In August the fund underperformed the MSCI EM index by 1.2% during a highly volatile period.
The main negative contribution came from continued weakness in Korea and Mexico as well as some smaller markets in EMEA and Latin America while India where we are underweight continued to push higher. On the positive side, our Taiwanese holdings continued to do well, outperforming the market.
While not making significant changes to overall exposures, we have been using the volatility to take profits on individual stocks and shift into those that have lagged with higher upside.
We often talk about looking for stocks where management is willing to return surplus capital to shareholders. In Taiwan, the vast majority of companies pay out high proportion of their income through dividends and this has been part of the superior returns profile.
The other form of cash return is through share buybacks – historically much more popular in the US. Mathematically a buyback works in the same way as paying investors a dividend who then use it to purchase more shares of the same company. The investor’s share of the company profits increases although in the case of the buyback that is reflected in higher earnings per share while with a reinvested dividend the share of ownership of the company increases.
Buybacks tend to be more efficient from a tax perspective for investors, but are not universally popular. It is true that a buyback may indicate a lack of growth options for management, but it also demonstrates capital discipline and a belief in their value of their business. In theory management have a better insight into their own company and should be able to exploit an informational advantage over the market. The risk is that companies overpay for their own shares when investors would be better off receiving cash. Around 90% of companies in the S&P have some form of share buybacks – it is implausible that all of these stocks are undervalued.
Nonetheless, studies by S&P shown that US companies running significant buybacks relative to their market cap have historically outperformed their peers (“Examining Share Repurchasing and the S&P Buyback Indices in the U.S. Market”, March 2020). In recent years this has not been the case as growthy mega-cap stocks have led the charge.
In Emerging Markets, buybacks are much less common, however this has been changing. Around 1/3rd of the companies in our portfolio have announced buybacks in the last 12 months. This is more than double the proportion within the wider EM universe. Many of these buybacks are very significant – up to 10% of their market cap and typically funded out of net cash on the balance sheet and free cash flow. The companies range from Chinese internet giants via Korean Chaebols to small-cap Brazilian companies. What they all have in common is inexpensive shares mostly trading well below 10x P/E which suggests attractive returns on the repurchased shares.
The increase in buyback activity in our markets is definitely a positive development especially in the context of low valuations. We continue to watch this phenomenon closely.
