Trustnet - Fundsmith’s O’Brien: Emerging economies’ growth to outpace developed markets despite coronavirus

by Abraham Darwyne | May 29, 2020
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Fundsmith emerging equities trust manager Michael O’Brien believes companies selected with the Fundsmith ethos will still ultimately benefit from the trends that drive emerging market growth.

Emerging markets are likely to come out of the coronavirus crisis in a stronger position than their developed world counterparts, according to Fundsmith’s Michael O’Brien.

Emerging markets were not spared during the coronavirus sell-off that caused investors to rush out of riskier assets as there was a fear that they were more vulnerable given the comparatively less government support some of these had during an economic shutdown.

Both developed and developing economies are starting to emerge from their Covid-19 lockdowns and O’Brien, manager of the £260m Fundsmith Emerging Equities Trust, believes growth in emerging economies will exceed that of the developed world.

“We continue to have the view that growth in developing economies in the medium to long term will continue to outpace that in the developed world, and given the large debt burdens developed world governments have taken on to deal with the pandemic, this divergence is likely only to increase,” he explained.

 

Government support often comes with strings attached, as seen in the UK with banks being asked to suspend dividends and authorities expecting changes to corporate governance behaviour, so O’Brien suggested the lack of support could be advantageous.

“Emerging markets have not seen the levels of government support for private businesses as developed markets have, so we do not expect the same constraints,” he said. “To put this into perspective, four of the five companies we own which are focused on China have recently declared increased dividends.”

Fundsmith Emerging Equities Trust applies the same investment philosophy as Terry Smith uses on the highly successful Fundsmith Equity fund, investing into quality-growth companies but into emerging markets.

O’Brien, who took over the day-to-day running of the portfolio from Terry in May of last year, believes this Fundsmith ethos is suited to developing markets. “Developing countries have increasing populations which are getting richer and developing the demand for either premium products or the development of new industries and sectors,” he said.

“The businesses which we own are typically long established and well placed to benefit from the trends which will drive emerging market growth.”

He added that during the outbreak, the trust did not deviate from the three-step investment process of ‘buy good companies, do not overpay and do nothing’.

“A sudden shock to the economic system in our view vindicates our investment process,” he said.

“The worse a company is, the weaker the control it has on determining its own outcome, something which in a severe economic dislocation is effectively taken outside of its hands.

“Good companies will typically have the financial strength to withstand sudden shocks, the ability to adapt to rapid changes in customer behaviour and the reassurance provided by prominent brands.”

The manager said many of the companies in the portfolio have no net debt and therefore a degree of headroom when managing the impact of the pandemic, and that this ultimately supports their ethos.

“We believe that there will be three main outcomes from the pandemic which will help the type of company which we invest in: consolidation, formalisation and digitalisation,” he added.

“Whereas most of the companies we invest in were benefitting from at least one of these trends, the aftermath of Covid-19 will see a major acceleration in these trends. As we are long-term investors focusing on quality businesses which we believe can compound returns well into the future, we actually used the market sell-off in the first quarter to start two new holdings.”

 

Over 2020, Fundsmith Emerging Equities Trust is down 4.09 per cent compared with a fall of 18.52 per cent from its average IT Global Emerging Markets peer and the MSCI Emerging Markets index’s 9.16 per cent drop

O’Brien said that given the resilient nature of the business models of the companies in the portfolio and their focus on products that serve an everyday need, he feels he has a good idea how those businesses will perform once the immediate Covid-19 impact has passed and has confidence in their valuations.

The trust has 43.1 per cent invested into Indian equities and has been consistently overweight in Indian companies since it launched in 2014.

O’Brien said this was not a macro view on India and its economic reforms, “but instead a reflection of India being a repository of some very high-quality businesses encompassing not just consumer goods but healthcare and technology”.

He added: “We have invested across listed multinational subsidiaries, nationwide companies and regional businesses in India, all of which have attractive business models, market positions and returns”.

However, the manager conceded that the strategy has not lived up to expectations and said it typically was a result of either currency, regulatory or macroeconomic risk, or because of companies where innovation has lagged.

“These are areas which we are actively striving to mitigate,” he said.

Over recent years the net inflows into passive funds in emerging markets and net outflows from active funds has been a headwind for the trust and O’Brien said that that a move into more actively managed funds would be welcome.

Data from FE Analytics shows Fundsmith Emerging Equity Trust has returned 5.67 per cent since inception compared with 4.42 per cent from the Global Emerging Markets sector and 41.35 per cent from the MSCI Emerging Markets index.

The trust has ongoing charges of 1.40 per cent of total assets and is trading at a discount of 12.7 per cent to net asset value (NAV).