Gary Greenberg, Portfolio Manager
Market and Performance Review
The benchmark MSCI Emerging Markets SMID Net Total Return Index fell 7.95% in US Dollar terms. Equity markets initially shrugged off concerns about the Coronavirus, supported by the expectation that any negative effects of the outbreak would be temporary and localised. However, the increase in cases outside China, notably in Korea, Iran and Italy led to a sharp sell off towards the end of the month. The US 10-year treasury yield touched an all-time low at 1.1%. Commodity prices weakened, the WTI oil price falling 13% in February and bringing the total year-to-date decline to 27%.
China was the only Emerging Market to finish in positive territory, up 1.96%, despite the expectation China’s economic growth will slow sharply in the first quarter as authorities introduced significant restrictions on travel and production to reduce the spread of infection. Policymakers have responded with several supportive measures. The People’s Bank of China cut the loan prime rate by 10 basis points, and provincial governments waived VAT, social contributions and rent to ease the financial pain, particularly for smaller businesses. However, hopes of a quick and sharp recovery in Q2 could be premature given the slow recovery in production and the uncertainty around the extent to which the virus will continue to spread.
In Korea, the country with the most confirmed COVID-19 cases outside China, consumer confidence fell sharply in February – the largest single month decline since June 2015. The close economic relationship between Korea and China also weighed on the economic outlook.
The Fund returned outperformed the benchmark index in relative terms. Country allocation contributed the most to relative returns, notably our overweight China which outperformed and underweight export-sensitive South Korea which has underperformed. Our underweight several commodity-sensitive markets South Africa and Saudi Arabia and non exposure to Thailand, heavily impacted by the outbreak due to its dependency on tourism also contributed. Stock selection in India and the United Arab Emirates detracted from relative returns.
China Communication Services, a new generation smart services provider, rose as the telecom regulator held a meeting on February 22nd to urge telecom operators to accelerate standalone 5G network construction and roll out. Nari Technology, a mainland China smart grid equipment supplier, rose as concerns that the appointment of a new Chairman of the State Grid Corporation of China (SGCC) would impact the pace of future grid investment proved unfounded as the SGCC said it would resume full construction of planned infrastructure. Shares in Baozun, a leading brand e-commerce solutions provider in China, rose as the share price had sold off prior to the Covid-19 outbreak and the company is regarded as relatively stable versus its peers.
Shares in NMC, which owns and operates hospitals in the Middle East, fell sharply after Louis Freeh, the former FBI director appointed by the Board to oversee an investigation into the allegations made by short seller Muddy Waters presented his review. He found businesses controlled by a founder of NMC and an associate allegedly accessed US$335 million in secret off-balance sheet financing without the knowledge of NMC’s Board. On February 27th, the Board requested that the Financial Conduct Authority (FCA) temporarily suspend its shares to "ensure the smooth operation of the market” and fired its chief executive, suspended a member of its treasury team and gave "extended leave" to its finance chief. These latest events relating to NMC lead the team to lower their estimate of “fair value” to a 70% discount to the last close prior to the suspension of the shares, or 281p. IRB Brasil, a reinsurer, fell following a short report raising questions about the company’s accounts. The team spoke to management, local analysts, and a reinsurance specialist but did not regain confidence in the company and began selling out as a result. Mail.RU, the Russian internet services provider, fell after reporting a mixed set of Q4 2019 results which were below consensus on revenue and net income.
The Coronavirus seems to have peaked in China and the team think that it will soon peak in Korea. The mortality rate is low but certainly there is a possibility that it turns into a major event which restricts global economic activity. However, they think it is more likely that it will be contained.
Strategy exposure to leisure and travel is limited. The team own Galaxy Entertainment Group which operates casinos and hotels in Macau, and Samsonite, the global luggage provider. They have no positions in Thailand which has a high dependency on tourism, and may look to add to the position in China as the market continues to sell-off. The overweight to India has benefited the Fund as the country has remained relatively unscathed from the Coronavirus outbreak. India has been the only stock market in Asia to post positive foreign inflows in 2020, helped by a recent decline in oil prices and a closed-economy that is seen as fairly insulated from the disruption.
The Coronavirus may tip the world economy into recession but on balance the view is that this will not happen. The team are not making any changes in the Fund except for buying opportunities when they become cheaper. They are doing research on high-quality companies that have been hit and if they prove to be attractive then we will pick them up.