Kunjal Gala, Lead Portfolio Manager
Market and Performance Review
The benchmark MSCI Emerging Markets SMID Net Total Return Index returned 2.76% in US Dollar terms in August. Emerging market equities rose in August for a fifth consecutive month. Positive economic data from China and signs of global growth over the third quarter, supported investor sentiment despite the continued spread of the virus which recorded 25 million cases globally. China Manufacturing PMI data for July came in at 52.8, indicating sustained expansion. Economic data for China in July was generally positive pointing to a continued recovery. India, Indonesia and South Korea reported a rise in daily new COVID-19 cases. However, the number declined in most other Asian countries. In Brazil, while the number of new cases remain high, the pace of gains slowed in July. The US Dollar moved lower against most major currencies after the US Federal Reserve affirmed its dovish stance and pledged support for further stimulus.
The fund outperformed benchmark index over the period. Outperformance was driven by a combination of asset allocation, notably the overweight China which outperformed and associated exposure to the currency which appreciated, and stock selection in Russia and China which offset the negative impact of weaker stocks in Korea and Taiwan.
SITC International, a Hong Kong-listed provider of shipping services across Asia, was the largest individual contributor after reporting a strong first half of 2020 beat despite trade disruptions. The company delivered 10% year-on-year earnings growth, thanks mainly to lower costs and management guided for double-digit volume growth in the second half of 2020, thanks to continued capacity expansion and improved demand outlook. Techtronic Industries, a Hong-Kong listed manufacturer of cordless power tools, rose after reporting strong quarterly results driven by innovation in new product development. Techtronic has benefitted from the positive momentum in DIY and strong traction in ecommerce sales. Yandex, Russia’s leading search and e-commerce provider, moved higher given a more upbeat outlook on their taxi business and for the Russian macro and domestic currency. COVID-19 social distancing has accelerated a shift of the Yandex taxi division to become a multi-purpose mobility operation utilized both by passengers and for food and non-food deliveries.
Eugene Technology, a Korean company manufacturing semiconductor equipment, detracted the most from relative returns. Investors took profits following strong performance and due to a slight miss for Q2 2020 sales and operating profit, a result of larger R&D costs. We believe profitability concerns are minimal as Eugene Tech is the only Korean equipment maker that can replace the Japanese vendors in the LPCVD BATCH space. Delta Electronics, a Taiwanese global leader in power switching supply products, fell as a result of profit-taking. Non exposure to NIO hurt relative returns as shares in the Chinese electric vehicle manufacturer have rallied strongly given record August sales.
We continued building positions in Sunny Friend Environmental Technology, an industrial infectious waste disposal company which operates medical and industrial waste treatment plants, Tokai Carbon Korea, a subsidiary of Tokai Carbon Japan, which manufactures silicon carbide rings (SiC) and Polymetal, a leading gold producer.
We sold out of Notre Dame Intermedica following strong performance and change to the company valuation. We trimmed several names including Delta, Eugene Technology and Nari Technology following strong performance year to date.
Emerging markets have rallied strongly from the March bottom, initially driven by unprecedented central bank and government monetary and fiscal stimulus, subsequently from a gradual relaxation of lockdowns as markets anticipate an economic recovery in the second half of 2020. The broadening out of the recovery has extended investor interest to more value sectors, sensitive to the economic recovery and trading at low valuations. Market sentiment has improved, and the focus has shifted to a sharp rebound in economic activity.
However, investors must weigh the possibility of further economic damage if the second wave lasts longer and economies are locked down again. A rollback of stimulus measures in many parts of the world risks increasing job losses and a softer recovery. In addition, a dramatically divergent move has occurred beneath the surface with real yields plunging to record lows and inflation expectations surging. The timing and efficacy of vaccines under development is far from clear, the business/consumer sentiment remains low, and geopolitical tensions are rising. With US elections coming up, the Trump administration has engaged in an expanding clash with China on various fronts from Huawei, Hong Kong, apps such as TikTok, We Chat and 5G wireless technology to a blame game over COVID-19 and Taiwan.
We believe that the world is likely to remain in a slow growth environment after the initial rebound. Hence, the fund remains focused on growth/quality and marginally adding to cyclicality where we feel that there is enough margin of safety and the company benefits from medium/long term catalysts.