Artisan Partners Sustainable Emerging Markets Strategy—Second Quarter 2019 Update

Artisan Partners Sustainable Emerging Markets Strategy—Second Quarter 2019 Update



in April we started off the quarter trailing the benchmark but then in May we had a much better month with good performance outperforming the benchmark June was a little bit behind the benchmark again but ultimately we ended up exceeding the benchmark on both the quarter today and year-to-date basis several of the stocks that we're our biggest contributors were off benchmark stocks including Panamanian Airlines copa Mercado Libre as well as a Brazilian stock Arco platform China was a drag on the portfolio for the quarter we were not immune as I don't think many were from the volatility as it relates to the us-china trade discussions we had negative stock selection but were underweight in China and so that mitigated a lot of the negative performance for the quarter I'd like to highlight one stock in particular for the quarter its Arco platform which is a Brazilian small cap company that we bought earlier this year and it develops and distributes K to 12 educational curriculum software to private schools in Brazil Arco is really about replacing traditional textbooks but it also offers crm capability to the private schools businesses so it's really a win-win for not only the schools that are buying the software but also the parents as well as the kids who are receiving a much superior curriculum as software and really the key to arco is its first mover advantage so the K to 12 private school segment in Brazil is not really growing and this is has a lot to do with the economic situation there so Arco is really looking at a market share story and as they gain market share these clients stay with them as well it's very important to realize that the client base is very sticky so they're delivering a mission critical software and once they get a client and they sell some grade curriculums then they add more and this is really part of the way they're gonna generate sustainable earnings going forward the other important part of the story is that they don't rely on the Brazilian economic cycle so that also creates sustainability but this because this is really a market share execution story so the quarter was very positive for them they bought their largest competitor called positivo and this is giving them immediate scale and a margin uplift because Argos business being asset light is very scalable so we continue to see good upside despite the recent run-up in the shares and we're very confident that they can generate sustainable earnings over the long term the main negative drivers of portfolio performance were Chinese stocks and the headlines related to the us-china trade dispute we were not immune from that and several of our stocks were negatively impacted by the volatility the real concern here is that the Chinese economy will slow as a result of this ongoing and what we see is a very long term issue companies like Alibaba for us could see a slowdown and consumption negatively impact them Baidu could see a decline in advertising spending and a company like sea trip and online see could see a pullback in travel and all of these are very warranted concerns but we think that that's the reason you focus on sustainable earnings all of these companies are doing the right thing really trying to gain market share through this volatility and so we're very confident that they can generate sustainable earnings over the long term the one I'd like to highlight is santoro which is Brazil's largest sportswear and sporting good retailer they operate in a very fragmented market actually they have just about ten percent market share as the leader and santoro it has several sustainable competitive advantages they have scale they have a nationwide presence and they have a very strong omni-channel presence already some might wonder why we're investing in a company that in that we're in the United States or globally might be eaten alive by direct ecommerce it's very difficult for global brands to do business in Brazil and this is because of unique customer preferences because of difficult infrastructure and logistics so Santoro is actually very attractive to global brands like Puma like Nike like Adidas these brands are actually pulling back out of their direct-to-consumer businesses in countries and specifically in Brazil and they see Santoro as a trusted partner someone who will give them a great platform for their products that has modern smart stores that provide superior customer service and is investing in a great omni-channel linking the brick-and-mortar with the e-commerce platform so really this is one of their sustainable competitive advantages they're the leader and global brands like Nike seek them out to sell their products so obviously it's a concern that as a brick and mortar retailer and some Toro is still expanding their store base that ecommerce will become a big problem for them but they are well ahead of many of their Brazilian peers on the omni-channel side they've built an excellent platform for linking their brick-and-mortar stores and their their inventory systems with their e-commerce and they have much higher penetration and e-commerce relative to many other retailers in Brazil and really these are the two pillars of sustainability for santoro it's the strong relationship with global brands as well as this Vance Minh Anh they're in there on the channel platform Centaurus valuation is also quite attractive it IP owed at a very attractive valuation yes part of this discount to global peers and local peers as a result of being new in the market it after all was an IPO but I saw it is overdone two of our biggest contributors by country are two smaller and frequently overlooked countries by investors which are Argentina and Greece and in Greece in particular we've been invested there since 2013 through a stock called jumbo which is a toy and stationery retailer there and jumbo did some amazing things through the Greek crisis to be able to gain market share and what we're really seeing in Greece now is a normalization of the market and this was reflected in the stock movements in the second quarter the the Greeks elected new democracy which is a pro-business party – in EU elections recently and this set the stage for the prime minister to declare snap elections parliamentary elections coming up in July no matter who governs Greece they're going to be strapped in by the requirement to meet a certain primary surplus target but really if new democracy is in power you're going to see better consumption from increasing consumer sentiment you might see increase in international investment and perhaps a quickening of the private privatization process that is moving but has taken a long time we don't have these in our numbers but certainly it will benefit our stocks to have new democracy and power two of the stocks we've invested in jumbo of course the the retailer we continue to own and jumbo is not only holding its own in Greece and expanding market share and growing quite wet quite well but it's also expanding into smaller markets in Eastern Europe like Bulgaria and Romania in particular there they've taken their business model from Greece they've put it in these new countries and they're really trying to penetrate what has for a long time than an under penetrated formal retailing market jumbo is really the poster child for doing everything right during a crisis and we have continued hopes that this will continue into the future as for Alfa that's one of the for systemic banks in and Alpha's really all about a gnarly turnaround story they are working with the government to be able to offload their non-performing loans and this will result in our OE uptick but with a new democracy government possibly coming in we think that this plan could pick up some speed and so they might reach that are we inflection much sooner than previously anticipated we continue to have an underweight in China and this is not because we're China haters nor is it directly related to the ongoing dispute trade dispute with the US this has been a long-standing position of ours and it's mostly driven by not owning the Chinese banks which are large components of the index we don't think that the banks valuations properly reflect the risks inherent in them we also don't own $0.10 so this is really driving the underweight again we're not China haters we actually own many stocks in China we own Internet stocks we own several consumer discretionary stocks and these are great opportunities it's just that they are not necessarily the same components of the benchmark and so really it's not owning those large banks and $0.10 that drives the underweight we continue to look for opportunities in China and we continue to look for stocks that we'll be able to weather the volatility associated with the us-china dispute because really we said that it is a long-term issue so we want to be in stocks that can generate sustainable earnings long into the future I think it's worth highlighting the situation in Mexico with the tariff dispute with the US as we know the US and Mexico recently reached an agreement that Mexico would spend more to deploy troops down on their southern border with Guatemala so this has resulted in a short-term resolution to the tariff question the tariff situation could come back into the headlines quite soon this plan is also very costly for Mexico and right now I don't think Mexico can really afford to be spending this money which is another negative associated with the situation but equally important from our point of view is the situation below the headline the tariff headlines and that's a very weak Mexican economy GDP growth is quite weak but there's a problem because the wage inflation is quite high and the labor market is very tight the central bank is actually in a tightening cycle so there's little hope little room for any easier monetary policy to really kickstart the economy and so we're concerned that we're in a low GDP environment from Mexico for some time to come the other issue is that AMLO has generally been a disappointment he of course has an anti business platform which has not been good for consumer sentiment or business sentiment and additionally he hasn't accomplished much on the anti-corruption front we continue to have an underweight in Mexico we had the underweight before Trump was elected after Trump was elected and then before and after after amla's elections so this is an ongoing position for us we don't believe the valuations reflect the real risks in Mexico whether they're tariff driven or whether they're real GDP growth concern driven or quite possibly in many instances regulatory risk because AMLO is known to intervene the banks could see higher fees so the banks need to properly reflect that risk as well so we continue to have this underweight position we own one stock which we've held for some time we continue to look for new opportunities but as it as of this point we still don't see any stocks that properly reflect the risks of the Mexican situation while we changed our portfolios name recently sustainability has always been a part of our process it's always been a core part of the process actually from the very beginning and we think the name change better reflects what we've always been doing sustainability is important not just from that ESG standpoint but really going beyond that we think of sustainability a little bit differently than where our peers we are not excluding companies or sectors due to a checkered past and we believe that you can't look at sustainability of am companies through a developed market lens these emerging market companies are operating in a lot more difficult circumstances typically it's important to look for positive changes in a company's behavior if they have had some incidents in the past we're looking for company management change in policy again we understand that this is emerging markets and so improvement is what we're looking for we're also making sure that the company's policies and their actions in particular are to the benefit of all their constituents this doesn't only include include shareholders but also their employees their customers and very significantly the population is the communities around them a great example of how we look at sustainability in a company is through a Colombian bank we own called de vivienda de vivienda isn't necessarily one of the largest Colombian banks but it is the one that we believe is most committed to improving the lives of the low-income segments of the Colombian population they have a product which they've increasingly been putting into the market called Dhabi Plata and Dhabi Plata is giving new life to millions of low-income Colombians they're able to make payments they're able to receive their pay stubs through this they're able to get personal loans and even small business loans and so many low-income Colombians have their own small businesses and this is a way for them to expand those and it's really creating a new economic reality for millions of Colombians that have otherwise been long forgotten by many of the large banks in yeah so we think dub WB endo through Davi Plata is a real great example of a company that's really embracing sustainability not just for financial purposes but also because of what it's what makes sense and it's what's advancing the population around it

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