The AFC Asia Frontier Fund (AAFF) USD A-shares declined −5.5% in October 2018. The fund outperformed the MSCI Frontier Markets Asia Net Total Return USD Index (−7.9%), the AFC Frontier Asia Adjusted Index (−6.4%) and the MSCI World Net Total Return USD Index (−7.3%) but underperformed the MSCI Frontier Markets Net Total Return USD Index (−3.5%). The performance of the AFC Asia Frontier Fund A-shares since inception on 31st March 2012 now stands at +39.6% versus the AFC Frontier Asia Adjusted Index, which is up +19.0% during the same time period. The fund’s annualized performance since inception is +5.2% p.a., while its YTD performance stands at −18.2%. The broad diversification of the fund’s portfolio has resulted in lower risk with an annualised volatility of 9.30%, a Sharpe ratio of 0.51 and a correlation of the fund versus the MSCI World Net Total Return USD Index of 0.37, all based on monthly observations since inception.
Global markets were in severe risk off mode in October as all major indices faced a heavy correction led by fears of overvaluation in developed markets and a global economic slowdown brought about due to protracted trade tensions. In recent years, we have seen similar global sell-offs such as in 2011 and 2013 and the current period of market corrections has only led to more attractive valuations in frontier and emerging markets. This makes it a good time to invest in well-established and quality names with a 3-5 year investment horizon as the consumption-led growth as well as improvements in infrastructure within our investment universe are here to stay for the long run and an on-the-ground visit to any of our markets will give the same picture, which is much different from the noise in the financial media.
Vietnam faced a heavy correction led by large cap stocks in the banking and real estate sectors as fears over slower loan growth raised concerns about the future earnings outlook for these companies. Most banks which have declared results so far in October have seen very soft sequential loan growth for the quarter. Combined with relatively higher valuations and worries about earnings growth going into 2019 it should not come as a surprise, in hindsight, that large cap stocks in the banking and real estate sectors led the correction this month. The fund does not have exposure to any banks in Vietnam due to their previous historic high valuations, but some of the names are beginning to look attractive. However, the weakness in banking stocks may not be over as the State Bank of Vietnam is in no mood to allow higher loan growth quotas.
Within real estate, the fund has no large cap exposure but is invested in a company which is focused on developing projects in the upcoming district of Thu Thiem in Ho Chi Minh City. The company also manages a host of toll road projects and has investments in some water utility projects. We believe this is a good diversified play on the overall growth of the country, especially Ho Chi Minh City where the company’s projects are located. The fund’s other two real estate plays are more indirect as they are industrial park operators with each of them having good locations in the North and South of the country and we expect both of them to benefit from increased foreign direct investment (FDI) into the country and especially from a protracted trade war.
Quarterly results for most of the fund’s Vietnamese holdings were excellent and were led by a pump manufacturer, real estate/infrastructure developer, industrial park operator, airport operator, automotive holding company and a cargo handling company, all of which witnessed greater than 25% earnings growth in the third quarter of this year.
Sentiment in Bangladesh continued to remain weak due to the upcoming elections which have been scheduled for 30th December 2018. However, earnings growth for most companies within the fund’s portfolio remained stable with growth being led by a mobile phone operator and a consumer appliance company (+20% earnings growth in 3Q18) while the fund’s bank, shoe retailer and tobacco holdings showed slower earnings growth. We expect sentiment in general to improve once the national elections are through and we believe that the fund’s holdings are well positioned to participate in any post-election rally.
Pakistan saw a month-end rally after starting the month on a weak note as Saudi Arabia has committed to provide USD 6 billion in financial assistance in the form of USD 3 billion as foreign exchange support and USD 3 billion as a deferred facility for oil imports. This offers much needed relief for the Pakistani government and there are now expectations that China will also provide some form of financial support which should help stabilize the country’s macro-economic situation. The Pakistani Rupee further depreciated by 8.6% during the month as the government announced approaching the IMF for further financial assistance. Both the currency depreciation as well as the approach to the IMF were not a surprise and a deal with the IMF is expected by the end of this year or beginning of 2019. All these moves to stabilize the economy should help improve sentiment but the immediate earnings outlook for most sectors is still negative due to the currency devaluation, though cheap valuations could provide an opportunity for us to increase our weighting to the country as we have reduced exposure significantly in 2018.
In Sri Lanka, the continued differences between President Maithripala Sirisena and Prime Minister Ranil Wickremesinghe most likely reached a tipping point which led the President to leave the current coalition set up on 26th October 2018 and join hands with the former President, Mahindra Rajapaksa, who has also been subsequently named the new Prime Minister of Sri Lanka. Immediately after this decision, the President suspended parliament till 14th November 2018 most likely for the new coalition partners (Sirisena/Rajapaksa) to muster up the 113 seats required to prove majority in the house since they currently hold only 95 seats together.
The now opposing Prime Minister Wickremesinghe’s United National Party (UNP) holds 106 seats in parliament and thus is closer to the 113 mark since he will most likely be able to count on the support of the Tamil National Alliance (TNA) party which holds 16 seats since this party is unlikely to support Mahinda Rajapaksa given recent historical events. Over the past two weeks the Sirisena/Rajapaksa combination have been looking for defections from the UNP to get to the 113 seat mark and they had managed around six to seven cross overs onto their side but it seems they are still short of the 113 seat mark.
Therefore, it does not come as a surprise that the President has decided to dissolve parliament on 10th November 2018 and hold early elections on 5th January 2019, more than a year ahead of schedule. The constitutionality of this decision will most likely be challenged by the UNP and its supporters and political uncertainties are expected to continue over the next few weeks. Given the political stalemate over the past few years, the fund has been underweight on Sri Lanka since 2015.
Uzbekistan aggressively continued its policy of opening up and liberalizing the economy. During October, Russia signed USD 27 billion and France USD 5 billion of investment deals with Uzbekistan. These were namely in the sectors of infrastructure, agriculture and energy. On energy specifically, Russia broke ground last month on Uzbekistan’s first nuclear reactor which is slated for completion in 2028. Inflation in the first ten months came in at 9.5%, and the government has been working hard to bring it down to the single digits for some time. This is quite an accomplishment as the government has simultaneously cancelled subsidies for bread and is raising prices of gas and electricity systematically until they cover the cost of production.
In Mongolia, the Development Bank of Mongolia issued a new USD 500 million 5-year bond with a yield of 7.5%. The bond was oversubscribed 8x. As the country has successfully rebounded from its bailout by the IMF in 2017 it is encouraging to see appetite for the country’s bonds, specifically as the country remains exposed to the boom-bust nature of global commodities markets. During the month the President, Kh. Battulga requested the Parliament to voluntarily dissolve itself after he accused it of inaction in forming sound and productive economic policies. This however is likely just political posturing for himself and his Democratic Party to regain its foothold in the 2020 Parliamentary elections, but nonetheless interesting.
The best performing indexes in the AAFF universe in October were Kyrgyzstan (+3.5%), Cambodia (+2.3%), and Mongolia (+2.1%). The poorest performing markets were Vietnam (−10.1%) and Iraq (−6.1%). The top-performing portfolio stocks this month were: an edible oil producer from Uzbekistan (+16.2%), a junior oil & gas company from Papua New Guinea (+15.1%), a Mongolian cashmere producer (+14.3%), a Mongolian meat producer (+12.7%), and a Mongolian leather company (+11.6%).
In October, we added to existing positions in Laos, Mongolia and Uzbekistan. We added an IT and an insurance company from Mongolia and a glass manufacturer from Uzbekistan to the portfolio, partially exited one port operator in Cambodia and four companies in Mongolia while completely exiting from a Pakistani passenger car manufacturer.
As of 31st October 2018, the portfolio was invested in 116 companies, 1 fund and held 3.6% in cash. The two biggest stock positions were a pharmaceutical company in Bangladesh (6.6%) and a pump manufacturer from Vietnam (4.5%). The countries with the largest asset allocation include Vietnam (25.1%), Mongolia (19.6%), and Bangladesh (19.5%). The sectors with the largest allocations of assets are consumer goods (30.2%) and industrials (20.0%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 13.00x, the estimated weighted average P/B ratio was 2.35x, and the estimated portfolio dividend yield was 3.86%.