Jonas and Adi, once again thank you for making time and for being here with us. I have observed a trend: generally, in the short-term – over a year or so, when net capital flows in emerging markets (EM) are negative, they are followed by extended periods of positive net inflows into EM assets. So, we may be at the start of a cycle where capital flows may return to the EM universe.
Q. With this backdrop, I would love to understand your perspective on why we should invest in the Ivy Emerging Markets Equity Fund?
- Pure EM focus: With rare exceptions, we are mostly invested in companies that are in emerging markets because we find ample opportunity there. So, we don’t see the need to invest in U.S. or European companies, which is to say, outside of our area of expertise anyway. Also, when beta for emerging markets becomes favorable, our strategy provides the exposure that our investors expect from us.
- Disciplined bottom-up stock selection: Ivy has a long track record for being a bottom-up fundamental investor. We depend on our deep bench of global equity analysts. In normal times, we travel around the world to do our due-diligence process, which is now all virtual and is equally efficient. Given the wide opportunity set in EM, we spend around 70-80% of our time on bottom-up research.
- Top-down macro overlay: The macro overlay helps us understand different themes across the countries in EM and, importantly, manages risk in the portfolio. Our investors are mostly U.S. dollar based, so it is important for us to consider not only the stock market beta of the EM countries we invest in but also the currency beta. Our top-down approach is a combination of science and art – where we depend on quantitative and qualitative inputs to drive our country research.
- Concentration in areas of high conviction: We have a concentrated portfolio and have our highest active weights in ideas with the highest conviction. Our portfolio has 50-80 investments, where we see a long runway for growth.
- Flexible approach: Philosophically we lean towards growth companies, but we are opportunistic and invest in cyclical stocks when fundamentals and valuations align. We believe our approach serves our investors through multiple market environments. During the pandemic, we took advantage of volatility in the financial markets. We were presented with an opportunity to invest in companies whose stocks suffered. For example, we invested in copper miners, travel companies and select consumer durables. We expect these investments to generate alpha as the coronavirus gets beaten.
Figure 1: Ivy Emerging Markets Equity Fund has exhibited strong returns
Overall Capture Ratio
Source: Ivy Investments, Morningstar data as of 10/31/2020. Data is percentile rank amongst the Morningstar peer group. Past performance is no guarantee of future results. Morningstar Ranking / # of Funds in category displays the fund's actual rank within the US Funds Diversified Emerging Markets Morningstar Category. Return: 1- , 3- and 5- year rank: 45/801, 142/736 and 81/681, respectively. Batting Average: 1- , 3- and 5- year rank: 26/801, 47/736 and 57/681, respectively. Overall Capture Ratio: 1- , 3-, and 5- year rank: 60/801, 153/736 and 81/681, respectively.
Q. There are EM funds that invest in developed international and North American equities as an alternative way to access EM growth. These strategies have had a tailwind due to these exposures. Why do you think a pure EM focus is a strength?
Adi: Emerging markets have evolved considerably over the last decade. EM of late 1990’s and early 2000’s had a significantly higher weight of cyclical growth opportunities. But today’s EM, offer considerable secular growth opportunities. For example, in technology there are great companies to invest in across the EM universe. We believe that today’s EM offers good risk/reward based, less-correlated returns. However, in our view, the MSCI Emerging Markets Index has not evolved as fast as the countries. We believe EM is an inefficient asset class that good active managers can exploit to generate strong risk-adjusted returns.
Figure 2: Evolution in EM: Consumption trends across US and China
Source: World Bank, Ivy Investments. Annual data: latest available until 2018
Q. The start of the week (11/9/2020) was an interesting day for financial markets – with Pfizer vaccine news – value outperformed growth. It might be too soon to ask, but what changes are you thinking of making in the portfolio?
Jonas: In our strategy, we focus on companies that can perform through market cycles, focusing on 3-5 year time horizons. They are based on secular themes that are underpinning growth and evolution in EM countries. These themes include but are not limited to - internet penetration, rise in middle class consumption, increase in health care expenditure. While some of our investments in the portfolio clearly benefitted from pull forward of trends during the pandemic, generally, we owned these based-on fundamentals prior to the pandemic.
With that, over the past few months, we have been trimming some of these positions (companies such as MercadoLibre, JD.Com etc.) as valuations of these holdings may be reaching the higher end of our targeted range. We are long-term valuation sensitive investors and we patiently wait for opportunities that, we believe, have compelling valuations and favorable risk-reward dynamics for our investors. We are monitoring the rotation from growth to value. We have seen short-term rotations like this in the past so it is difficult to say if this will be a sustainable change in the markets.
Q. In the portfolio, there are some large allocations to certain industries. Tell us more about the concentration in the consumer discretionary sector (as of 9.30.2020, we have 9.3% overweight in this sector) and which other areas/sectors might be the future in emerging markets?
Adi: The consumer space offers an interesting backdrop for investing (see figure 2 above). The consumer and consumption driven economies in China, India, and Brazil are good environments for bottom-up stock pickers to find companies that have innovative consumer platforms, are leveraging strong brands and have good backdrops for growth.
Figure 3: Value add from the sports industry continues to rise in China
Source: Source: Ivy Investments, Bloomberg. Past performance is not a guarantee of future results.
In China, the middle class is growing. They are now number one or two in global appliance sales, apparel sales, alcohol sales, etc. In this environment, we believe companies with strong brand value could be big winners with a huge addressable market.
For example, like in the U.S., athletic wear is gaining popularity in China (figure 3 above). Li Ning is a company we have invested in to seek to take advantage of the rising middle class and increase in expenditure on higher quality athletic apparel. In our view, Li Ning is like the Nike of China. It’s a sporting goods company with a focus on apparel and footwear manufacturing. The company is the second-largest domestic sportswear player in China, with 6.3% market share in 2019.
Due to the rise of the middle class, athletic apparel in China is experiencing, what we believe is a long-term sustainable trend. With Li Ning, we believe we are able to leverage the “wealth affect” in China as the young wealthy Chinese spend more on higher end goods.
In our view, the company has transformed itself as a result of management's efforts to improve products, channels and retail capability. After recording an earnings loss in 2012-15, Li Ning's core earnings turned around in 2016 and doubled in 2017. We believe a lucrative backdrop combined with the above-mentioned efforts would continue to pave a long runway for growth for the company.
Jonas: In other opportunities, I want to talk about a Taiwan based mature company – Taiwan Semiconductor Manufacturing Company (TSMC). TSMC manufacture semiconductor chips that are a key part of the global supply chain and it remains a stock with steady compounder characteristics in the technology ecosystem. TSMC acts as the foundry of the world and it enables most devices that have silicon inside, including smartphones, servers, automotive electronics, industrial automation, PCs and tablets, and many more. As silicon intensity rises, TSMC benefits with its diversified manufacturing strategy, its dominant market share advantages (>60%), its execution in node transitions (7nm/5nm/3nm and beyond), and its sustainable capital allocation. The company continues to invest in the future of technology. In our view, TSMC’s business model deserves a higher multiple that more appropriately reflects the growth potential for investors.
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Past performance is no guarantee of future results. The opinions expressed in this commentary are those of Ivy Investment Management Company and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through Nov. 11, 2020, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. It should not be assumed that investments made by any Ivy Investment product will match the suggested performance or character of the investments discussed in this commentary. Investors may experience materially different results. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Any securities discussed herein are presented in a fair and balanced manner and were chosen based on objective, non-performance-based criteria, and securities discussed may or may not be held now, or in the future, by any Ivy Investment product. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.
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Risk factors: The value of the Fund's shares will change, and you could lose money on your investment. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Investments in countries with emerging economies or securities markets may carry greater risk than investments in more developed countries. Political and economic structures in many such countries may be undergoing significant evolution and rapid development, and such countries may lack the social, political and economic stability characteristic of more developed countries. These and other risks are more fully described in the Fund's prospectus.
Top 10 equity holdings as a percent of net assets as of 09/30/2020: Taiwan Semiconductor Manufacturing Co. Ltd., 9.2%; Alibaba Group Holding Ltd. ADR, 8.4%; Tencent Holdings Ltd., 8.2%; Samsung Electronics Co. Ltd., 6.9%; Reliance Industries Ltd., 3.3%; Yandex N.V., Class A, 2.9%; Midea Group Co. Ltd., Class A 2.8%; JD.com, Inc. ADR 2.6%; Li Ning Co. Ltd., 2.5% and MercadoLibre, Inc. 2.5%.
The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.