e-fundresearch.com: What lessons have you learned from 2015?
"I don’t want to sound too gloomy, but we have to accept that the years of double-digit nominal growth in China are behind us."
Samir Mehta: While not a personal lesson as such, I think investors may well look back on 2015 as the year when China's once widely-accepted economic omnipotence was finally called into question.
I don’t want to sound too gloomy, but we have to accept that the years of double-digit nominal growth in China are behind us. Stories of urbanisation, or ‘one belt, one road’, cannot gloss over the fact that the accumulation of debt, when faced with deflation, does not result in accelerated growth. China has become the new 'Old Japan'. That, in itself, is not a bad thing. After all, even in during its 'lost decades', innovation thrived in Japan. Automation and robotics gave us Fanuc, electronic games gave us Nintendo, and automobiles gave us Toyota. But just as Japan’s almost-35% weighting in global equity indices in the early 1990s marked the peak of its index representation, when Chinese ‘A’ shares are fully inducted into the MSCI index, it will be the high watermark of China's weighting in the benchmark.
As for personal lessons, I was probably a little late in selling out from my Chinese cyclical exposure in the middle of the year.
e-fundresearch.com: To what extent has your strategy been able to benefit from this year's market environment and which particular investment themes have delivered the strongest performance contribution on a year-to-date perspective?
"(...) we are prepared to pay up for this quality. Fortunately this approach has worked well in markets characterised by slowing growth and declining investor confidence."
Samir Mehta: The core (75-80%) of our portfolio is built on high conviction stocks that can deliver quality, long-term and sustainable growth. We look for quality metrics, especially high and rising returns on capital employed and strong cash flow generation. And we are prepared to pay up for this quality. Fortunately this approach has worked well in markets characterised by slowing growth and declining investor confidence.
From a country angle, our Indian overweight and stock picks within that market have been a major influence on our outperformance in 2015.
e-fundresearch.com: Are you more or less constructive than you were this time last year, and why?
"A strong US dollar has historically been bad news for Asian equities. Certainly Asian and emerging markets have been roiled by the mighty greenback this year. With the Federal Reserve now officially in tightening mode, this headwind looks likely to remain in place next year."
Samir Mehta: 2016 looks like being another challenging year for Asian equities. A strong US dollar has historically been bad news for Asian equities. Certainly Asian and emerging markets have been roiled by the mighty greenback this year. With the Federal Reserve now officially in tightening mode, this headwind looks likely to remain in place next year. And the salad days of credit-fuelled growth are long behind us. Credit slowdowns across the region, coupled with government transparency and anti-corruption drives, are translating into slower growth, while you can see overcapacity everywhere. I've recently returned from the Philippines, an economy which is in better shape than most in the region, but where earnings growth is sluggish. As for China, it's a far more depressing vista. Every Chinese management team I speak to is very gloomy. One shaft of sunlight, though, is afforded by commodities prices. I think we are in a structural, decade-long bear market in commodities. That's good news for commodity importers like China, India and the Philippines.
e-fundresearch.com: You have recently started to reduce your allocation to Indian equities – what was the motivation behind this decision?
"As such, India is a market that fits our investment philosophy very well. But there has been a lot of excitement about this market (...)"
Samir Mehta: I’ve had a significant investment exposure to India within the portfolio since 2012, which has been helpful. While it still remains a large part of our fund, I have pared our exposure in the past couple of months. Respect for the cost of capital in the long run and significant barriers to entry allow good businesses to flourish. As such, India is a market that fits our investment philosophy very well. But there has been a lot of excitement about this market over the past 12-18 months, which has been reflected in surging share prices. Valuations no longer look as compelling as they once did. As for the macro, the rural and industrial parts of the economy are slowing; there's going to be a lot of reliance on the government sector (e.g. road, railway and defence expenditure) for growth in the near term.
e-fundresearch.com: What obstacles and challenges should investors be prepared to overcome in 2016?
Samir Mehta: It's really those things I've mentioned earlier: sustained US dollar strength, a tough earnings environment, deflationary pressure across the region and more tough times ahead for China.
