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Why Due Diligence Matters...

We were having an investment discussion recently on risk and opportunities based on the economic and business numbers we have seen due to COVID. One thought was that emerging markets could be positioned to outperform developed markets given the drawdown in both business and wholesale inventories.

While many emerging market countries have moved beyond being mainly commodity providers, they still perform that function as well as providing low-cost production of basics. If restocking is going to be needed at both the business and wholesale levels we could see a big bounce in both commodity and basic material production that would benefit emerging markets more than developed ones.

We pulled up one of the emerging market mutual funds that we have used in the past to look at the performance and analyze the holdings of the fund…we had some surprises among the top 10 holdings:

Microsoft Corp – an American multinational tech company.

Tencent Holdings - a Chinese global multinational holding company providing internet related services.

Reliance Industries - an India multinational engaged in energy, petrochemicals, textiles, natural resources, retail, and telecommunications.

Alibaba Group – a Chinese multinational technology company specializing in e-commerce, retail, Internet, and technology.

MercadoLibre - an Argentine company incorporated in the United States that operates online marketplaces dedicated to e-commerce and online auctions

Kweichow Moutai - is a partial publicly traded, partially state-owned enterprise in China, specializing in the production and sales of Maotai baijiu (a type of liquor), together with the production and sale of beverage, food and packaging material, development of anti-counterfeiting technology, and research and development of relevant information technology products.

Kotak Mahindra Bank - an Indian private sector bank that offers banking products and financial services for corporate and retail customers in the areas of personal finance, investment banking, life insurance, and wealth management.

Facebook - an American online social media and social networking service company.

Taiwan Semiconductor – a Taiwanese semiconductor company, the world's largest dedicated NON (independent, pure-play) semiconductor foundry.

AIA Group – based in Hong Kong, is the largest public listed pan-Asian life insurance group.

This fund is well established and one of the best performing funds in its sector – but, not necessarily what one would consider an emerging market fund by looking at the holdings:

1. At least a few of those holdings are well known US and many decidedly NOT emerging markets companies (we do not consider China, with the world’s second-largest GDP, as ‘emerging’).

2. Most are multinationals

3. Many also are tech, internet-based and have overlap

Why does this matter? Two main reasons.

First, you always need to know what you hold if you want to measure your risk and try to maintain diversification. Adding this fund might mean one needs to reduce exposure to these companies somewhere else in the portfolio not to be overexposed.

Second, it can point out that the fund manager has either changed his focus and/or is not following the focus of the fund in an attempt to increase returns. Either is important to know and why you should review their top holdings regularly.

You should always know what you own and why, the effort is worth it.

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