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Ashoka WhiteOak Emerging Markets Trust

Ashoka WhiteOak Emerging Markets Trust (AWEM)

As promised in the last newsletter, we are providing full details of this new trust as an interim update before the May issue, to allow subscribers to make a timely investment decision. AWEM is the first investment trust IPO for more than a year, and our initial thoughts from the advance information were positive. We have since met the manager Prashant Khemka and members of his team for a first-hand update in our offices, and the trust has also issued its prospectus. The trust is seeking £100m from its launch, with a £30m minimum and £300m maximum. Given the management team are planning on investing £5m too, we think there is a strong chance of a successful offer here, unless markets are suddenly plunged into an unexpected crisis.

To recap, White Oak Capital Partners is the investment management company founded by ex-Goldman Sachs investment manager Prashant Khemka, who is also the manager of the Ashoka India Equity Investment Trust (AIE, 180p). AIE has established a strong track record and a high reputation to match. It stands up well against its peers, having delivered a 97% NAV return in sterling over the last three years, and generally trades close to NAV, allowing it to issue more shares when on a premium.

AWEM is a more broadly diversified offering, building on Prashant’s successful past experience as a global emerging markets manager with Goldman Sachs from 2013 to 2017. The managers believe this represents a compelling entry point for emerging markets, with valuations at multi-year lows against developed markets, yet with lower inflation, lower debt, and higher growth. Emerging markets have been less vulnerable to recent inflationary and monetary shocks than the major developed markets. Prashant appreciates that backdrop, and it is supportive of the launch, but that is really not the foundation on which this trust is based. Prashant seems laser-focused on extracting ‘alpha’ (excess return) from a detailed stock-selection process, and it is here that he sees more opportunity in emerging markets than elsewhere. Emerging markets are broadly less efficient, less well researched, and because of the diversity of opportunity and higher growth on offer there is more scope to capture higher alpha potential. He says it is “unthinkable” that such opportunities could be available in a highly developed market like the US. “In a world of mediocre returns”, he adds, “each percentage point of alpha is highly valued.”

To capture more alpha, the trust intends to spread its focus across the capitalisation spectrum, with an initial allocation of around 60%-65% to large caps and the balance in mid and small caps. Over time this may move closer towards the 50/50 spread that is more typical for Ashoka India. The new trust will also have the capacity for some small exposure to pre-IPO unquoted companies, which has been a successful ploy for AIE.

The detailed investment process is quite research intensive, and of course global emerging markets provide a big footprint that is not easy to cover. The White Oak team is far larger than we might have imaged, with a team of 40 professionals spread across offices in India, Singapore, and Spain. Prashant told us that company visits and close contact with management is important in the process of narrowing down the choices from a broad investible universe to a portfolio or around 100 companies. One important element here is to screen out poor governance, which can be a major problem in emerging markets, and Prashant spent some time explaining how certain company ownership structures are undesirable, including state-owned enterprises, which will usually be screened out. The trust will also watch keenly for other issues such as misaligned interests or objectives, poor accounting, unethical conduct, stock price manipulation, price rigging, unrealistic projections, related-party transactions, and the like. It’s a long list, and we liked the accompanying quotation in the presentation from Benjamin Franklin saying “he that lieth down with dogs shall rise up with fleas.”

Prashant explains that it is growth in earnings that really counts over time, which is why there is an emphasis on quality in the portfolio selections, although he says it is right to be price and valuation sensitive too. The entry price matters in less efficient markets where anomalies and mispricing can regularly occur, and so does an attractive exit price. Whilst the trust is seeking great businesses it does not intend to hold them for ever, but says the holding periods will generally be more than three years. The launch material included a model portfolio with holdings in some well-known names such as Taiwan Semiconductor Manufacturing (TSMC), Samsung Electronics, Wal-Mart de Mexico, Naspers, and Dino Polska, but in there as well are LVMH and Hermes International, two luxury brands listed in France. They qualify because the countries of operation are what counts here, and these companies sell at lot of their products and find even more of their growth in emerging markets.

This led on to a discussion about the importance of the Chinese consumer and hence to the ‘democratic overlay’ that has been trumpeted as a feature of this trust. The trust wants to favour countries with stable democratic systems as a way of mitigating governance risk at the macro level, but this does not mean a zero weighting to countries like China. In the model portfolio China has a weighting by listing of 22%, which is 10% underweight against the benchmark index, and this position is replicated across other ‘less democratic’ countries such as Thailand, Turkey, Egpyt, and the middle eastern gulf states. Overall, the trust will have a heavy underweight here, indicated to be around half of the weighting in the MSCI Emerging Markets Index. Prashant explained concerns over issues such as property rights, and reiterated that whilst China is too large to ignore, and the trust does want exposure to all alpha-rich segments of the market, the mitigation of risk is also at the forefront of its thoughts. There are implications here too for sector composition – the trust’s desire to stay away from state-owned enterprises and what Prashant called “sketchy entrepreneurs” means there are unlikely to be any meaningful positions in energy or utilities.

The balance of chasing alpha and moderating the risk was a recurring theme during our meeting, and Prashant summarised it neatly with a cricketing analogy, saying that his approach was more about scoring the ones and twos consistently rather than going for sixes over the boundary. The aim is to perform consistently.

The management fees are a major topic for discussion here. Like AIE, this new trust will have the unusual fee structure of a zero base fee. The managers will be entirely remunerated on a performance fee, very much swimming against the tide of the rest of the sector. Performance fees can evoke fiercely negative reactions and there have been examples in the past of poorly-structured fees that have rewarded managers with spectacularly handsome sums for brief flashes of strong performance – most famously Henderson Technology Trust in the dot-com boom and more recently Chrysalis Investments (CHRY, 69.7p). We put those examples to Prashant, who agreed that fee arrangements based on absolute performance can be abused and can produce poor outcomes for investors. Importantly, the proposed fee on AWEM is effectively an ‘alpha fee’ that is based on the outperformance, so a year of strong growth in emerging markets will not generate a fee at all if the trust fails to add extra value over the benchmark returns. Prashant says that once this is understood, the feedback he receives is “very positive”. It seems carefully structured, with a three-year measurement period and a cap as well, and upon examination we feel comfortable with it. We have the experience of seeing how it has worked with AIE as well, where the manager has received zero fees for a couple of years, and then some larger fees, but overall it seems to work well for all parties.

In conclusion, we feel this is a high-quality investment proposition that has worked well in the past under this manager, who has also proved his investment trust credentials with the strong performance of AIE. There is always risk, but this manager’s highly thoughtful approach and risk controls stand a decent chance of replicating his past success. We were impressed by Prashant and feel this IPO should comfortably raise sufficient funding to proceed. In common with the manager though, we feel the entry price matters, and we still feel that paying a premium to buy in at the launch does not make complete sense. With the scope for the IPO to scale up to £300m and market conditions still generally fragile we think the chances of a big initial premium are slim, and we note that AIE is currently trading at a small discount. That said, as an equity trust we think AWEM can quickly become fully invested, so there is no investment lag as there often is for alternative asset trusts.

We like the trust and believe it has a chance of establishing itself as a winner in the general emerging markets sector that lacks a clear leader. We feel that long-term investors convinced of the merits of the trust can simply buy in at launch and lock it away. Those who are half-convinced could also wait a few weeks or months and seek an opportunity to buy in at a discount, although we suspect sellers may be scarce unless there is a crisis or a sudden bearish downturn. The offer for subscription closes on April 27th, though you should check your own stockbroking account to see if an earlier deadline applies. The issue price is 100p and the initial net asset value will be 98p.

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