The key to success in emerging markets: investing in quality

At FSSA Investment Managers, we take a patient, long-term approach when investing in global emerging markets, with a concentrated portfolio of high-quality companies. We examine why this philosophy has endured for the past quarter-century.

Investing in a concentrated group of high-quality companies and holding them for the long term has been at the heart of our philosophy since our team was established in the 1990s – and it’s been central to our success.

Our primary goal is to deliver positive returns for clients. But investing in emerging markets means not just focusing on the potential upside – we must also consider the risks.

With this in mind, we think about how not to lose our clients’ capital. And we found the most reliable way to build a resilient portfolio was by investing in exceptional companies with high-quality, dependable management.

Our approach may seem obvious – what fund manager would invest in unattractive businesses? But subpar companies can sometimes appear attractive when their valuations have declined.

When investing in great companies, we believe it is essential to do so at a fair price. But we believe it is more important to invest in quality than to focus purely on cheap valuations.

Sometimes, quality businesses fall out of favour with investors – and this often presents an attractive buying opportunity. For example, our team has held Taiwan Semiconductor Manufacturing Company (TSMC) for nearly two decades, having first invested in TSMC at a time when it was unloved by the market. We were impressed by its management team, its technology leadership and the evolution of its strategy.

In the early 2000s TSMC was considered a cyclical stock to be traded in and out according to the cycle. But we saw that its business model – focusing on the latest technology and partnering with its customers instead of competing with them – could position it as a long-term winner. As higher cost players exited, either through outsourcing or partnerships, TSMC’s business grew stronger.

Today, TSMC is the world’s largest foundry (manufacturer) and, in partnership with its customers, produces some of the most advanced semiconductors in the industry. It has been a major beneficiary of AI (Artificial Intelligence) adoption, and we believe it will likely continue to compound for years to come.

On the other hand, our emphasis on fair value means that we sometimes choose not to invest in companies with otherwise attractive business models. For example, India has long been a favourite market, due to the quality of the companies there.

But over the past two years valuations have become stretched, and some pockets of the market are now expensively valued. We believe there are reasons to be cautious and we have leaned against the market’s euphoria.

This valuation discipline has served us well over the years and has added to our overall performance.

While our investment approach has remained largely unchanged, the countries we invest in have seen significant developments over the past quarter century. The liberalisation of China’s capital markets and India’s growing prosperity have reshaped the region – and the world.

Equally important has been the development of highly competitive franchises with emerging-market roots. TSMC is of course one example, but we would also highlight MercadoLibre in Latin America – arguably a stronger ecommerce business in this particular market than, say, Amazon is in the US.

As long-term GEM investors, we are excited to find more high-quality businesses that we believe can capitalise on the secular growth drivers (factors that cause long-term, fundamental changes in an economy or market) and growing domestic demand in emerging markets in the years ahead¹.

¹ Reference to specific securities (if any) is included for the purpose of illustration only and should not be construed as a recommendation to buy or sell the same. All securities mentioned herein may or may not form part of the holdings of a First Sentier Investors portfolio at a certain point in time, and the holdings may change over time.