Best in Class: FSSA Global Emerging Markets Focus

Whether it is e-commerce, delivery or entertainment - technology has been the place to be for investors in a challenging 2020.

In a world hampered by lockdowns and social distancing, the technology megatrend has grown exponentially.

We are all aware of the success of the FAANGMs as they continue to drive the S&P 500 higher, but tech has also been a key cog in the rebound in global emerging markets.

The returns have been exceptional in the region – but, as with the US, the big question is whether they are sustainable.

On the face of it, the high valuations many of these companies have is offset by strong fundamentals.

However, internet and e-commerce companies do have reasonably low barriers to entry and marginal costs – both of which could attract competition and makes those profits less sustainable.

I recently read that over the past 12 months the combined free cashflow generated before investments by the five largest digital technology companies in emerging markets amounted to $50bn, or 2.5 per cent of their current market capitalisation.

At that speed, it would take the group 40 years to return its current market capitalisation from the free cashflow it is generating – more than twice the length of the average emerging markets company*.

These concerns, coupled with hopes of a broader economic recovery, make me believe diversification is essential in emerging markets in 2021 - something this week’s Best in Class fund offers in spades, with information technology only accounting for 6 per cent of the portfolio.

The FSSA global emerging markets focus fund is managed by Rasmus Nemmoe. Rasmus joined FSSA in 2016 having previously worked at LGM in London, where he ran their global emerging markets strategy.

He also worked in developed and emerging market equities in his native Copenhagen. Since Rasmus took on this fund in July 2018, it has returned 26.1 per cent to investors (compared with 22.9 per cent for the peer group average).

FSSA Investment Managers has a consistent investment approach: managers look for quality companies demonstrating sustained and predictable growth over the long term. These companies will be found through a bottom-up approach, with managers holding a strong valuation discipline, preferring capital light, cash-flow generative companies.

The team carries out around 1,500 company meetings per year, while also conducting extensive analysis on each company’s financial position and every portfolio manager is also an analyst.

Mr Nemmoe's total universe starts with around 36,000 companies. The FSSA philosophy is that company management needs integrity and a focus on the long-term. As such, managers will avoid sectors that cause direct harm to society.

These will include tobacco, munitions and gambling companies. To make the cut, companies will also need a free float of at least $1.5bn and an average daily turnover of $5m.

From here, Mr Nemmoe will cut the universe further by assessing the quality of a firm’s franchise, management team and culture before conducting a deep dive into the firm’s financials.

The best ideas are placed on the watchlist. From this, a portfolio of 40-45 names is chosen based on the quality of the company, how much visibility there is in the earnings and the potential for long-term growth over five to 10 years.

Mr Nemmoe wants the portfolio to remain well-diversified and not exposed to one particular risk. No single country weighting can be more than 30 per cent, and frontier country weights are limited to up to 10 per cent. No sector can be more than 40 per cent of the portfolio, with the exception of consumer products and financials, which can be up to 50 per cent. The fund has a 1.1 per cent ongoing charge.

Mr Nemmoe's absolute mindset and valuation-sensitive approach means this fund should outperform more in falling markets. However, this may come at the expense of underperformance towards the end of a cycle, as Mr Nemmoe will not chase momentum-driven stock markets.

While it is still early days for this fund, we feel the focus on quality companies, supported by the extensive research team at FSSA, gives this offering plenty of scope to succeed over the longer-term.

Darius McDermott is managing director at FundCalibre