The AFC Uzbekistan Fund Class F shares returned −5.6% in August 2023 with a NAV of USD 1,728.23, bringing the return since inception (29th March 2019) to +72.8%, while the return for the year stands at −0.5%. On an annualised basis, the fund has returned +13.2% p.a. with a Sharpe ratio of 0.81.
August saw additional great results from some of the fund’s portfolio companies, though what took eyes off the stock market was the surprise adjustment of the Russian ruble, which, along with weakness in the currencies of Uzbekistan’s other trading partners, led the Central Bank of Uzbekistan to devalue the Uzbek som by 3.5% to UZS 12,075.03 on 10th August. This impacted fund performance and led to some profit-taking among bluechip names on the Tashkent Stock Exchange.
AFC Uzbekistan Fund Valuations as of 31st August 2023:
|Estimated weighted harmonic average trailing P/E (only companies with profit):
Estimated weighted harmonic average P/B:
|Estimated weighted portfolio dividend yield:
New Capital Markets “Sandbox” Legislation Announced
Before getting into what led to August’s negative performance, on Monday, 4th September 2023, Presidential Decree #291 was signed “on additional measures of development of the capital markets”. Having undergone drafting since the beginning of the year, the decree covers a wide range of upgrades to the capital markets infrastructure with plans for rollout from the second quarter of 2024. This decree parallels the broader capital markets legislation, which is currently in the Oliy Majlis (Parliament) and is still scheduled to be passed in time. However, this presidential decree and the accompanying roadmap for execution of the decree’s details certainly accelerate the much-needed capital markets reform we have been anxiously waiting for.
Below is a snippet of the most notable items from the decree, most of which we hope to receive and share more clarity on as they come to fruition. Each item below is included in the decree’s roadmap, which outlines measures to be taken, by which department of government, and the respective timeframe to make them a reality.
- By 2025:
- The Central Securities Depository will consolidate the custody of corporate and state securities and will be transferred to the oversight of the Central Bank of Uzbekistan from UzSAMA (the State Asset Management Agency);
- The National Clearing Center will be established together with the Republican Currency Exchange (which currently operates the State Securities Market). The company will become the central counterparty and will be regulated by the Central Bank;
Dividend distribution will be automated (from a cumbersome manual paper process today);
- Legislation and regulation:
- A new regulator - The National Agency of Perspective Projects – will be taking over control of the capital markets, insurance market, and the planned development of the crypto/blockchain market from 4th September 2023 onwards;
- A regulatory sandbox regime will be introduced for operations with international clearing companies, nominees, and brokers. This section additionally discusses the terms and conditions of operations for such organisations. Legislation will need to be updated to allow terms such as “foreign broker”, “foreign nominee holder”, “foreign UBO”, and “omnibus accounts” to be utilised. Such organizations and clients can operate in Uzbekistan without licenses and open accounts with Central Securities Depository and Central Bank. Such accounts and assets will be protected by most types of possible seizure and limitations (this pertains to criminal activity or failing to disclose information requested by the government);
- Amendments of the measures in “2b” above will pave the way for Uzbekistan’s capital markets to be connected to Clearstream and other international organisations by February 2025;
- Market activity stimulation:
- Uzbek citizens will be able to invest up to 100x the minimum wage (currently approximately USD 8,100) of their salary on an annual basis into local securities and have this portion of their income be exempted from income tax;
- Employees of state-owned companies planned for IPO will have preferential rights to subscribe to the offerings and their investments into said IPOs;
- The tax benefits on dividends (currently 5% for institutional investors and 0% for retail investors) and income tax on corporate bonds (0%) provided for investors in 2020 will be prolonged from the end of 2024 to the end of 2028;
- The Central Bank of Uzbekistan will consider changes in the legislation regarding limitations on investments into banking shares from off-shore jurisdictions (currently this is a significant issue inhibiting the much-needed capital increase into the equity of banks across the banking system);
- Remote brokerage account opening and annual general meeting/extraordinary general meeting voting system modernisation and development;
- Minority rights protection:
- Companies that place shares on the open market will be required to distribute at least 30% of profits via dividends for seven years;
- The regulator will be able to force the replacement of management of publicly traded companies that violate capital markets legislation requirements on financial reporting and announcements two or more times within a year
Currency Volatility Leads to Adjustment in Uzbek Som
In mid-August, the Russian ruble briefly touched 100 to the USD before the Central Bank of Russia increased the policy rate by 350 basis points to 12% on 15th August. The ruble has depreciated 22.8% year to date. One key reason for the ruble’s weakness is the country’s budget deficit due to falling hydrocarbon exports. However, the currency depreciation isn’t expected to cause much, if any, domestic inflation in Russia as the country has heavily invested in import substitution since 2014, and aside from outbound tourism, shouldn’t put much pressure on the finances of Russian citizens. Thus, Russia’s economy looks quite resilient even in the face of the depreciating ruble.
However, as Russia is Uzbekistan’s second-largest trading partner and biggest source of inward remittances (representing 87% of all remittances), with Russia being a key market for Uzbek textiles and agricultural products, the Central Bank of Uzbekistan decided to loosen the currency’s trading band and allow the som to devalue 3.5% on 10th August 2023 in order to keep the country competitive on the regional market. Surely another incentive for the Central Bank of Uzbekistan to devalue the currency during August is weakness in the currencies of its other key trading partners, China and Turkey, whose currencies are down 4.7% and 42.97% year to date versus USD.
Year to date, the Uzbek som is down 7%, and we are comfortable with this, having stated from the inception of the fund that annual depreciation in the mid-single digits should be expected as Uzbekistan is a manufacturing and export centre, thus following in Vietnam’s footsteps of preventing the currency from strenghtening to remain competitive. For the remainder of the year, while we could see some additional minor depreciation, we don’t foresee any big devaluations like last month.
August Inter-Ministerial Shakeup
The market saw very positive developments during August in regards to the Ministry of Economy and Finance being back in charge of major economic decisions and reforms after they were handed over to the Presidential Administration in December 2022. As the MinFin’s wings were clipped, with the head of the Presidential Administration and former member of the Ministry of Investment, Sardor Umurzakov, gaining more control of economic decision-making, most of the western-educated Uzbeks who had come back to partake in nation-building and worked at the MinFin quit, along with the Minister of Economic Development and Poverty Alleviation and Deputy Prime Minister, Jamshid Kuchkarov who was heavily involved in economic reforms.
The investment community, including us, were hopeful these changes would accelerate broader economic reforms as the presidential administration could facilitate reforms, sidestepping the Oliy Majlis, Parliament, including in the realm of privatisations where they controlled the Agency for Strategic Reforms, which oversees 31 SOE’s slated for privatisation. However, with no forward progress in the first seven months of the year, August saw some radical changes as the MinFin regained its former power as “nature heals.”
As a result of the Presidential Administration’s failure to manage the budget and broader economy, last month Mr. Umurzakov was fired, while former Minister Kuchkarov was promoted to Minister of Finance, as well as retaining his position as Deputy Prime Minister. Several Uzbeks who left last year are in discussions to come back to the ministry, and the most high-profile name on this subject is former Deputy Minister of Finance Odilbek Isakov, who has returned as an advisor to the MinFin where he will be focusing on government debt, collaborating with international rating agencies, and more. Mr. Isakov was a key driver in getting Uzbekistan’s sovereign credit rating, issuing Eurobonds and pushing for the development of the capital markets, and we couldn’t be more pleased that he is involved again with the government. Further, the Agency for Strategic Reforms is in the process of being overseen by the MinFin, which means they will have more direct power in regard to facilitating SOE restructuring and privatisations.
Lastly, as the sideways choppy action in the market has certainly been monotonous, nothing moves in a straight line and a bet on Uzbekistan is a bet on what I like to call the New Fertile Crescent. As the world bifurcates and investment in the region accelerates, Uzbekistan is among the best-placed countries in the region to benefit from this interconnectivity and growth from the Middle East into Central Asia, especially as it has roughly USD 33 billion in foreign exchange reserves and thus can retain its independence without worry of falling into a debt trap.
So, while the fund is now flat for the year, under the hood, our portfolio companies continue to do very well. During August, one of the fund’s five largest holdings, a consumer goods conglomerate, filed second-quarter 2023 earnings, which were superb! Second quarter year-on-year profit grew 370%, while trailing twelve-month earnings rose 45%. The company ended August at a P/E of 5.75x and P/B of 3.14x.
Second AFC Uzbekistan Fund Investor Tour "Sold Out"
Thanks to the significant interest in our second Uzbekistan investor tour, we are planning to host our 3rd tour in early May 2024. We will share more details about this over the coming months.
At the end of August 2023, the fund was invested in 25 names and held 8.4% cash. The portfolio was allocated to Uzbekistan (91.60%) and Kyrgyzstan (0.04%). The sectors with the largest allocation of assets were materials (40.4%) and financials (34.7%). The fund's estimated weighted harmonic average trailing 12 months P/E ratio (only companies with profit) was 3.72x, the estimated weighted harmonic average P/B ratio was 0.74x, and the estimated weighted average portfolio dividend yield was 4.78%.