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Charlie Wilson B. G., Opalesque Geneva: In part II (of II) of this interview, Charlie Wilson, co-manager of the Thornburg Developing World Fund, describes the investment shifts his portfolio has made of late, including a shift away from Russia and towards China and Latam, and a steady increase in financials, consumer discretionary and technology. He also talks about market pessimism and investors' reactions towards emerging markets (EMs).
You can read Part I of the interview here.
Opalesque: What investment shifts have you made in terms of geography?
Charlie Wilson: The primary shift that we have made over the last six months or so has really been a reduction in our exposure to Russia.
Our stock selection process is focused on businesses that have a dominant position in the markets or value chains, so from a commodity producer perspective, we look for low-cost producers that might have a resource base that is definitively better than the rest in the industry. We look for the best commodities from lower-cost producers.
Unfortunately, last year the best opportunity set for companies in extractive industries was in Russia. They are the stand-out leaders in oil, gas, mining, etc. So, most of our commodity exposure was in Russia. That has been a long-term holding for us. We have benefited both from stronger commodity prices as well as dividends.
Furthermore, Russian companies that want access to global markets have done a great job on the ESG side. They have made great strides, making sure they have independent boards and professional management teams. Those were the kind of companies we were trying to align with.
Sadly, the war broke out. It was unexpected to us as we had expected a diplomatic solution in this case. Once we realised we were going to see an armed conflict, we decided to exit our Russian positions. Fortunately, we were able to exit all Russian positions before the markets froze. We re-allocated much of that capital to other commodity producers around the world located in places such as Thailand, Brazil, and India.
Opalesque: So out of Russia and into...?
Charlie Wilson: We also made minor changes in positioning: as China continues to struggle to reopen, the stock prices there became more and more attractive, so we continued to add to our favourite China holdings and established some new holdings. We saw several opportunities that were sensitive to re-opening in China or general economic recovery. Secondly, as the LatAm markets continue to lag, we have continued to add to some positions there both on the domestic cyclical side in the expectation of recovery and in the big commodity producers I mentioned.
On the other side, India has been a stand-out in terms of valuation. Markets and valuations continue to remain at all-time high levels. So that has become increasingly less attractive, especially in a high commodity price environment. They don't benefit from high commodity prices because they are primarily an importer of commodities, so we have seen inflation starting to pick up a bit.
Opalesque: What about your exposure to financials?
Charlie Wilson: We have noticed increasingly attractive opportunities in financials, partly tied to interest rates moving higher globally. That usually benefits banks that have good deposit funding - typically banks that have focused on strong deposit franchises and usually have the lowest-cost funds in the system.
Also, over the last year, capital market activity has slowed substantially for a variety of reasons. Some of them are country-specific, and some of them are more global-market related. So, we have seen some good opportunities in businesses that are more tied to capital markets activity, for example, the equity and fixed income exchange in Brazil known as B3. We also own the Charles Schwab of Brazil, named XP, which is a digital online brokerage platform.
Longer term, financials have been a consistent overweight for us because we are very optimistic about the financial inclusion theme and the penetration of additional financial services in the many EMs.
Opalesque: And your exposure to consumer discretionary and technology?
Charlie Wilson: We quite frequently have an overweight in consumer discretionary and that is the case right now. Many emerging markets have yet to recover fully from Covid, partly because vaccinations were delayed getting off the ground. So there are some very early-cycle consumer discretionary-type stories. A good example is Tata Motors in India; they have a large domestic commercial and passenger vehicle business in addition to owning Jaguar Land Rover, so a big part of this is the recovery of the India business which is starting now.
We have also been overweight on technology for the last couple of years. Part of that was taking advantage of the shift to the work-from-home world which required additional consumer electronics. Part of that was a 5G upgrade cycle. Another angle to it is many traditional businesses recognized the need to move to the digital world. So, we own two IT services companies that we previously sold for valuation reasons last year but recently repurchased.
Opalesque: How are EMs affected by Russian oil?
Charlie Wilson: Several emerging markets have partnerships with Russian producers. There are several Indian oil companies that also jointly own assets with Russian producers. The refineries in India do purchase Russian oil and they don't stick to the same international standards with respect to purchasing Russian commodities that others do.
That has been a benefit in the past and I think it will be again; it tends to be temporary because at some point the Russian suppliers will find a home closer to market prices. So now is a short-term period of over earning but this is not a prolonged event. A Chinese gas distributor recently told us they have access to Russian gas via a pipeline and they are seeing the benefit of that short term in their margins. That will even out over time.
Opalesque: How is market pessimism affecting EMs?
Charlie Wilson: It really feels like a lot of pessimism is baked into the markets at this point. Any dovish hint that the Fed throws out, markets skyrocket. If we see any type of turn and inflation - or just even a plateauing of prices - in the US or globally, that's enough to change perspectives.
One of the things that may not be apparent is that the inflation basket for emerging markets is much more tied to commodity prices. Commodity prices actually had easier comps in the second half. So many EMs are expecting inflation to normalise fairly early, towards the first half or the middle of next year. This gives central banks a lot of wiggle room to start to cut interest rates. Because they were aggressive in raising interest rates early on, EMs are also in a good position now to see the benefits of lower interest rates if inflation does in fact peak and fall.
Opalesque: How are investors reacting?
Charlie Wilson: Many people view EMs as risk, regardless of the starting point. This year, I remind investors of the period of 2004-2007 when US interest rates kept on moving higher, inflation was higher than normal globally, and EMs massively outperformed developed markets, specifically the S&P. The current environment feels a lot like that.
The broader argument is the starting point matters: valuations in EMs are very low and attractive and in some specific cases, markets like Brazil are at an all-time low. Then there is a backdrop that benefits some EMs and interest rates are already very high, which protects, and at times, strengthens the currency. That does not even take into account the longer-term tail winds around the rise of the middle-class within EMs, which is expected to double this decade.
If you go back to the global financial crisis of 2008, EMs bottomed about six months before developed markets. It feels like there could be a similar setup here because they are perceived as such high risk. This is good timing to be invested in emerging markets.
You can read Part I of the interview here.
Past Big Picture articles here:
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