Editing Utilico Emerging Markets Trust (section)

==The fund manager: Charles Jillings==

'''The manager’s view: A challenging macro backdrop'''

Jillings says the world’s attention is now focused on Ukraine following the Russian invasion. He considers it shocking that Russian President Vladimir Putin is going down the route of victory at all costs and has escalated the level of aggression. Western nations are trying to put as much pressure as possible on Russia via sanctions and these are expected to increase, with the refusal to accept Russian oil imports by the US an important development. The manager says that unfortunately, the next major step is likely to be weeks or months away. He believes that energy sanctions will bring a whole different ball game, as it will have a material effect on global markets given that the West is short of energy. He suggests that even if a resolution is found or there is a change in direction, taking a medium-term view, Russia will be a pariah state as the West will not back down now and has recognised the leadership’s real motives. Jillings expects commodity prices to remain elevated; he sees the beneficiaries as emerging markets, including Latin America. He opines that there will be a scramble for soft commodities, with farmers likely to offload their excess stocks.

The manager believes that the loss of economic activity in Russia and Ukraine will be more than made up for by strength elsewhere in the medium term. He is optimistic about the prospects for emerging market equities over this time frame; however, over the short term he thinks that it is unclear how the Ukrainian-Russian situation will be resolved and how much of an impact it will have on global stock markets.

While everyone is understandably talking about Ukraine rather than the global pandemic, Jillings says that a real challenge is how China will deal with its zero-COVID-19 policy and move towards a strategy of living with the disease, which has been adopted in other parts of the world. Now that antiviral therapies have been developed and the Omicron variant has been less severe that prior strains, hospitalisation and death rates have declined. However, as evidenced in the UK, with people developing COVID-19 symptoms and isolating, there can be significant disruptions within the work force. The manager suggests that China will have to change its zero-tolerance approach to the disease, but this could lead to disruption in global supply chains and affect China’s short-term GDP growth.

Turning his attention to inflation and interest rates, Jillings believes that while higher interest rates are a headwind to global stock markets, they will not restrict economic activity and business performance; instead, he views them a sensible normalisation following an extended period of very loose monetary policy. The manager says that before the war in Ukraine, European inflation was declining, compared to an acceleration in the United States due to higher wage pressure. He suggests that the war has dented central banks’ confidence in raising interest rates, although an energy price shock remains an issue. Jillings opines that it will be very difficult to deal with a global energy shortage, which he considers is very different to straightforward higher fuel prices.

UEM had less than 0.5% of the portfolio invested in Russian securities before the local stock market closed, as the manager had already sold two-thirds of the trust’s single Russian exposure as tensions built. The residual holding has been written down to zero (for more detail please see the Current portfolio positioning section below). Jillings suggests that the world will recognise that there are a lot of checks and balances that need to be put in place, and the fact that NATO, the United States, Europe and the UK are standing shoulder-to-shoulder against Russia is important as it means that China should think twice before undertaking any aggressive policies. As a result, the manager believes that geopolitical risks should actually decline in the future rather than escalate, although he thinks that China–US trade frictions are likely to continue, and in the short term, tensions remain high.

In general, UEM’s portfolio companies’ earnings continue to surprise to the upside. Its largest holding International Container Terminal Services (ICTS) is a global port management company headquartered in the Philippines. Jillings refers to the firm as a ‘poster child’ that rightly deserves to be UEM’s number one position. ICTS’s recent earnings release was very strong, with Q421 revenues rising by 24.4% and EBITDA by 32.5% with a 61.9% EBITDA margin. Volumes increased by 4.7% and yields rose due to higher port tariffs and the addition of ancillary services. The company’s management is confident that current yields can be sustained, which provides a firm footing for its business in 2022, while it is cautiously optimistic that volumes this year can rise in the mid- to high-single-digit range. ICTS’s exposure to Russia/Ukraine is only via two ports, one in Georgia where 20% of volumes are from Russia and Ukraine, but this represents c 1% of the company’s total throughput, while the other port is in Poland, which has low exposure to Russian businesses. The manager believes that although there may be a disconnect from the conflict in Ukraine, global trade remains strong and ICTS is well positioned given higher tariffs and strong cost controls, which the company implemented during the COVID-19 pandemic-driven economic slowdown.

Jillings notes that portfolio companies provided conservative revenue and earnings guidance during the pandemic, but now some firms are increasing their dividends, including ICTS, which increased its annual distribution and also paid out a special dividend. Generally, capex was reduced during the pandemic but now cash flows are coming through strongly and companies are more willing to return cash to shareholders.