The life of an emerging market fund manager is nothing short of dramatic under normal circumstances. It’s a world filled with political noise, a constant stream of political drama that often gives both fund managers and clients something to worry about.
Most of the queries, concerns and questions we receive have something to do with some “political” event that’s just occurred. Over the past few years Brazil’s president has been impeached, South Korea’s prime minister is undergoing her own impeachment trial. The Turkish prime minister is seeking authoritarian powers after the failed coup attempt. South Africa’s own government has been at war with itself and, well, then there is Russia, so you get the picture. All this political noise creates great investment opportunities for investors like us. We thrive in environments where markets discount great businesses to highly attractive prices for us due to perceived uncertainty. Especially when this uncertainty has nothing to do with the underlying fundamentals of the companies in which we invest.
2016 was the year we were introduced to the concept of political risk in the developed world. First with Brexit then with the man that’s currently dominating water cooler conversation or as the millennials would say “trending on twitter” – President Donald Trump.
A question we often get asked is: What effect will Donald Trump’s America-first policy have on emerging markets?
Before we gaze into the crystal ball, in investing it often helps to look back in history. Trump’s primary rhetoric has been directed against globalisation, with the ambition of bringing jobs back to America – with a particularly keen interest on bringing back manufacturing jobs.
Let us look back at the fascinating history of US manufacturing. Manufacturing as a percentage of GDP and manufacturing employment peaked in 1953. Therefore manufacturing in the US and its employment has been in decline for 64 years.
President Trump is trying to reverse a 64-year trend in his first few weeks in office. Digressing a little, it’s fascinating to note that global manufacturing as a percentage of GDP has also been in decline. Mexico’s manufacturing peaked in 1987 at 27% and bottomed out at 16% in 2010 before rising to the current 18%. Even China, the world’s leading manufacturer has been in decline since 1978. So what is the issue here? The world has changed and President Trump seems to have failed to acknowledge this. The list below reflects the largest companies in the US in 1960 and at present day. The largest companies in the US in 1960 were heavy industry companies in the auto, steel and oil industries.
60 years on and the same S&P 500 Index is dominated by companies that manufacture very little. They are marketplaces, social networks and new economy companies. You have to work very hard to find heavy industry companies that are thriving in the US these days or for that matter in the rest of the world.
Now take time to refer back to the Wall Street Journal’s headline. We suspect there could be some truth in this headline: When Presidents Defy Economic Gravity, Gravity Usually Wins – WSJ Headline on Donald Trump.
Ultimately our job is not to speculate on the economics of the murky world of politics. We are bottom-up fundamental investors and hence our expertise is in the detailed analysis and understanding of specific companies. Specific company examples always add context, therefore let us take a look at a few.
Apple is the largest, fastest-growing and one of the most-loved companies in the world. President Trump has spoken extensively about Apple moving some of their production facilities back to the US.
Globalisation has resulted in the global consumer gaining access to better quality products at lower prices. To be able to deliver these products efficiently, companies have developed intricate and complex yet highly efficient global supply chains that have been engineered over decades to deliver quality at the best price.
In the Old Mutual Emerging Markets Fund, our clients’ funds are invested in companies that participate in the Apple supply chain, it is thus very important for us to pay close attention to any activity related to Apple’s supply chain. One such company is Taiwan Semi-Conductors (TSMC). TSMC is the largest independent semi-conductor foundry in the world. One product they exclusively manufacture is the A10 chip, which effectively runs Apple’s latest flagship phone (iPhone 7).
What’s fascinating about this Taiwan-based company is that it employs around 45,000 employees. Around 19,000 of these employees have at least a Master’s Degree or a PHD. A further 12,000 have a bachelor’s degree. TSMC’s highly skilled staff produce chips that operate the products at the leading edge of human ingenuity and innovation. The idea of moving TSMC’s capability to the US should prove to be a little more complicated than simply sending a tweet. Mind you at the unemployment rate of 4.8%, the US is pretty much at full employment (with the unemployment rate of college graduates at 2.5%). President Trumps call for jobs in the US is thus peculiar. TSMC spends about US$10bn annually on enhancing research & development and manufacturing capability. Can you imagine how much a US company would have to spend today to replicate this capability?
On the back of Apple devices is a telling inscription. “Designed by Apple in California. Assembled in China”. Two sentences that abbreviate a very complex supply chain. Our analysts have travelled to Taiwan, China and Korea several times to visit the facilities of these companies. We’ve spent many hours interrogating the management of over 30 companies in the mobile telecommunications arena. Largan Precision for example is one of the Taiwanese companies we’ve spent extensive time with. They design and manufacture advanced camera modules for high-end phones. Their latest innovation is the dual camera as seen on the iPhone 7 plus. Apple dedicated a large segment of their product launch to profiling the advanced photographic abilities of this camera. Dual Camera capability is an innovation originated in Taiwan, through significant R&D spend.
Catcher Technologies is another company in the Apple supply chain. They specialise in the manufacture of casings (basically the outside of an iPhone). Walking around their factory is a fascinating experience as we had completely underestimated the complexity of making the covers for these high-end phones. To us, the casing was merely a commoditised product that could easily be replicated in China. There are only three approved casing manufacturers globally in the Apple supply chain and this for good reason, it’s a highly complex process. Then finally all these components are sent to Hon Hai for assembly. This is possibly the simplest part of the value chain that could be replicated in the US. However, we should bear in mind that it’s assembled in China for economic reasons (very cheap labour). Last year the same Foxconn (a subsidiary of Hon Hai) replaced 60,000 factory workers with robots. Therefore these are probably not the kind of jobs the president is talking about.
During times like this, we like to refer back to our investment philosophy. We seek to invest in quality companies in emerging markets, trading at attractive valuations with sound corporate governance. Our disciplined adherence to this philosophy has allowed us to generate pleasing returns on behalf of our clients and thus we will continue investing in accordance with our philosophy.
We are unable to predict the future. Therefore our firm belief is that if we buy strong businesses (with proven sustainable competitive advantages), at attractive valuations and with sound corporate governance, they tend to withstand crises and continue growing their earnings over the long run.
Whether Trump adheres to his policies and what that means for emerging markets is thus of far less importance to us than our assessment of the strength and competitive advantages of the companies we invest in.
In short – we believe that strong, quality businesses with attractive valuations TRUMPS all other considerations
This article was originally published by Old Mutual. Siboniso Nxumalo is the boutique head for global emerging markets at Old Mutual. Sharief Pansarey is an investment professional for global emerging markets at Old Mutual.