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‘$16 trillion of negative-yielding assets are looking for yield…’

Feroz Basa on prospects for emerging markets and the investment approach of the Sanlam Global Emerging Markets Fund and its feeder fund.

RYK VAN NIEKERK: Welcome to this Market Commentator podcast. It’s my weekly podcast where I speak to leading investment professionals. My name is Ryk van Niekerk and my guest today is Feroz Basa. He is head of global emerging markets at Sanlam Investments, and manages the Sanlam Global Emerging Markets Fund and its feeder fund. Feroz joined Sanlam Investments around 18 months ago and took over the Sanlam fund from Denker Capital at the time. So he’s been managing it for around one-and-a-half years. Feroz, thank you so much for joining me.

Emerging markets is an interesting and possibly exciting place at the moment in the context of world markets. There’s so much liquidity around, especially in the developed market, and this liquidity is in search of higher yields. What is your perspective on emerging markets in the world we are currently experiencing, especially the market world?

FEROZ BASA: Yes, Ryk. I think that’s a very good point. There’s lots of liquidity around currently looking for yield. If I think about negative yielding assets around, they are currently at $16 trillion. If you look at the rates in the developed world, and even in emerging markets, lower-risk rates are probably trading at their record lows, so there’s a clear search for yield. And this makes me excited about emerging market equities, given where we’ve been and where they are currently trading.

Bonds

RYK VAN NIEKERK: You’re bullish on equities. In some emerging markets there are also very attractive bond rates. Is money flowing to bonds?

FEROZ BASA: If I think about emerging-market bonds, you can see South African bonds are trading at very attractive yields. In other emerging markets we’ve seen a similar trend, but those yields come with risk. I think if you look at the fiscal side, from all of these emerging markets, there is risk attached – and that’s exactly why yields are trading at very attractive levels relative to developed markets.

I think the more interesting concept for me is there’s only so much that investors allocate to bonds, and with all these negative-yielding rates around the world, and lower relative rates, the next port of call is obviously equities. And, if you look at equity markets globally, the valuations of emerging markets relative to developed markets are at extremely attractive levels.

Equities and emerging markets

RYK VAN NIEKERK: Let’s talk about the equities again. Where is the money going to? What are the trends in the fund flows?

FEROZ BASA: I think if you look at it, Ryk, if you just take a step back, we’ve seen a very quick response to Covid globally. Monetary authorities have been quicker to react to the pandemic relative to, let’s say, the global financial crisis (GFC), where they still had to work out what they’re going to do. They implemented quantitative easing, where they flooded the market with money by doing asset purchases. At that point in time, I think global quantitative easing stood at $3 trillion.

Currently what we’ve seen now is that global asset purchases are already at $6 trillion. So it’s double what we’ve seen in the GFC, but it’s also at a quicker rate. And a lot of that money has gone into it. It has fed globally into equity markets.

So we’ve seen the US market rerate significantly post-Covid; and even pre-Covid the market was trading at elevated levels.

What we have noticed is that emerging-market flows were not as positive as developed market flows. So, for a long time in emerging markets, up until a month ago, flows were negative. Money was actually leaving emerging markets, and you can see the valuation of emerging markets versus developed markets.

Now what we have seen is that in the last few weeks we’ve started to see those positive flows back into emerging markets as investors recognise [that] global assets, particularly in the US, are trading on very high multiples and emerging markets are looking a bit more attractive and recovering faster from the Covid pandemic.

RYK VAN NIEKERK: Does that apply to all major emerging markets, or is the money actually flowing only to southeast Asia and especially China?

FEROZ BASA: That’s a very good point, Ryk. I think we’ve seen record flows into Southeast Asia. But we are starting to see flows turn, particularly in markets like Brazil, even South Africa.

In the last two weeks we’ve seen net inflows into our markets.

So even in commodity markets, we’re starting to see that turnaround in flows in those markets as well. In South Africa we are dealing with the pandemic much better. Our recovery rate is much higher than the global rate. Even with Brazil we are starting to see those numbers level off, as we are seeing in India as well.

RYK VAN NIEKERK: How does this impact valuations?

FEROZ BASA: If you look at it from a valuation perspective, we like to use the cyclically-adjusted price-to-earnings [PEs] of developed markets versus emerging markets. In simple terms, it tries to take out the volatility in that. So it looks at a normal long-term cyclically adjusted PE. And, if you look at the price-to-earnings ratio of developed markets versus emerging markets, developed markets, particularly in the US, are trading on record levels. So I think if you look at the current cyclically-adjusted price-to-earnings ratio of the US, it is currently at 30 times, versus globally emerging markets currently at 9.7 times. Even if you look at the standalone price-to-earnings ratio, the US is trading on 21 times and emerging markets on 13 times.

So, when you look at the valuation, globally, emerging markets are extremely attractive relative to developed markets – and per se the US, the US making roughly 60% of the global index in any event.


Sanlam Global Emerging Markets Fund

RYK VAN NIEKERK: That is significant. So let’s see what you have been doing recently within your Sanlam Global Emerging Markets Fund. Have you been trading actively? Is the shifting strategy may be due to excessive liquidity?

FEROZ BASA: We haven’t been trading excessively. There’ve been some very good opportunities in the fund and we’ve taken advantage of those opportunities, particularly in the technology space. We took advantage of those opportunities early in the Covid pandemic, and those opportunities have paid off handsomely. But the opportunity set in emerging markets is fine, wide, and the nice thing about emerging markets is that a bank in China, for example, versus banks in India, is totally different. So you have a wide opportunity set, and that gives you so much room to invest in the best high-quality businesses across the globe which are actually growing faster than the world.

RYK VAN NIEKERK: It is interesting to see that the fund’s exposure is dominated by the US; around 40% of the fund is in US assets. Can you explain that?

FEROZ BASA: Those are not US assets. What we tend to do is that we tend to buy ADRs (American depositary receipts). So a company operating in China, but listed on the ADR, just simplifies buying in the US market – for example, Alibaba. Alibaba is a Chinese internet company, and we buy that on the US exchange. So it’s a Chinese company, but it’s just listed in the US. Similarly NetEase [and] a company like Noah Financial Systems; all are listed in the US. So we purchased those ADRs. Remember, like we also maximise on the opportunity set, we have our clients invest in US dollars and we then – instead of taking those US dollars, converting them to Hong Kong dollars [and] buying on the Hong Kong Exchange – we buy the ADRs, which are exactly the same shares as the Hong Kong shares. We buy directly in the US.

RYK VAN NIEKERK: Let’s look at the top 10 holdings of the fund. Right at the top is Alibaba, which you’ve just referred to, which is nearly 5% of the portfolio. And second is Samsung at 4.4%. Interesting choices, especially if you look at the US market, where these companies’ competitors have run extremely hard – Amazon and Apple, for example. Can you maybe discuss the dynamics between, say, investing in Alibaba and not in Amazon, as well as Samsung and not in Apple?

FEROZ BASA: I think those are two very good examples. Alibaba is very similar to Amazon in terms of the business mix. The companies’ returns are also very similar. Alibaba trades on a forward price-to-earnings multiple of 28 times. So, when you look at it in the context of growth for the next three years, if you look at the Bloomberg consensus, what analysts are expecting is around 30% growth per annum for the next three years. So that’s robust growth. And also with Alibaba, you’ve got the upcoming IPO [initial public offering] of Ant Financial – which probably is going to be the biggest IPO globally – trading on 28 times.

Amazon, also a bellwether in the US, a very good company, is also growing earnings at 30 to 35%, so slightly higher than Alibaba, but trades on a 58 times multiple. So Alibaba is almost riding on half the multiple of Amazon, and that gives you an idea of those companies. And when I think about the market potential for Alibaba and Amazon, they are both very similar. So that just gives you an idea of the valuation.

Samsung and Apple are very interesting. For a long time Apple traded, on average, between 14 and 15 times. Samsung is a hardware company with some software and services. Today Apple trades on a forward price-to-earnings multiple of 31 times. You’re paying 31 times forward earnings for Apple today, and the earnings of Apple are not at a low level – I would say a normalised level or slightly above normal – whereas Samsung, although Samsung does have memory, it makes less on smartphones. But let’s compare them, as both companies have significant net cash on their position, and those are where the opportunity sits. Samsung trades on 12 times earnings. So those are two very good examples, two big bellwethers in GEM [global emerging market] versus two big bellwethers in the US, and you can see the differential in valuation.

RYK VAN NIEKERK: Number three on your list is British American Tobacco, at 3.6%. That’s probably a defensive stock. Then TCS Group Holdings. I haven’t heard of TCS – what do they do?

FEROZ BASA: TCS is a very good one. I think, if you look at it, it’s a Russian fintech company. So it’s similar, if I had to use the South African example, [to] Capitec. So it’s just a branchless version of Capitec. Now, having said that, TCS’s return on equity is probably double that of Capitec, but a fast-growing market, a huge market opportunity, very similar companies. TCS trades on a nine times forward multiple. There is a buyout potential coming for this company, but TCS is trading on nine times versus Capitec trading on 24 times. So I think that also just highlights the opportunity set in the emerging markets ex-South Africa. Now, South Africa also looks cheaper on an overall basis, but the high-quality companies are trading on very high multiples and Capitec’s a very good vehicle example versus TCS.

RYK VAN NIEKERK: A noticeable company that is absent is Tencent. Why?

FEROZ BASA: Ryk, that’s a good observation. If you look at Tencent, if you look at the combined exposure to MTN, Tencent it is probably the second-biggest share in the whole portfolio. If you take the combination of Tencent, Naspers and Prosus, Naspers is trading at a 55% discount on a NAV [net asset value] basis relative to its value in Tencent. So we take some of our exposure in Tencent via Naspers, and then also Prosus at a 36% discount. So we do have a very high holding to Tencent in our portfolio, but it’s just split between Naspers, Prosus and Tencent.

RYK VAN NIEKERK: So there is a significant bias toward technology and fintech stocks. Are there other noticeable companies in your portfolio which are not in one of those categories?

FEROZ BASA: Yes, we do have a big exposure to e-commerce and Chinese entertainment. It’s also big in the index, and those are the companies that have done very well of late. Lower down, there we also have significant exposure to other areas; 31% of our portfolio is linked to consumer staples, pharma companies across emerging markets, and food retailers. So there’s significant exposure to those spheres as well. And if you look at some of the exposure in those emerging markets, compared to the developed markets, the multiples are on much lower rates than in developed markets.

RYK VAN NIEKERK: Then let’s look at the performance of the fund. You took over around 18 months ago, so let’s look at the one-year performance. The dollar-denominated fund up 11.3%, the benchmark 14.5%. But the local feeder fund has gained 25.3% against the benchmark of 14.5%. Is it only the rand exchange rate which weakened which resulted in this significant difference in performance?

FEROZ BASA: I think we took over 15 months ago, Ryk. I sent you the latest Morningstar numbers. If you look at our Global Fund, where the bulk of our assets sit, that fund outperformed the index by just on 1% net of fees.

The Sanlam Global Emerging Market Fund returned 20.3% versus the index of around 19.7%. So it ranks us seventh globally. That’s just the ranked returns that we’ve delivered for our clients since we’ve taken over the fund.

The difference between the feeder fund is that the pricing is in rands, and the cash position, and those are totally different. But I think looking at the 15-month numbers is very similar for both funds.

Liquidity

RYK VAN NIEKERK: I’m looking at the latest fund fact sheets [Sanlam Global Emerging Markets Fund and Sanlam Global Emerging Markets Feeder Fund] that were published on the Sanlam investment website. I think many investors would be really happy with this performance.

Let’s get back to the liquidity, which seems to support valuations quite significantly. Do you think that is a risk in the short term – that conditions may change, maybe higher interest rates in some markets? Do you think there’s a bit of an overhang or a future risk that should be priced in?

FEROZ BASA: Look, that’s a very good question, Ryk. We try and focus more on the bottom-up – a stock-specific focus on the bottom up – because the top-down [approach], trying to analyse macro, what’s going to happen with Covid, is there going to be a second wave; those things I don’t think can add value. If you look at central bank purchases around $6 trillion – and you spoke about rising interest rates and those things – if economies don’t recover, how are countries going to be able to raise interest rates. I can’t see it happening. We haven’t seen it in the last 10 years where the Fed [US Federal Reserve], as the economy does better, started increasing interest rates; but they only started doing it when there was a sustainable level of economic activity within their market. So I don’t see that as a big risk.

Having said that, how does the globe get out of all this debt? The only way they can is inflation. So those are things potentially coming down the line, but that would mean economies do recover.

The other thing that’s important globally is around the US dollar. That’s another tailwind for emerging markets. If you look at the US dollar versus emerging market currencies on a PPP-adjusted basis [purchasing power parity], or if you look at them versus their share of global exports, emerging markets are fairly cheap relative to developed markets, and relative to the US. So that could be another tailwind for emerging markets going forward.

RYK VAN NIEKERK: Does that mean that you think the dollar may weaken in future?

FEROZ BASA: Ryk, if I think about the US dollar, they’ve got record central bank purchases. So, if you think about quantitative easing, this is probably at a record level. If I just think about where our currency is trading relative to purchasing power parity, and versus our share of global exports, it tells me that emerging market currencies are undervalued. Now I’m not sure, I don’t know, I can’t forecast currencies, whether in the next year or two they are going to weaken or strengthen,

…but I do know from a valuation perspective and from an economic perspective, that the US dollar is trading at very high levels.

RYK VAN NIEKERK: Feroz, thank you so much for joining me today and sharing your insights. Good luck with managing an emerging market fund with all this noise around. That was Feroz Basa, the head of global emerging markets at Sanlam Investments.

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There are periods in history where negative yielding but safe is better than positive yielding, but far more risky.

This is one of them.

Great to see Feroz in the market – still pushing his EM game? Fails to mention how terrible his Old Mutual GEM fund was managed and subsequently closed down. The under performance in USD vs the Benchmark is telling – there isnt much skill on display.

The rand and other emerging markets will most certainly strengthen. The rand was at R19. Not R16.5. And much more rand strength expected.

So sad to see how ordinary investors have lost money sending out rands at weak levels and already losing out because the rand is getting stronger. They were better off investing in SA.

Very wise remark. I got burned several years when rand went from R6 to R12 to the USD (then recovered back to R6).

Nevertheless that investment in a global equity fund is one of my best investments today. Just took forever to pay off.

If we can restore confidence, the ZAR will provide some new opportunities.

End of comments.

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