40 ETF. The ETF is 60% Brazil, 25% Mexico but also contains some interesting large caps from the rest of the region.
Brazil - Samba Time
Within the broader portfolio, the 🐿️ has been clipping dividends with a core holding in iShares Brazil EWZ 0.00%↑ for years. In late 2023, I added a tactical position with the ‘Samba Time’ basket but took it off in Q1 2024.
My small position in Brazilian fintech NU Holdings NU 0.00%↑ was the only position that I kept when closing my digital payments basket earlier this year.
I was on the point of adding back a tactical basket of Brazilian assets if EWZ 0.00%↑ held on to its recapture of the 200-day SMA in late March. ‘Liberation Day’ delayed those plans!
Brazilian equities at a 6.8x forward PE should be a no-brainer until you remind yourself that the average multiple for the past 4 years is only 7.1x. I buy the bulls’ thesis around the 2026 election and the end of Lula but do have concerns that this year’s tick up in core inflation may lead to a cutting cycle that is less impressive than what the market had previously hoped for.
I think I want to wait until we have sight of June inflation data (expected 10th July) before adding to my Brazil holdings but there are a couple of technical indicators on the EWZ daily chart that definitely have this rodent’s attention.
Mexico - Salsa Time
Without a position in the core portfolio, I was less patient about waiting to add Mexico back to the portfolio. When I got bullish on Mexican assets this time last year, I was seeking to fade a noisy view that incoming Presidenta Sheinbaum was ‘a commie’ who was about to turn Mexico into ‘the next Venezuela’.
The acorn position was via another closed end fund, MXF 0.00%↑ The Mexico Fund. MXF is currently trading at a 17.58% discount to NAV. No promises that the managers ever do anything proactive about this discount, but they do have the authority to tender for shares.
We were stopped out of the trade ahead of the US election but reentered the position in late April. It is working well so far.
It turns out that Ms. Sheinbaum has demonstrated some impressive diplomatic skills with her handling of the new Trump administration. I suspect that the economy continues to benefit from longer-term nearshoring effects, and the existing USMCA trade agreement protects most industries from reciprocal tariffs.
One thing that may also become a tailwind for local equities is pension reform. Local pension funds (AFORES) have their lowest allocation to domestic equities in history (ANOTHER foreigner overweight US assets!). The new rules could see the AFORES’ AUMs double. Those new (employer) contributions to pension pots are likely to find their way into (still cheap) local stocks.
The 🐿️ feels good about Mexico. Running the position in MXF with a trailing stop which is currently set at $16.50 per share (about 7% below Friday’s close).
Africa
I continue to believe that African equities can benefit from ‘playing all sides’ in an increasingly multi-polar world order.
The pace with which AFK 0.00%↑ recovered from the ‘Liberation Day’ sell off in risk assets was impressive, recapturing positive trend within 7 sessions.
Zooming out to the monthly chart is even more interesting. It looks to me like a clear breakout of downtrend that has been in place since the financial crisis.
Happy to stick with the core ETF position in Africa and am starting to flesh out some of the ‘Digital Africa’ themes we touched on in last November’s note.
Turning to bonds - EM Fixed Income
The 🐿️ has been a fan of EM local currency denominated fixed income for a while. The thesis is pretty straightforward. In general, emerging market central bankers generally do a vastly superior job when it comes to managing domestic inflation (they frankly have no choice if they want to protect their currencies). As such positive real rates (some significant) can be found throughout EM. The strategy has now been turbo-boosted by the recent dollar weakness.
The tail end of that fantastic FCIT paper also ended up touching on another core BUSHY™ holding. After World War 1, emerging market debt investing was a fringe investment activity until the creation of Brady Bonds in 1989 following multiple Latin American sovereign debt crises.
In 1993, JP Morgan created the EMBI, its index of EM (USD-denominated) bonds. 2 closed end funds benchmarked to this index were launched by Templeton TEI 0.00%↑ and Morgan Stanley MSD 0.00%↑ that same year. The 2 funds still exist today, and the Templeton fund is a major allocation within BUSHY™ (and a major contributor to year-to-date returns).
MSD still predominantly holds USD-denominated bonds, but TEI has now been focused on EM local currency fixed income for several years. ETFs were created on the USD EM index in 2007 (EMB 0.00%↑) and on the local currency index in 2010 (EMLC 0.00%↑).
BUSHY™ owns both TEI and EMLC but has a much larger allocation to the actively managed Templeton fund. TEI’s 1.14% expense ratio has been fully justified by some significant out performance versus the benchmark (same is true of Morgan Stanley’s USD product). There is clearly some alpha to be harvested in EM fixed income, but you need an expert.
TEI has a diversified portfolio (129 holdings) but some of the larger positions (13.8% allocation to Egypt and 8.2% to Kazakhstan) may raise the eyebrow of a few readers! Of course, these bonds are largely issued in the same currency as the printer of that currency. The PMs are there to make sure that we earn a positive real rate in a currency that is not about to fall out of bed. This is why I am less keen on the ETF product, EMLC 0.00%↑.
As a closed end fund, TEI 0.00%↑ can trade a relatively steep discount to NAV (currently 6.7%) but has traded at a premium when the EM theme is hot. In the meantime, TEI’s monthly distributions offer a 9.78% yield (which you can elect to reinvest via the fund’s dividend reinvestment plan).
TEI is core allocation for BUSHY™ and likely to stay that way.
Part 2 was going to continue the closed end fund theme by revisiting the 🐿️’s UK Midcap Investment Trust theme (I like the idea of getting back in the trade), but we have run out of time to make any more old DMs being new EMs jokes. Refresh yourself on the thesis if you have time.
We will start with it in next week’s stock take which will also cover most of our financials themes, including financial exchanges, digital payments, banks - from Japanese behemoths to advisory boutiques - and of course our dear friends at #TeamSaddlebags!
As ever, please get in touch if you have any questions - via comments below, in The Drey or privately via DM (link below):
Thanks for your readership. I hope that as many of you as possible will be joining our great community in The Drey this month.
Squirrel out!
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Thanks Martin. Bushy has ILF - pan LatAm exposure. The EWZ and MXF are in the Acorn book.
Hey, great take on the EM market. Sadly these markets are not weighted accordingly. I read there is EWZ exposure, but the bushy portfolio doesnt include it. Is there an additional basket? Greetz