Commentary
Backdrop
The backdrop for corporates operating in EM ex-China remained largely buoyant during the third quarter. In Asia, the World Bank at the end of the quarter upgraded the 2023 forecast for South Asia from 5.6% to 5.8%. Despite sabre-rattling with China and Canada during the quarter, India continues to be the ‘golden child’ of the asset class in terms of growth expectations, and this has been reflected in the ongoing strong performance of the equity market there.
In Latin America, conversations with corporates and headline data both suggest that activity here remains robust, with a relatively controlled level of inflation in key markets Brazil and Mexico. Despite this, long-term government yields in these two markets have risen notably, and after a period of currency strengthening against the dollar, most Latin American currencies have traded-off since August.
What continues to feed much of equity and debt investor anxiety in Latin America is the political backdrop, both domestic and international (US election cycle). Currently policy makers however have not set the bar high, and so ‘uncertainty’ does not necessarily mean heightened risk. For example, in Argentina - a country plagued by hyper-inflation - upcoming elections could see a radical shift to the economic right if libertarian Javier Milei wins. The fund currently has no Argentinian listed exposure, however part of Mexican steel production firm Ternium’s business does operate out of the country. We spoke with the IR and the CFO of Ternium during the quarter, and they note that the election is indeed creating uncertainty, although the firm has some degree of built-in resilience as it prices in dollars, not peso.
Performance
EM ex-China market activity over the third quarter weakened - the MSCI EM ex-China index returned -3.2% and the fund -2.4%. Beyond the headline figures, Latin America performed behind Emerging Asia, and there was a broad evidence of a market reversion - what had otherwise worked in the first two quarters, lagged in the third (and visa-versa).
Key contributors to the funds total return were Petrobras, Buenaventura and SK Telecom; key detractors to fund performance were Copa Holdings, Embraer, and Indofood. Petrobras, a Brazilian oil and gas producer, enjoyed positive performance due primarily to the rally in the oil price. It remains the case that the firm is one of the most attractively valued global oil major by most key measures – most notably, its total cash return yield. Operationally, the firm couples a low-lifting cost protecting on the downside, with ongoing exploration of the Brazilian pre-salt fields providing opportunity for growth.
In the instance of Buenaventura, a Peruvian mining company, the firm continues to benefit from a buoyant gold/silver/copper price, and recovering production. Peru has had a tumultuous decade, churning through four presidents, each from a different party. This has proven problematic for a business model that relies on government permits for new mine exploration. We recently spoke with management however, and encouragingly the state has put in place a streamlined procedure that avoids an otherwise myriad of multi-departmental processes.
The weakest fund contribution was from Copa Holdings, a regional aviation leader in South America. The firm operates out of Panama, and combines favourable low-cost economics with an improved post-COVID competitive landscape. Sentiment during the quarter may well have been affected by the firm’s redemption of its convertible notes. The redemption, while dilutive to shareholders, ultimately cleans up the capital structure and removes any uncertainty surrounding the firm’s refinancing needs.
The share price performance of Embraer, a Brazilian domiciled aircraft manufacturer, was also disappointing during the quarter. Negative share returns were partly a pullback from a period of strong share performance earlier in the year. Fundamentally, there still remains a very strong valuation case to continue holding the stock, be it compared to its own historic valuation level or that of peers. Furthermore, there has been evidence of ongoing incremental improvement in its outlook during the recent months, with an uptick in new order wins. We had multiple conversations with management over the quarter, and also engaged with an NGO involved in policy-campaigns for sustainable aviation, to further our understanding on how the economics of the future are affected as the aviation industry hits a period of energy transition.
Activity
During the third quarter, the fund initiated a new position – Orbia. This was part funded from the exit of JSE, the South African stock exchange, and Turkcell, a Turkish mobile telecom operator. In both cases, the level of political and country risk had heightened to a level that made the risk/return profile of these holdings materially less favourable.
Orbia is a Mexico based multinational firm namely operating along the PVC supply-chain, but also has the rights to the world’s largest fluorine mine. The firm’s share price has recently been weak due to normalisation in the PVC price after a COVID ‘peak’. Longer-term however the case for structural growth in demand remains, moreover supply is tight and new investment limited. In terms of downside protection, the firm has consistently been free cash flow profitable since 2005, and the 2023 dividend yield of 6% provides a good degree of valuation support. Additionally, while the firm may be domiciled in an emerging market, the majority of end-consumption is in developed markets. The upside is if there is a normalisation in key valuation metrics, stabilisation in PVC pricing, and/or M&A.
Russian holdings
Please note that on 3rd March 2022 the Fund’s investment in Lukoil ADR listed on the London Stock Exchange (LSE) was suspended from trading. Our Valuation Committee considered it was in the Fund’s best interests that the holding of Lukoil ADR be fair value priced (FVP) at zero. In June 2022, we elected for the holding to be converted into local shares (Lukoil PJSC).
Given the current international sanctions on Russian securities and cash balances, we believe that if lifted and the Fund was able to access the local market, the holding in Lukoil PJSC (with a current FVP of zero) would represent 5% of the Fund and cash dividend of 0.7%. On 22nd August 2023 a Reuters article suggested that Lukoil was planning to repurchase 25% of its shares from foreign shareholders. The repurchase price would be at least a 50% discount from the quoted price. We continue to monitor the situation closely.
Portfolio Management
We are excited to announce that Charles Sunnucks joined the Global Emerging Market and Global Emerging Market ex-China strategies as an Associate Portfolio Manager as of October 1st 2023. In this role, Charles will begin to participate in the portfolio construction and risk management aspects for these strategies, while Tom Taylor remains the Portfolio Manager. This change is in recognition of the strong, diverse pipeline of talent and our desire to give additional responsibility which we firmly believe will benefit our clients and support our long-term succession planning.
Charles joined OP at the start of 2023, prior to which he was involved in cross-border M&A transactions at investment bank NovitasFTCL. He previously worked at Jupiter Asset Management where he co-managed the Jupiter Emerging & Frontier Income Trust. Charles speaks fluent Mandarin and is a CFA/CAIA Charterholder.
Newsletter changes
We are moving to Quarterly Newsletters. These will now encompass a fuller write up of what has been happening in the portfolio over the previous quarter. In between these Quarterlies, we will produce a monthly fact sheet. These will not have a written piece but will have comprehensive facts on the fund. Why have we done this? We have a longer-term outlook, have low turnover and things don’t change an enormous amount month to month. We felt that readers would learn a lot more from a fuller review of portfolio movements on a quarterly basis.
If you have any questions, please contact Ed Troughton or James Lindsay.
Commentary
Backdrop
The backdrop for corporates operating in EM ex-China remained largely buoyant during the third quarter. In Asia, the World Bank at the end of the quarter upgraded the 2023 forecast for South Asia from 5.6% to 5.8%. Despite sabre-rattling with China and Canada during the quarter, India continues to be the ‘golden child’ of the asset class in terms of growth expectations, and this has been reflected in the ongoing strong performance of the equity market there.
In Latin America, conversations with corporates and headline data both suggest that activity here remains robust, with a relatively controlled level of inflation in key markets Brazil and Mexico. Despite this, long-term government yields in these two markets have risen notably, and after a period of currency strengthening against the dollar, most Latin American currencies have traded-off since August.
What continues to feed much of equity and debt investor anxiety in Latin America is the political backdrop, both domestic and international (US election cycle). Currently policy makers however have not set the bar high, and so ‘uncertainty’ does not necessarily mean heightened risk. For example, in Argentina - a country plagued by hyper-inflation - upcoming elections could see a radical shift to the economic right if libertarian Javier Milei wins. The fund currently has no Argentinian listed exposure, however part of Mexican steel production firm Ternium’s business does operate out of the country. We spoke with the IR and the CFO of Ternium during the quarter, and they note that the election is indeed creating uncertainty, although the firm has some degree of built-in resilience as it prices in dollars, not peso.
Performance
EM ex-China market activity over the third quarter weakened - the MSCI EM ex-China index returned -3.2% and the fund -2.4%. Beyond the headline figures, Latin America performed behind Emerging Asia, and there was a broad evidence of a market reversion - what had otherwise worked in the first two quarters, lagged in the third (and visa-versa).
Key contributors to the funds total return were Petrobras, Buenaventura and SK Telecom; key detractors to fund performance were Copa Holdings, Embraer, and Indofood. Petrobras, a Brazilian oil and gas producer, enjoyed positive performance due primarily to the rally in the oil price. It remains the case that the firm is one of the most attractively valued global oil major by most key measures – most notably, its total cash return yield. Operationally, the firm couples a low-lifting cost protecting on the downside, with ongoing exploration of the Brazilian pre-salt fields providing opportunity for growth.
In the instance of Buenaventura, a Peruvian mining company, the firm continues to benefit from a buoyant gold/silver/copper price, and recovering production. Peru has had a tumultuous decade, churning through four presidents, each from a different party. This has proven problematic for a business model that relies on government permits for new mine exploration. We recently spoke with management however, and encouragingly the state has put in place a streamlined procedure that avoids an otherwise myriad of multi-departmental processes.
The weakest fund contribution was from Copa Holdings, a regional aviation leader in South America. The firm operates out of Panama, and combines favourable low-cost economics with an improved post-COVID competitive landscape. Sentiment during the quarter may well have been affected by the firm’s redemption of its convertible notes. The redemption, while dilutive to shareholders, ultimately cleans up the capital structure and removes any uncertainty surrounding the firm’s refinancing needs.
The share price performance of Embraer, a Brazilian domiciled aircraft manufacturer, was also disappointing during the quarter. Negative share returns were partly a pullback from a period of strong share performance earlier in the year. Fundamentally, there still remains a very strong valuation case to continue holding the stock, be it compared to its own historic valuation level or that of peers. Furthermore, there has been evidence of ongoing incremental improvement in its outlook during the recent months, with an uptick in new order wins. We had multiple conversations with management over the quarter, and also engaged with an NGO involved in policy-campaigns for sustainable aviation, to further our understanding on how the economics of the future are affected as the aviation industry hits a period of energy transition.
Activity
During the third quarter, the fund initiated a new position – Orbia. This was part funded from the exit of JSE, the South African stock exchange, and Turkcell, a Turkish mobile telecom operator. In both cases, the level of political and country risk had heightened to a level that made the risk/return profile of these holdings materially less favourable.
Orbia is a Mexico based multinational firm namely operating along the PVC supply-chain, but also has the rights to the world’s largest fluorine mine. The firm’s share price has recently been weak due to normalisation in the PVC price after a COVID ‘peak’. Longer-term however the case for structural growth in demand remains, moreover supply is tight and new investment limited. In terms of downside protection, the firm has consistently been free cash flow profitable since 2005, and the 2023 dividend yield of 6% provides a good degree of valuation support. Additionally, while the firm may be domiciled in an emerging market, the majority of end-consumption is in developed markets. The upside is if there is a normalisation in key valuation metrics, stabilisation in PVC pricing, and/or M&A.
Russian holdings
Please note that on 3rd March 2022 the Fund’s investment in Lukoil ADR listed on the London Stock Exchange (LSE) was suspended from trading. Our Valuation Committee considered it was in the Fund’s best interests that the holding of Lukoil ADR be fair value priced (FVP) at zero. In June 2022, we elected for the holding to be converted into local shares (Lukoil PJSC).
Given the current international sanctions on Russian securities and cash balances, we believe that if lifted and the Fund was able to access the local market, the holding in Lukoil PJSC (with a current FVP of zero) would represent 5% of the Fund and cash dividend of 0.7%. On 22nd August 2023 a Reuters article suggested that Lukoil was planning to repurchase 25% of its shares from foreign shareholders. The repurchase price would be at least a 50% discount from the quoted price. We continue to monitor the situation closely.
Portfolio Management
We are excited to announce that Charles Sunnucks joined the Global Emerging Market and Global Emerging Market ex-China strategies as an Associate Portfolio Manager as of October 1st 2023. In this role, Charles will begin to participate in the portfolio construction and risk management aspects for these strategies, while Tom Taylor remains the Portfolio Manager. This change is in recognition of the strong, diverse pipeline of talent and our desire to give additional responsibility which we firmly believe will benefit our clients and support our long-term succession planning.
Charles joined OP at the start of 2023, prior to which he was involved in cross-border M&A transactions at investment bank NovitasFTCL. He previously worked at Jupiter Asset Management where he co-managed the Jupiter Emerging & Frontier Income Trust. Charles speaks fluent Mandarin and is a CFA/CAIA Charterholder.
Newsletter changes
We are moving to Quarterly Newsletters. These will now encompass a fuller write up of what has been happening in the portfolio over the previous quarter. In between these Quarterlies, we will produce a monthly fact sheet. These will not have a written piece but will have comprehensive facts on the fund. Why have we done this? We have a longer-term outlook, have low turnover and things don’t change an enormous amount month to month. We felt that readers would learn a lot more from a fuller review of portfolio movements on a quarterly basis.
If you have any questions, please contact Ed Troughton or James Lindsay.