Emerging Markets – Q2 2022

The Pender Emerging Markets Impact Fund began operating in April and this represents our first quarterly commentary.

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The second quarter broadly saw drawdowns in equity markets as investors anticipated weaker global growth in the coming quarters as developed market policymakers raise interest rates to tame inflation. This contrasts with the dynamic in many emerging markets, where inflation remains manageable.

Policymakers are far more advanced in their tightening cycle and, in certain economies, are already easing.

The current trend of US interest rate increases, as well as the recently announced reduction of quantitative easing, are both needed to better control the significant liquidity still flowing in the economy. The psychological outcome of volatile markets and higher rates are already containing demand. At the same time, we are seeing a response from the supply side to raise production levels to meet demand. While we subscribe to the notion that inflation will reach higher-than-anticipated levels in the near term, we are not likely to see inflation expectations get carried away by investors. With inflation likely peaking in the short term, and markets already beginning to discount slower economic growth, we believe this bodes well for the global macroeconomic picture and, in particular, for emerging economies.

The current state of the market has created uncertainty in the near-term outlook and led to volatility. This has been an opportune time for the Fund to invest and take advantage of the many opportunities to buy strong emerging markets’ businesses at low valuations. Our fundamental research process aims to identify long-term compounders with business models that have and, we believe, will continue to exhibit sustainable economic profitability over time. We are looking at an investment horizon of 3-5 years and are excited about the opportunities we are finding to build a portfolio of companies that we believe are long-term wealth creators.

At the end of June, the Fund had 21 holdings across a variety of emerging market jurisdictions with exposure in sectors such as Communication Services, Diversified Financials, Information Technology, Consumer Discretionary and Consumer Staples. Holdings in these sectors represent over 50% of the Fund’s mandate. From a geographic perspective, our largest weights are in China, Indonesia and India and these countries make up about 40% of the portfolio. Our investment strategy is not based on targeting specific sectors or country weights. Weightings are a direct outcome of our bottom-up security selection process. The resulting portfolio is concentrated what we believe are the best opportunities across various sectors and countries, and we view this is a better approach to the vast universe of investment opportunities in emerging markets.

The positioning of the Fund derives from our research, which shows us that despite the uncertain macro trends globally, opportunities abound in these deep and broad markets to add value through fundamental research and security selection.

An example of a business that demonstrates our process well is PT Sarana Menara Nusantara, Tbk. (IDX: TOWR). The company owns and operates telecommunication towers for wireless operators in Indonesia. It leases space at its multi-tenant towers for wireless operators under long-term lease agreements. In addition to having a predictable revenue stream from existing tenants, the company also has growth potential from incremental revenue earned through co-location or higher asset utilization from more rental agreements on the same tower. The company has benefited from increasing demand for wireless data, creating the need for more towers and fibre optic connections.

Sarana Menara Nusantara has many positive attributes: high and sustained return on invested capital, long-term revenues with minimal customer churn, high margins and operating leverage, as well as significant growth opportunities. For these reasons, we view it is an attractive investment and is one of the largest holdings in the portfolio.

Clicks Group Limited (JSE: CLS) is another example of a company we bought in the portfolio in the second quarter. The South African retailer operates a health, beauty and pharmaceutical network of approximately 840 stores in the country. The company has consistently grown revenues at a high single- digit or low double-digit pace over the last five years through a combination of same-store sales growth and new store openings. The company has converted this to elevated and consistent returns, creating significant shareholder value over the long term. It squarely fits the definition of a long-term compounder, which we believe can continue for many years.

As we look forward to the second half of the year across the broad investable universe we cover, we are already seeing important and strategic decision-making at play from well-managed companies operating in these economies. With macro-dominated headlines grabbing the markets’ attention, we will continue to focus on the company-specific drivers that we believe lead to long-term value creation for shareholders. We are tried and true bottom-up investors and our decades of experience in navigating market cycles keeps us focused on the company-specific factors that matter most. The opportunities we are finding today make us confident in our belief that these challenging times will pass and the quality businesses we target will come through stronger.

We look forward to keeping you updated in the months ahead.

Patricia Perez-Coutts, CFA and Aman Budhwar, CFA
July 20, 2022