Emerging Markets Equity Opportunities
Achieving Impact in New Growth Markets
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Emerging Markets Equity Opportunities: Achieving Impact in New Growth Markets
Craig Churman: Emerging markets equity opportunities. We’ve been talking about this subject at great length within our firm for the past few months, and as you know, we did a webinar a month or so ago that talked about the global debt market and particularly emerging market opportunities. So, this time we have Monem Salam who’s an Executive Vice President and a Portfolio Manager for the Developing World Fund among other strategies he runs for the firm. And Levi Zurbrugg, who you recall was a key contributor and developer of our Amana Impact Report, which this time, the 2020 report included information about the Developing World Fund and how we achieve impact in that strategy. So, this is Craig Churman, I welcome you to our call again and look forward to the discussion. Emerging market investment opportunities have been both interesting and curious and challenging over the last few years and Monem and Levi will both share some of their insights really from the last couple of years and even looking back ten years, the strategy we run has been run for 11 years or so. It’s done very well, Monem and Levi and Scott Klimo had a really good last half of the year, and then that Fund has performed well. I wasn’t surprised because it’s been front of mind, the Amana Developing World Fund was developed in 2009 and Monem took it over as the full portfolio manager about a year ago. So, I’d like to introduce Monem and let him talk a little bit about the strategy that we run as we tee up some other conversations that will include the dollar and strength and weakness of the dollar and maybe topics around China... which, when you’re talking about EM, is top of mind with a lot of our clients. Thank you, Monem, for joining us.
Monem Salam: Yeah, thank you, Craig. And thank you, everyone, for joining the conversation. I just wanted to kind of give you a little bit of a brief highlight of the Fund itself. We do have a retail class and an institutional class. We started the Developing World Fund back in 2009 just as a diversification tool for the Amana Fund family that we have. At that time, we only had the Growth and the Income Fund. And, you know, although the Growth and Income Fund are allowed to have a little bit of exposure outside the US in the developed world, really taking advantage of the emerging markets was somewhere we felt, in the long run, it would actually work out really well. But, you know, timing is everything. So, the last decade or so, you know, the emerging markets really haven’t gone anywhere. Pretty much been flat on an annual basis. But I do feel, and we’ll get into this a little bit more, there are certain trends that are happening now that I feel, or we feel, actually, will show that the next decade is probably going to be very similar to what happened in the first decade of the century. Like I said, so established in 2009. Portfolio managers... you know, Scott Klimo ran the Fund for a very long time when I went to Malaysia, and when I came back two years ago, I took over, last year. And then, Levi also provides good complimentary services to me. I mean, he knows the emerging markets and also the ESG space really well. It is a Shariah compliant fund, so you know, the idea is that we are staying away from the sin stocks. So, we don’t get involved with anything dealing with alcohol or tobacco, gambling, pork products, insurance, those things. And the other thing is that we also have financial ratios that we keep and then, thirdly, it’s also the ESG criteria. And the ESG criteria not only looks at the negative side of it, which it’s kind of complimentary to the Islamic side. But also, there are positive screens that we look at. And here, Levi will talk in a little bit more detail later on in the presentation. But we’re looking for strong performers when it comes to recycling, when it comes to resource efficiencies, production of greenhouse gases, community labor relations, safety, and then on the “G” side, board diversity, business ethics, and those things as well. So, those are the types of things that we look at along with... it’s an integrated process when an analyst looks at the companies. So, it’s not only about the fundamentals but it’s also about the Shariah and the ESG criteria as well. One of the unique features of our Fund, also, is that we are able to invest in companies no matter where they are traded in the world as long as over 50% of either the production, assets, or revenues come from developing countries. So, if you look at, you know, at the holdings in the Amana Developing World, you will find companies that are domiciled in the US and traded in the US but when you dig a little bit deeper, you realize that either through exposure into Asia or other countries or other emerging market countries, they have significant amount of revenues or production assets in emerging markets. So, we’re able to take advantage of that as well. And then, the last thing that I wanted to mention regarding... this is one of the unique features of the fund, is that we don’t have very heavy China exposure and actually, we don’t have any direct exposure into China when it comes to trading on the Shenzhen or any other markets in China itself. So, how we access China is through Hong Kong and through ADRs in the US. And we made a call that, you know, especially when it comes to governance, you know, there’s a lot of opaqueness in China, especially for those companies that are trading only in China itself. However, you know, the depth of the market in the US, obviously, with regulations, is at a higher standard and so is Hong Kong. Hong Kong is one of the developed markets and is something that regulations are very, very strong when it comes to governance reporting, accounting, those type of things. So, that’s kind of giving you just a little bit of an idea of the features of the fund. We are, as Craig alluded to in the beginning, very bullish in the next coming decade for the Amana Developing World.
Craig Churman: Yeah, and Monem, we don’t really track benchmark... we’re not really benchmark managers. And one of the discussions that we’ve had in the past is there was a heavy weighting in some of the countries toward traditional financial institutions. But I think you’ve been able to find some other financial institutions because we have more of a weighting in finance compared to some of the other Amana Funds. And we can talk about that later.
Monem Salam: Yeah, I mean I can just mention quickly. You know, traditionally in the emerging markets, there have been, you know, the largest companies with the largest market cap and liquidity have always been in four different industries. There was a bank, there was an insurance company, there was a telecommunications company, and usually a natural resource like a fossil fuel company or oil and gas exploration. So, if you look at it from the Amana perspective... you know, banks would be out. Insurance would be out because of the riba reasons. Typically, the telecommunications would be out, not always but typically would be out because of debt. And the last one, oil and gas, because we are fossil fuel free, that would be out as well. So then, where do you turn to do that? So, that was, you know, one of the factors we looked at but luckily, and we’ll talk about this later, there has been a shift in emerging markets as to what the dominant industries are. What helps, also, in our space, is that there are now more Islamic banks that are actually trading publicly, whether they be in the GCC—the Gulf Cooperation Council—in the Arab world, in Malaysia, in Indonesia, there are more opportunities for us to have exposure into financials that we probably didn’t have ten years ago.
Craig Churman: And I would also add that, you know, you were in Malaysia for six years so you got a lot of first-hand experience in the melding of Islamic finance and ESG and also visiting those countries and companies where we found investment opportunities that you’ve been able to parlay into this Fund, now.
Monem Salam: Correct. It’s been really exciting. It was an exciting time for me to be there and learn and really, you know, I guess, in hindsight, prepare myself for coming back and doing the Developing World Fund. There’s a lot of, you know... a lot of understanding you have to have when it comes to culture. When it comes to how companies trade and how liquid the markets are. Sometimes it can be very deceptive.
Craig Churman: Okay and in the next slide... you’ll go into this in more detail, but we shared some of this when we were talking about our global bond strategies and how we are really bullish on the emerging markets in certain areas.
Monem Salam: So, what I wanted to kind of do, is if you look at the market capitalization, you know, by country, you’re obviously going to find that the US is going to be the dominant player when it comes to global. However, you know, in the landscape, when you’re looking out in the long run, ten years, twenty years, thirty years down the road, there is a significant shift that’s actually happening when it comes to the largest economies when it comes to GDP in the next few years. So, on the right-hand side of the slide, which you’ll find is in 2016, the top ten largest economies in the world. And then if you look at 2050 what the projections are, you’re going to find... I’ve highlighted in red, the ones that are coming down, meaning they are becoming smaller as far as GDP production and then the black ones are staying the same, but then the green ones are the ones that are increasing their GDP. Now, one thing to keep in mind, this is not, in my opinion, a zero-sum game. So, you know, a rising tide, which is the global economy, is going to lift all boats. So, it’s not that the US or Japan or Germany will have negative growth rates and so that’s why these other countries are doing better. It’s just more a matter of, you know, these companies are just having higher growth rates. So, for example, you know, minus last year, Indonesia was averaging roughly about a 4.5% GDP growth rate. Right? And so, you know, if you compare that to the US at about 1.5-2% ex-last year, that’s a significant amount of growth and much faster way for Indonesia and also China to be able to catch up, and India as well. So, it’s not really a matter of the ones in red are going to do poorly. It’s more a matter of that the emerging markets are just going to do better than the rest of the world. On a relative basis. That’s why there has to be exposure there. And then, the other thing is that that the emerging markets allow you to do, is they allow you have a non-US Dollar exposure. Right? And again, in this particular case, it’s not a matter of, you know, the Dollar is going to lose value considerably into nothing, which a lot of people sometimes talk about. It’s more a matter of the growth in the emerging markets will cause their currencies to strengthen even if the Dollar stays the same. But it’s important to keep the Dollar in mind. So, what we’ve done here in this slide is we’ve taken a look over a ten-year period, what the Dollar has done relative to our Fund. And what you’ll find, which is normal, and expected, but we want to be able to show it, is as the dollar does well, the fund, you know, underperforms relative to the dollar. And then the opposite is true, as well. So, just wanted to kind of show that so it is a good, you know, play on having non-US Dollar assets in your asset portfolio mix.
Craig Churman: And then, tying back to the last slide, the allocation that we have, you’d recommend something in the neighborhood of, you know, 5%, 10%, even 15%, because 15% of the equity opportunities are in that market. So, we’ve been both strong on the EM but actually encouraging our clients to do a stronger allocation and that paid off well for clients last year.
Monem Salam: Yeah, roughly 10-15% is usually what’s a good recommendation for an allocation. You know, there’s a lot of companies in the US that have global exposure and so, you know, you invest in the S&P 500 and the majority of the companies in the S&P 500 have more than 50% of their assets in revenues coming from outside the US. And so, you’re going to get that exposure anyway, but this is even a deeper dive into being able to get exposure into not just global but specifically emerging markets.
Craig Churman: So, we’ll turn it over to Levi now. And just, you recall that Levi was one of the producers of our Amana Impact Report and we had a webinar specifically on that. So, we’ll take a deeper look into how the Developing World Fund compares to the benchmark and how it compares in some of the categories we use for screening and ESG. That you, Levi, for joining us.
Levi Zurbrugg: Yeah, thanks, Craig, for the opportunity and thanks to everyone for joining us on this webinar. We see ESG as an opportunity in the EM space and in the developing world because the performance on ESG really helps to highlight the strength of management and management’s commitment to sustainability. So, in the developing world where regulatory oversight can vary wildly depending on jurisdiction, ESG gives us a better compass to understand how companies are actually performing regardless of varying regulations. And implementing this approach is something that we had done previous to last year when we added the Developing World Fund to our Impact Report, but we thought the Impact Report and the metrics were at a point where it was important for us to communicate that information to investors so that they can see how this process really plays out and how integrating ESG considerations into the Developing World Fund has actually really led to some strong performance in terms of various ESG factors. So, two examples that we consider, just at a high level, are greenhouse gas emissions and renewable energy and board diversity. In terms of climate change, we look at greenhouse gas emissions and renewable energy, two commonly reported metrics. And the graph on the left-hand side shows you that the Fund holdings have a higher average consumption of renewable energy, but what’s really impressive, we think, is the 64% reduction in average greenhouse gas emissions that the Developing World Fund has compared to its benchmark.
Craig Churman: You know, Levi, this is one of my favorite slides because I think the chart on the left really demonstrates why you would be an active manager, why you would underweight China, and then why you would end up with a much smaller carbon footprint, so in order for us to achieve impact, I think this slide makes that case very strongly, so thanks for doing this.
Levi Zurbrugg: Yeah, my pleasure. I think the case has been made for ESG, globally, but it’s especially interesting in the developing world where again, companies may be newer, there may not have been as much investor oversight, and it really gives us an added lens to understand management and management’s ability to deliver on targets while addressing social and environmental concerns.
Craig Churman: And then, on board diversity, obviously, in other markets it’s maybe a different challenge than it would be in the US but I think you have some strong metrics here, also.
Levi Zurbrugg: Yeah, so the board diversity is still, you know, not quite to where we see in the S&P 500. It’s below that. But I think it’s telling to see the difference, whether that be independent board directors which lend that independent perspective, and that’s really what we’re trying to get at with board diversity, is having a diversity in thought. We believe that companies that have that diversity in thought are going to be more well-adapted to deal with risks as they arise and highlight opportunities before those that may not and so these metrics are a demonstration that the Developing World Fund tends to have a higher percentage in both independent and female directors and when it comes to the number of women on the board, we see both the Fund and benchmark are short of what’s become known as the power of three threshold. That’s where research has shown that boards with three or more women are inclined to incorporate underrepresented viewpoints. So, it’s something that we’re continually looking for to see progress and you know, another area that we see less well-disclosed, in terms of quantitative metrics, is cultural or ethnic diversity and that’s something that we are paying attention to, as well, and would expect to see improved disclosure on in the future.
Monem Salam: When we talk about board diversity and speaking to the idea of active management, I mean you can easily have a screen that shows that yes, we do have... as a passive index, you could have a screen that shows women on the board but digging a little bit deeper, you might realize that it’s the founder’s mom, wife, and daughter. And so, you know, that’s not going to show up if you don’t do an active search for what’s really going on in the board. That’s one part of it. And then, the other part of it that kind of speaks to a little bit of cultural sensitivities. We talk about board diversity in the US because a lot of times we talk about having African Americans and other underrepresented minorities on the board itself. Well, I mean if you go to places like Malaysia... I mean you go to places in some countries where 95% of the population is of one ethnic group. So, how do you define board diversity is a question that we ask ourselves very often, as well.
Craig Churman: ... which is going to vary.
Levi Zurbrugg: I think that’s a great point. There’s so much more to board diversity than these headline metrics. I mean, these are very much a starting point. After that, we dig into each one of those board members and we look at... what’s their previous history? What’s their expertise? What are their relationships? Sometimes a board member may seem independent but maybe they worked previously with the CEO, so there’s a lot that’s lost if you limit yourself to just the headline metrics, but they provide more of a starting point than an end point for us.
Craig Churman: And now, you’re going to move on to tell the story of Delta Electronics which is one of the case studies that we highlighted. If you have a copy of the Amana Impact Report, feel free to ask us for a copy or we’ll send you one after the webinar and Delta Electronics is one of the case studies that we highlight on page 9 of that report.
Levi Zurbrugg: Yeah, and as we were kind of alluding to or speaking about with board diversity, similar with portfolio metrics, you know, it’s interesting to see how the Fund performs at a portfolio level, but I think looking at these case studies gives you a better understanding of what the initiatives companies have implemented look like and just a little more of a tangible feel to how ESG plays out. And Delta Electronics is a great example of the trend that Monem was speaking to earlier in terms of the developing world moving from a resource or extractives-based economy to a much more technologically advanced economy. So, Delta Electronics is a provider of thermal and power management solutions. Basically, what that means is that they produce inductors which allow various electronics to use the appropriate wattage or voltage of electricity. And their mission statement is to provide innovative, clean, energy-efficient solutions for a better tomorrow. So, just that message statement alone is telling in terms of how they are positioning themselves to be a real leader in climate change and the transition to a low-carbon economy. One other area that we think that they have shown impressive improvement in their performance is regarding water use. So, Delta recognizes that this is another important aspect of managing its environmental footprint and as part of its management systems, the company maps water stress in the regions where it operates and incorporates climate models to understand how risks may develop going forward. So, unlike climate change, water is more of a local issue. In some places there’s not enough. In others, there’s too much and so allowing the company to understand its water risks in the context of local circumstances is really powerful.
Craig Churman: And in the report, you also highlight, give an update on Taiwan Semiconductor, another firm that has water as a major part of its business model and how they are doing in terms of managing that key resource.
Levi Zurbrugg: Yeah, exactly. So, we wanted to show, and for one... we wanted to show an update on the companies we looked at last year for our report, because this is an evolutionary process. It’s not just to say, “Well Taiwan Semiconductor did great in 2019 but worse in 2020,” We want to compare that, make sure that this isn’t stagnant, and what we actually saw was Taiwan Semiconductor has continued to perform really well. And they added another lens to water, whereas Delta has a focus on... I mean, it’s a robust system but the headline metrics that they are looking at is water use intensity, so not consuming too much water per unit of output. And they’ve done well to reduce that. One of the areas that’s important for Taiwan Semiconductor is to reduce pollution. So, semiconductor manufacturing actually requires very pure water but can produce quite a lot of pollutants and in particular, ammonia is one of the common pollutants and Taiwan Semiconductor has been able to reduce the pollution of ammonia or the production of ammonia by 89% since 2018. So, we see that they are continuing to move forward and progress their abilities to reduce water pollution.
Craig Churman: Okay, and now we are going to move on and talk a little bit more about the Fund itself and any questions from the audience, feel free to bring it up. I think we shared our top ten holdings and the 1-year performance numbers, as you can see, up until the end of last year, the Fund had a really good year and a really good fourth quarter, so thank you Monem and Levi and Scott Klimo, for that. If there are any questions from the group, we’ll take them now. Monem, one of the questions I wanted to ask you before is when you went to KL, we were a traditional manager with the Islamic screens and negative screens and you were able, in that time, particularly as our firm started to incorporate more positive and ESG, you found that the clients in that market, and the institutions, really loved the integration of ESG in Islamic finance. Do you feel the same thing in the States and what was your experience in terms of sharing our ESG story as you were marketing in Asia?
Monem Salam: Yeah, I mean, I think if you look at the number of UNPRI signatories in Asia, you’re going to find, for obvious reasons, the majority of them being in Japan, Hong Kong and Australia. However, there has been, over the period of even the past five years, much growing interest in fund owners finding out what ESG... and doing a deeper dive into what ESG is, how can it actually impact portfolios, and specifically in Malaysia itself, they’ve had a lot of fund owners that have actually signed up to the UNPRI and begun to implement ESG strategies, eventually to be able to have their entire portfolio done that way. In some countries, actually, you know, because in the emerging markets it’s usually a top-down... meaning the government has an initiative and everybody follows along... and so in some countries they have actually made it a priority either through tax incentives or other ways for not only investors to be able to invest in ESG funds that might have a tax advantage or fund owners, you know, large institutions, that make it advantageous for fund managers to be able to move much more toward the ESG space. So, that’s happening a lot in Asia as well. So, I think that’s really an important highlight. It’s not only happening in the fund management space but also in the banking and insurance area as well, where the governments are becoming much more restrictive in how much a bank can actually have in a portfolio of companies, for example, that are doing exploration for oil and gas versus solar power, wind power, those types of things.
Craig Churman: Okay, so here’s a question we got in. With Chinese government interfering with Alibaba, there’s talks of that also happening with Tencent, is that a concern you have? How are you following that, Monem?
Monem Salam: So, we are following that quite closely. There’s a couple of things happening with Alibaba. The first one is that you have to keep in mind the cultural norms. The Communist Party is not going to allow a citizen to become more powerful or more influential than the Premier, okay? And one of the ways... and this I think was more for Alibaba was Jack Ma just kind of overstepped his comfort zone and began to speak negatively of the authorities, especially when it comes to the regulatory authorities in China, and that’s a big no-no. And for that reason, I think that was the start of the repercussions that took place. Now, that being said, yes, you know, Tencent, Alibaba have been able to kind of skirt a little bit of the financial regulations by really being a technology company and not a financial institution. That being said, I do think that the Chinese government is going to be a little bit more lenient on, you know, companies like Tencent versus Alibaba only because of the fact that what Jack Ma specifically did. And why I say that is because after that event happened and he went to go meet with the regulators... you haven’t really heard from him for a very long time, right? That speaks to a lot about what they are trying to reign in... a personality, not just a company itself.
Craig Churman: Okay. Thanks for the question. Appreciate that. Any other closing remarks from Levi or Monem?
Monem Salam: Yeah, I just want to highlight one thing and circle back. I told you about the four major industries maybe about ten, fifteen years ago that would have shown up in an emerging market fund. The two areas that I think that you’re finding a lot more opportunities in are going to be technology, which I mentioned, but also consumer goods, whether they be discretionary or staples as well. And so, if you look at, you know, our top ten holdings, you know, you do find companies like LG Household in there, that specifically in that space, we own companies in Indonesia and Brazil that are taking advantage of that. But really, technology has really become a really large part of the emerging markets and that’s an area that is still growing and will continue to grow over the next decade.
Craig Churman: And the other thing I wanted to mention is... when you moved out to Malaysia, we built out part of our research team, so we are actually able to leverage the feet on the ground out of our Malaysia office to look for opportunities that we build out that didn’t exist when we launched the fund in 2009. So, that’s been an asset for our clients to just have that on-the-ground research team in Malaysia.
Monem Salam: Yeah, and the other thing to keep in mind is, I’ll give you two examples. A lot of people think that emerging markets, for example companies in Malaysia, you’re only taking advantage of that country or that region. However, to give you an idea, Malaysia is the largest manufacturer of rubber gloves in the world and so, two or three of the largest companies are actually domiciled in Malaysia, traded in Malaysia, but their shipments, the majority of it going to the developed world and the US. You know, if you go into a doctor’s office, more times than not, those rubber gloves the doctor is using are going to be coming from Malaysia. Another example I can give you is not the largest but one of the largest chocolatiers, Godiva, is actually owned by a Turkish company. And so, when I was in Malaysia, I used to tell people, “You know, you have to have access to the developed world because you’re using products that are not manufactured or not even, you know, not manufactured here.” So, how do you take advantage of that? You have to invest in the US and the developed world. In the US, I would flip that around. I would say now more and more than ever, there are products that you are using, even in your iPhone, that are coming from the emerging markets and in order to be able to have exposure to that, to take advantage of those, you have to have some exposure into the emerging markets and to the Amana Developing World Fund.
Craig Churman: There you go. Very good. And thank you for this webinar. Thank you for your comments. And you know, Gus will reach out to the attendees. Make sure you have a copy of our Impact Report, a copy of the slides, and if you have any questions, feel free to get ahold of one of us. Thank you very much. Thank you, Levi. Thank you, Monem.
Monem Salam: Thank you so much.
Levi Zurbrugg: Thank you.
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