Any chance Fundsmith Emerging Equities Trust (FEET ) had of beating its stock market benchmark last year marched out of the door on 8 November.
Two events that day shook the investment trust Citywire AAA-rated Terry Smith launched in June 2014. Firstly, the election of US president Donald Trump sent emerging markets tumbling as investors feared his protectionist, America first policies would lead to a trade war with China and Mexico and a strengthening of the dollar that would suck hot money out of the developing world.
Secondly, and quite coincidentally, India’s prime minister Narendra Modi announced the withdrawal of the country’s largest bank notes – the 500 and 1,000 rupee notes roughly worth £6 and £12 respectively – in an effort to crack down on the black economy.
The ‘demonetisation’ was a huge deal for FEET given the £247 million fund has over a third of its investors’ assets invested in the country, much of it in consumer stocks that reeled from the sudden decline in the amount of legal tender in circulation.
Writing in the trust’s annual results, Smith said the performance of FEET was ‘distinctly different’ before and after 8 November. The previous day FEET’s share price had risen 19% year to date, just behind the 21% growth in the underlying portfolio. After that double blow, however, the trust retreated and ended 2016 with a share price gain of 10.5% and a 12% advance in net asset value, way behind its benchmark, the MSCI Emerging and Frontier Markets index which soared 32.4%.
Smith is sanguine about the short-term Trump effect on emerging markets, pointing out FEET has less than 4% each in China or Mexico, although recognising, ‘When the police raid a bawdy house even the piano player gets arrested’.
The demonetisation had ‘a more direct impact upon our portfolio’, with 35% of the portfolio in Indian stocks. ‘This disruption is hardly surprising given that our companies supply consumer goods in an economy in which 98% of transactions by volume and 65% by value were in cash and over 85% of the notes by value were ‘demonetised’, leading to a large and immediate, albeit probably temporary, shrinkage in purchasing power,’ said Smith.
He said the problem was exacerbated by the fact that a large proportion of Indian consumption is from ‘informal retailers who rely upon wholesale distributors and transact in cash using the high denomination notes and maybe haven’t been declaring all their income’.
The result of India’s reform was ‘still uncertain’ but Smith felt it would be positive ultimately with more government spending, lower interest rates and a fairer tax system.
‘It certainly seems likely to favour the modern retail channel in which branded goods are supplied to consumers by manufacturers through retailers who rely less upon cash payments,’ said Smith. ‘If so, our portfolio companies in India should benefit.’
Over 2016 the portfolio turnover was 38%, which Smith (pictured) said was ‘higher than we would ideally like it to be’ but the breakdown of the trend over the year – with 30% in the first half and 10% turnover in the second half – ‘worth noting’.
The biggest change was the sale of Jollibee Foods, a fast food operator in the Philippines, although all the other sales following three main themes. ‘[The first was] reducing our exposure to China even further, we sold Hengan, Sun Art and Want Want, and switching into companies which we believe have better prospects such as Dali Foods,’ he said.
The sales also reduced exposure to Nigeria, which has seen its currency devalued, and Smith got rid of companies which had engaged in acquisitions in mature, developed markets.
Smith managed to buy ‘our long-sought-after holding in Vinamilk, Vietnam’s dominant dairy business’ and also started a position in Kimberley-Clark de Mexico, the tissue manufacturer’s Mexican subsidiary.
He also started a holding in Olympic Industries, Bangladesh’s leading biscuit manufacturer, and Jyothy Labs, India’s leading manufacturer of fabric whiteners.
‘We hope and expect turnover to gravitate towards or below the second half level, although it is somewhat dependent upon events,’ he said.
Having traded at a small premium above NAV for most of the past three years, FEET shares have fallen to a small discount of less than 1% under NAV in the past month.