The AFC Uzbekistan Fund Class F shares returned +8.2% in May with a NAV of USD 1,979.57, a new all-time high, bringing the return since inception (29th March 2019) to +98.0%, while the year-to-date return stands at +47.6%. On an annualized basis, the fund returned +37.7% p.a. with a Sharpe ratio of 2.33.
May 2021 was yet another strong month for the AFC Uzbekistan Fund, now up for 13 consecutive months. The two main contributors to performance during the month were a dividend and share split by two of the fund's largest holdings. Additionally, the fund saw a record inflow of new money from new and existing investors during the month.
There were two primary catalysts for the fund’s positive performance during May. The first was the annual general meeting of Qizilqum Cement (TSE:QZSM), held on 22nd May 2021, where a dividend of UZS 989 per share was announced for financial year 2020. As of 31st May 2021, this translates to a dividend yield of 14.5%, well above Uzbekistan’s 12-month inflation rate of 10.9%. Inflation and currency depreciation are investor worries often expressed to us, and which is addressed in detail further below, but nonetheless, there are still plenty of opportunities to purchase shares in companies where dividend yields and returns on equity are well in excess of inflation and certainly well above any depreciation in the Uzbek Som versus the US Dollar.
QZSM’s dividend payout in nominal terms has risen steadily since we began investing in Uzbekistan in 2018. The dividends for 2018 and 2019 were UZS 227 and UZS 460 respectively. From the fund’s initial investment in QZSM, we have recouped well over 100% of our principal from dividends alone, and based on QZSM’s strong start to 2021, with first-quarter YoY earnings growth of 61%, we expect the dividend for 2021 to be as good, if not better than for 2020. The consistently strong performance of QZSM can be attributed to an annual deficit of cement supply in Uzbekistan of approximately three mln tons and which we anticipate will take some while to shrink as new residential construction and infrastructure projects countrywide appear to be absorbing new cement supply coming online.
Further, on 6th May 2021, the fund’s third largest holding, Toshkent Vino (TSE:TKVK) conducted a 10:1 share split. While share splits, from a valuation point of view, don’t make a stock any cheaper, they give the appearance that the nominal value of the stock is more palatable for retail investors to initiate or grow their exposure. So, while a retail investor may be pleased to own one share of TKVK post-split at UZS 66,000, he only owns 1/10th of a pre-split share. This is a pretty typical phenomenon that often happens globally after share splits, but especially in frontier and emerging markets. The AFC Uzbekistan Fund benefitted greatly from TKVK’s 119% price rise during May.
Forever a Country of Currency Depreciation
Recency bias can be a very dangerous trap for investors to fall into. Uzbeks have traditionally been very skeptical of keeping their savings in Uzbek Som (UZS) due to its consistent depreciation over the years. As of 31st May 2021, the USD/UZS rate is 10,573, though for investors who joined us on our Uzbekistan Tour in May 2019, we gifted everyone the first ever Uzbek Som note printed in the Republic, just after independence—a UZS 1 Uzbek Som note which due to historically high inflation is today a mere collector’s item, similar to what happened in Vietnam. So, Uzbeks, like Vietnamese, are no stranger to hyperinflation and have historically viewed the US Dollar and gold as better stores of value than the national currency.
Things began to change, however, when on 5th September 2017 the Central Bank of the Republic of Uzbekistan (CBRU) eliminated the peg it held on the UZS/USD, devaluing the currency by 48% overnight, from UZS 4,210 to UZS 8,100 as it transitioned the currency peg to a managed free float. The reason for the currency adjustment was a bid to eliminate the black-market (bazaar) exchange rate which was ~UZS 8,000 at the time, and to make it economically viable for foreign investors to re-engage the country with foreign direct investments.
When we began investing in the country in 2018, it was easy for locals to be confused that we were comfortable owning assets denominated in UZS, and further to buy shares in companies whose dividend yields were lower than term deposit rates offered at banks (at the time term deposit rates were as high as 24%). Though part of our thesis for the overall opportunity in Uzbekistan was that as inflation was brought under control from the devaluation and the CBRU’S policy rate was able to be lowered, the currency should begin to stabilize. Then, as foreign direct investments increasingly grew over the coming years, there would be a higher risk of currency appreciation rather than rapid depreciation as foreign investors would convert their foreign exchange into UZS to build factories, make financial investments and the like. Of course, we did not fall prey to recency bias and have so far had our thesis validated, further benefitting from rising equity prices and compressing dividend yields (still high in our view with further compression to come). Since 2019, inflation has fallen from 15.2% to 10.9%, as of May 2021—this successful reigning in of inflation can be partially contributed to the CBRU’s transitioning to an inflation-targeting regime and aiming for 10% inflation by 2022. This disinflation in recent years has also led the CBRU to lower its policy rate 200 basis points in 2020, from 16% to 14%.