The AFC Asia Frontier Fund (AAFF) USD A-shares declined -1.5% in March 2018. The fund underperformed the MSCI Frontier Markets Asia Net Total Return USD Index (+5.2%) and the MSCI Frontier Markets Net Total Return USD Index (+0.9%), but outperformed the MSCI World Net Total Return USD Index, which was down -2.2%. The performance of the AFC Asia Frontier Fund A-shares since inception on 31st March 2012 now stands at +69.6%, representing an annualized performance since inception of +9.2% p.a., while its YTD performance stands at -0.6%. The broad diversification of the fund’s portfolio has resulted in lower risk with an annualised volatility of 8.84%, a Sharpe ratio of 1.01 and a correlation of the fund versus the MSCI World Net Total Return USD Index of 0.33, all based on monthly observations since inception.
The first quarter of the year ended with uncertainties on the global front as U.S. President Donald Trump continues to push for tariffs on Chinese imports into the U.S. with further tariffs being announced last month in addition to the 25% and 10% import duties on steel and aluminium. China is expected to retaliate with its own measures aimed at U.S. imports which has led to fears of a trade war resulting in weak global markets last month.
However, as discussed previously in our manager comments, most frontier markets in general are less impacted by global politics/global macro concerns as was the case this month, with Pakistan and Vietnam gaining +5.4% and +4.7% respectively even though most global markets ended the month in the red. Lower foreign participation, domestic driven economies, low cost manufacturing, and under-researched equity markets are some the main factors for Pakistan and Vietnam’s outperformance.
Within our universe, Vietnam is heavily dependent on exports, but the recent import duties on steel should not have a major impact on the country as steel exports to the U.S. account for neither a large part of Vietnamese steel exports nor total exports (0.2% of total exports). The recent import duties imposed by the U.S. on washing machines and catfish as well should not have a major impact on Vietnam as both these products account for around 0.3% and 0.2% of total Vietnamese exports respectively. The majority of exports from Vietnam to the U.S. are textiles, footwear, and mobile phones and these do not face a threat at this point in time. Furthermore, both Vietnam and the U.S. appear to be building closer relations politically and economically so import duties on any major items that Vietnam exports to the U.S. would be a surprise.
Vietnam delivered robust 1Q18 GDP growth of 7.4%, led by the manufacturing sector which grew by 13.6% due to the country continuing to be an attractive lower cost manufacturing hub backed by political stability. A few large cap stocks took the Ho Chi Minh VN Index higher (which was the case for the fund’s benchmark as well) while gains for the fund in Vietnam were led by an industrial park operator based in a very good location outside of Ho Chi Minh City that is expanding capacity, an oil/coal transportation company which will benefit from the new oil refinery and coal power capacity coming up in the country, and an air cargo terminal operator which is expected to see robust volume growth over the next few years.
Pakistan saw good gains in local currency terms and this positive sentiment was due to weakness in the Pakistani Rupee (PKR) which depreciated by 4.5% this month on the back of a wide current account deficit. The close to 10% fall in the PKR since December 2017 has cheered local investors as they see this as a positive signal that the government is looking to stabilize the current account and also because foreign investors may revisit Pakistan since currency depreciation is what most foreign investors have been waiting for. This depreciation, as well as attractive valuations, has led the KSE-100 Index to rally this year by 12.6% in local currency terms and 7.4% in USD terms, making Pakistan one of the top performing markets in Asia so far in 2018.
The State Bank of Pakistan surprisingly did not raise its key benchmark rates, but this does not change our view that the interest rate cycle in Pakistan has turned and we may possibly see higher rates in the second half of this year as the impact of the PKR depreciation begins to take effect. Economically, the numbers coming out of the country are still positive, with cement and auto sales continuing to show strong volume growth, with cement players in the North of the country raising prices by 7-8% due to robust demand in order to pass on the cost pressures they have faced due to higher coal prices. All of the major auto players have also raised prices in the past few months which reflects their ability to pass on some of the cost pressures due to strong consumer demand.
Politically, the situation also remains stable with Senate elections taking place on time, while national elections are also expected to take place on time later this August. This month in local currency terms, the fund’s cement holdings did well due to higher selling prices and strong volume growth, while the bank that the fund holds also performed well as the interest rate cycle turns which should be positive for the industry’s net interest margins. Local currency gains, however, were negated by the PKR depreciation, which resulted in a loss of around 85 basis points.
Bangladesh continued to be weak as the banking sector, which has a high weight in the index, is expected to face margin pressure due to the recent central bank directive reducing loan to deposit ratios. Most of the well-established banks are now down 15-20% this year with the fund having no exposure to banks in Bangladesh. The fund invested into a commercial vehicle company which is now beginning to assemble vehicles in the country instead of importing and distributing them and this should help improve its profitability going forward. The commercial vehicle industry in Bangladesh is still nascent with annual volumes of approximately 45,000 units, much lower than more industrialized countries with a similar sized GDP such as Vietnam, which does >100,000 units of commercial vehicle sales annually. Bangladesh continues to lag the region in terms of quality of infrastructure and as this is expected to improve, this company can benefit from higher commercial vehicle sales going forward as it has a well-established market share, brand, and distribution network.
In Sri Lanka, the fund invested into a telecom operator which has the highest market share in the mobile telecom space and on a relative basis is trading at a significant discount to most telecom companies in the region. This company is seeing high growth from its data business as smartphone penetration increases and as the company expands its 4G network. There is also a possibility of industry consolidation which could lead to more price stability going forward, benefitting larger players.
On 21st March, the President of Myanmar, U Htin Kyaw, announced his sudden and unexpected resignation. A surprise to many, it was later reported that U Htin Kyaw had supposedly intended to step down early on as President, acting as a placeholder of sorts in order to execute on the State Counsellor Daw Aung San Suu Kyi’s directives, since Daw Suu can’t hold the position of president. This led to the election of a new president, U Win Myint on 28th March. It remains to be seen if he will be granted more power than his predecessor, as the Myanmar economy in its present state needs a more proactive government at all levels to ensure the economy can continue to grow and that bureaucracy is reduced. The coming months will be telling as to whether the president’s duties will grow or if we are to experience more of the same.
The biggest detractor to performance this month were the fund’s resource/mining stocks as they faced pressure due to worries over a trade war which has so far focused on commodities.
The best performing indexes in the AAFF universe in March were Pakistan (+5.4%), Vietnam (+4.7%), and Mongolia (+1.6%). The poorest performing markets were Bangladesh and Iraq, both of which declined -3.6%. The top-performing portfolio stocks this month were: a Mongolian meat producer (+25%), a Mongolian concrete company (+21.9%), a Vietnamese industrial park operator (+19.8%), a Mongolian duty-free shop operator (+18.5), and a Vietnamese communication equipment producer (+15.8%).
In March, we added to existing positions in Mongolia, Sri Lanka, and Vietnam and added a commercial vehicle assembler in Bangladesh and a telecom operator in Sri Lanka, both being new positions in the portfolio. We exited a Bangladeshi mortgage finance company, a Pakistani oil producer, a Pakistani business outsourcing company, a Vietnamese plastic bag producer, and a Vietnamese lighting company. Additionally, we partially sold one company in both Bangladesh and Mongolia, two companies in Sri Lanka, and three companies in Vietnam.
As of 31st March 2018, the portfolio was invested in 111 companies, 1 fund and held 6.0% in cash. The two biggest stock positions were a pharmaceutical company in Bangladesh (8.3%) and a pump manufacturer from Vietnam (3.5%). The countries with the largest asset allocation include Vietnam (26.1%), Bangladesh (18.4%), and Pakistan (17.3%). The sectors with the largest allocations of assets are consumer goods (28.6%) and industrials (16.6%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 13.72x, the estimated weighted average P/B ratio was 2.72x, and the estimated portfolio dividend yield was 3.46%.