Christopher Johnson: Welcome to Morningstar. My name is Christopher Johnson and today I'm joined by Raheel Altaf, Fund Manager at Artemis Investment Management.
Raheel, thank you so much for being here with me.
Raheel Altaf: Good to be here.
Johnson: So, my first question to you is, in comparison to the MSCI Emerging Markets Index, you are overweight Brazil. Why are you so bullish on the Latin American country?
Altaf: Well, there are certainly some interesting trends developing in Brazil. Brazil is an agriculture and commodity powerhouse in the world, and it supplies food products, things like soybeans, coffee, sugar to lots of countries around the world. And what we've seen in the last few years is rising inflation has led to increasing prices and demand has been pretty firm. So, Brazil as an economy is benefiting from exporting these goods all around the world.
Now, as inflation has gone up, they've raised interest rates quite aggressively to protect against those inflationary pressures. And as inflation has started to come down, we're starting to see those interest rates coming down. So, I think that's quite supportive to growth in the economy. And then for shareholders, we see very attractive dividend yields, depressed valuations, that suggests it's a great entry point. And you've got these longer-term growth drivers that are likely to be quite positive for shareholders.
Johnson: You mentioned agriculture and global food demand, particularly from China, is driving agriculture in Brazil and it now accounts for about 25% of Brazil's GDP. But with agribusiness booming, it doesn't seem to feature much in your fund. Why is that if it's so important?
Altaf: I think if you look at direct sort of agriculture producers, we don't have any in the fund. But what we do have in the fund are companies that really benefit from that surging demand. And the discipline that we follow is ultimately about trying to identify fundamental trends in companies. So, where are you seeing growth coming through? And where is that good news not reflected in the share price today? So, is there an opportunity for an investor to participate in the shares performing well? And we think the opportunities are in financials, are in other commodity plays, like energy, for instance, and some of the metal producers, and also within the insurance sector. So, our capital is allocated towards those areas. But some of those companies really do benefit from that rosy picture that's developing in the economic side of things.
Johnson: So, Petroleo Brasileiro or Petrobras [PBR] is a top holding of yours at 3.4%. So, why are you bullish on this stock and how is this energy company benefiting from the increase in agriculture in Brazil?
Altaf: Well, Petrobras is one of the biggest energy producers in the world. And clearly, energy stocks have had challenges in the last decade, and that's led to a lot of underinvestment, if you like. What we've seen happening over the last few years or the last decade is that the company has cleaned up its balance sheet. Now, as oil prices have been going up because of pretty robust and firm demand from around the world, the company is benefiting from that demand. And that's leading to cash flows that are going up. The company's shares are trading on quite a depressed valuation. But I think more importantly, they've been paying out this cash that's been generated to shareholders. And so, the dividend story in Petrobras has been an exceptional one over the last few years. And if we look at the total return that investors have got, that has outpaced the market quite substantially.
Johnson: On dividends, I mean, there was a story coming out about Petrobras that they withheld their dividends from shareholders recently. So, does this lead you to have any governance concerns at all? Or is this just an aberration?
Altaf: I think it's important to consider the governance for companies, particularly in emerging markets. And that has been a problem in the past. And certainly, Petrobras has its own checkered history. When I look at the company, what we're seeing is governance is certainly improving. In the last three years alone, the company has paid out about $75 billion in dividends. Now, the company's market cap today is around $100 billion. So, it's paid out almost all of its market cap in the last few years. And it's forecast to do pretty well on that side of things going forward. So, the story that's come out more recently is really about the extraordinary dividends, what's happening to surplus cash that's being generated. And there's some concerns amongst investors that that's not going to be delivered to shareholders. But even when you adjust for that, the yield that shareholders are getting is very attractive.
Johnson: I wanted just to circle back to agriculture. So, the reason why I'm interested in this topic is because I was reading about the fact that, of course, agribusinesses are growing, but there are also concerns about how climate change could impact the yields of crops and so forth, of sugar or soybeans. Is that something you're taking into consideration as obviously we're going to be feeling more effects of climate change and maybe the possible ramifications that we'll have on this bourgeoning sector in Brazil.
Altaf: I think that's certainly been a concern in the last few years and it's something that we're very aware of. What we're looking for in business is firstly evidence that there are sustainable efforts underway when it comes to the practices that they have, whether it's food production, whether it's energy production or whether it's manufacturing of goods. There are some businesses that have understood these longer-term risks around the climate and the effect that that's going to have on the world, and they are starting to evolve and change their practices for the better. We think those are likely to be winning businesses over time and you can find some of those in Brazil as well. But clearly, the other side of things is that demand for these things is not going to go away. So, we've got to focus on identifying the companies that have good practices but also find the winning businesses that are going to benefit from those longer-term growth drivers.
Johnson: And Banco do Brasil [BDORY] is another top holding of the fund. Its share price has seen a consistent uptick over the last five years. So, what do you think is driving these businesses and positive momentum?
Altaf: Well, quite simply, financials tend to benefit when interest rates go up, then their income margins go up and their profitability improves. Interest rates in Brazil are north of 10%. Inflation is much lower. So, the funding yield that Banco do Brasil is enjoying is a very favourable one. The bank is connected to the agriculture sector, and it's been growing its loan book particularly on the rural side of things and that's been a strong growth driver. Now alongside that, you've got a very positive dividend story. The dividend yield in Banco do Brasil is around 10%. So, the shares have performed well because the bank is profitable. It trades on a very cheap valuation compared to its peers and it continues to grow quite rapidly.
Johnson: I wanted to speak to you about India which also features within the fund. It is underweight in comparison to the MSCI Emerging Markets Index. Why is this? Does this have anything to do with the fact that equity valuations in India are extremely high?
Altaf: I think that's certainly some of the reason. I mean, if we take a valuation metric like Shiller PE where, for instance, you're looking at the last 10 years earnings and you're comparing that to the share price today, then India is the most richly valued equity market in the world. It's more expensive than the US. That's surprising given, yes, there has been very attractive growth in the economy and in a number of companies, but share prices are clearly overshot the fundamental story. I think some investors are really buying into this persisting for a long period of time. Our view is that one should be cautious as valuations become quite excessive. So, we think there are some parts of the Indian equity market that are very overvalued and we're nervous about what that means for future returns.
Johnson: So, which parts of the equity source within India are you avoiding because of high valuations?
Altaf: I think there's certainly some consumer segments of the market where the growth rates in these businesses have not really changed. They're seen as quite defensive businesses, so consumer staples for instance. There's no shortage of businesses where the company's share prices are trading on 50 or 60 times earnings. So, those are the sorts of companies where we think you're not really getting the reward for improving growth prospects and that valuation is really quite restrictive.
Johnson: India is going through a general election that's imminent, and Narendra Modi is expected to win at another term. How do you think a possible Modi win will impact India's economy going forwards?
Altaf: Yeah, it's quite unprecedented. It looks like Modi is likely to win his third term. If we look at the history of India, you haven't had a majority government in the past. So, it is interesting that we're moving towards this direction. I think if we look at what has happened in India, there's been a lot of infrastructure spending, there's been an increase in manufacturing and there's a confidence that's come back into the economy. So, I'd expect this to continue in the years ahead. But there were some challenges that mean that reforms need to continue. The poverty level is still at slightly concerning levels in many parts of the economy. There's a lot more work that needs to be done there to improve and increase the levels of urbanization that we've seen over the last decade or more.
Johnson: On to the fund, according to Morningstar data, over one year, the fund has experienced an inflow of over £239 million. So, what do you put this down to?
Altaf: Well, I think, the positive flows that we've seen in the fund are firstly down to the fact that performance has been good within the fund, and we've outperformed the market fairly consistently since we launched the strategy. But I think also looking back, investors had become quite crowded towards some high growth and some of the more quality parts of the market. The fund that we run is biased towards companies that trade on more depressed valuations. So, it's very complementary to some of those popular funds and it's acting as a good diversifier within that portfolio mix.
Johnson: Thank you so much for being here with me.
Altaf: Thank you.
Johnson: This is Christopher Johnson for Morningstar UK.
