A blueprint for success

It’s not often that when a new investment trust is launched there’s already a blueprint for success, but one could argue that is the case for Ashoka WhiteOak Emerging Markets (AWEM).

Manager Prashant Khemka has demonstrated that his approach to investing can yield spectacular results via Ashoka India Equity (AIE), the top-performing India trust it launched in 2018. Recognising the broader opportunity set in emerging markets and subsequent growth potential, Prashant and his team launched AWEM in May 2023.

AWEM provides access to a multi-cap portfolio of emerging market equities and has many attributes in common with its more established stablemate, including focusing on small- and mid-cap (SMID) opportunities – a segment of the market that remains largely under-researched. It also employs the same performance-first culture, designed to maximise alpha through stock selection, while minimising volatility.

Prashant brings a wealth of experience from his 17-year tenure at Goldman Sachs Asset Management and founded WhiteOak Capital Partners, the advisor to AWEM, in 2017. He is supported by two investment directors, Fadrique Balmaseda and Lim Wen Loong, alongside one of the largest and best-resourced investment teams in the emerging markets sector.

The team’s on-the-ground presence enables regular access to company management, a close connection with domestic markets and a greater understanding of the companies within their investment universe.

The WhiteOak team aims to strip out businesses with poor governance, high debt levels and those lacking a sustainable competitive advantage. This distils a universe of c. 2,800 companies down to c. 750.

The high-quality companies eligible for inclusion in the portfolio must be able to deliver superior returns, have scalable business models, possess a sustainable competitive advantage that others in the industry struggle to replicate and be well-managed both operationally and in terms of governance.

Unique frameworks

The team then assesses the businesses’ fundamentals and valuations using a unique analytical framework called OpcoFinco, developed by Prashant during his tenure at Goldman Sachs.

OpcoFinco nets off the cost of capital of a business in order to identify the self-sustaining, recurring cash-revenue growth of a company. Essentially, it’s a more sophisticated cash-flow valuation model designed to help differentiate quality businesses from those whose current high returns may not be sustainable without substantial future capital injections.

The team uses another internally developed framework called ABLEx, which is designed to help avoid companies with inherently poor governance, and to strengthen their ESG risk assessments. The framework includes a sector-specific list of ESG risks and opportunities, against which companies' practices, policies, and disclosures are assessed and rated. The results of this analysis are then integrated into the overall valuation of each business.

There’s a reasonably high degree of turnover in the portfolio (approximately 30% per year) because the team rigorously assess their holdings’ valuations, selling when it aligns with the team’s assessment of fair value. This allows them to reallocate to other high-conviction opportunities with greater upside potential.

At the moment, the team believes that large-cap valuations tend to be more closely clustered around fair value. They find more inefficiencies in SMID segments. AWEM currently has 35% invested in SMIDs, versus 16% for the benchmark. Over time, Prashant expects the split between large and SMID stocks to be around 50/50.

The case for emerging markets

On an absolute basis, compared to their average valuations, one could argue that emerging markets are neither cheap nor expensive. Indeed, the 12-month forward price-to-earnings (PE) ratio of the MSCI EM Index is c. 12.1x, narrowly higher than the index’s 30-year mean average of 12x. The 12-month forward price-to-book (PB) of the index is 1.6x, bang on the 20-year average.

Yet, on a relative basis, the case for investing in emerging markets becomes much more compelling. The MSCI EM Index is trading on a c. 36% discount to the MSCI World Index on the forward PE metric, the biggest discount seen in about 20 years. On a forward PB basis, the discount is 47%, again a level not seen for more than 20 years.

This looks attractive when you consider that emerging markets were valued at a double-digit premium on the forward PB measure as recently as 2011.

Then, there’s the fundamental investment case, which is centred on the fact that emerging markets house some of the fastest growing economies in the world. Emerging market economies generate 65% of global growth.

GDP growth in emerging market and developing economies is expected to be 4.2% in both 2024 and 2025, according to the International Monetary Fund (IMF), ahead of global GDP growth of 3.2% and almost two and a half times faster than advanced economies, which are predicted to grow by 1.7% in 2024 and 1.8% in 2025.

There’s plenty of scope for growth, too. As an example, India has 800 million people aged under 35; by contrast, 2024 is expected to be the first year there are more people over the age of 65 than under the age of 15 in the US. Even in Mexico, 64% of the population is aged under 39, versus 51% in the US (in India, it’s 66%).

The emerging market complex is one of the few areas where finding a good-quality active manager can pay clear dividends. This is particularly true in the SMID-cap segments, which often harbour strong, alpha-rich companies that have not yet been fully recognised by investors.

An active manager can make a number of calls that gives them an edge over a passive emerging market strategy. In particular, it can decide to shy away from the less democratic and over-regulated countries, investing only where the opportunity to make money is the most attractive.

Indeed, the average net democracy score of the MSCI EM Index is 3.6, with its large weighting to China a big drag, as well as modest positions in Saudi Arabia, UAE and Thailand. AWEM, by contrast, has a net democracy score of 6.2 due in part to its underweight call on China (on a direct exposure basis). AWEM is 13.6% underweight the least democratic emerging market nations and 12.7% overweight the most democratic countries.

Similar is true when it comes to state-owned enterprises (SOEs), which are common within emerging nations’ stock markets but are often run for the good of the government that part-owns them, rather than outside shareholders. The MSCI EM Index has 19% invested in SOEs, versus just 3% for AWEM, a 16% underweight.

The blueprint

For many, putting their trust in a new strategy is a risk, but Prashant and the WhiteOak team’s success with AIE gives confidence that AWEM can thrive.

AIE’s net asset value (NAV) and share price total returns since IPO have been 194.5% and 173.4% respectively, to 09/10/2024. The share price total return for the Morningstar India Index in that time is 131.6%.

It’s clearly early days for AWEM, but the early signs are encouraging. Although only a relatively short period, it's encouraging that since inception in May 2023, AWEM has outperformed its benchmark, and has done so in rising and falling markets in all but two quarters, and both of those involved only modest underperformance, as the table below shows. The outperformance during declining markets is particularly striking.

As with AIE, AWEM charges no management fee, instead levying a performance fee earned only if the portfolio demonstrates relative outperformance of its benchmark over discrete three-year periods and is capped at 12% of the time-weighted assets over the three-year period. Any performance fee due is paid entirely in shares, 50% of which are subject to a further three-year lock-up period.

This incentivises the team to remain focused on delivering alpha through stock selection, which one can certainly see has worked with AIE. The managers have achieved a ‘hit rate’ of c. 65%, well above the c. 55% that is considered a high standard in the industry.

If that can be translated to AWEM, the future looks positive. For now, AWEM’s differentiated process, unique charging structure, large research team and strong recent performance positions it as a standout option for capitalising on opportunities in many of the under-researched emerging markets.

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