New Capital Emerging Markets Future Leaders Fund

30 April 2024

Marketing Communication

Executive Summary

Key events in market

Equity markets fell in April with Global equities down -3.2%. The S&P500 fell 4.1%. Emerging Markets in aggregate rose 70bps led by China, which was the standout market in the month, rising 6.7%.

Key performance & positioning updates

The Fund underperformed its benchmark (Solactive Emerging Markets ex China) in April by 0.72%. India, Taiwan and Greece were the biggest positive contributing countries. Brazil, Indonesia and Kazakhstan were the biggest detractors.

Market Update

April saw the latest instalment of market driving macro-economic issues: the inflation debate; China’s recovery and geopolitics. All, unfortunately, impacted the Fund – directly or indirectly.

Jerome Powell confirmed the higher for longer policy stance after a series of elevated inflation readings. The first order impact of this shift in message – not wholly unexpected by markets – was a parallel shift in the US yield curve and the 10 year selling off 40 bps. Within emerging markets there is a varying degree of sensitivity to US rates – with some sectors positively exposed to higher yields (e.g. several financial institutions in the Middle East), whilst Latin American curves tend to be particularly sensitive: Brazilian front end yields (3yr) widened 80 basis points and the terminal rate rose almost 70bps. This precipitated a sharp sell off in equities with the market down 4.1%.

The sell off in emerging bond markets is from relatively rich levels: the average spread of hard currency bonds to US Treasuries is 340 basis points, versus 460 basis points 5 months ago. Pushing out a rate cutting cycle in the US (consensus is now for 1 cut in 2024, versus 4-5 in January 2024) means that a key leg of the bond rally has been removed; and dollar strength is back – at least temporarily. The overspill into certain equity markets is obvious and has been problematic in the recent past.

Brazil is front and centre of this debate. After being one of the earliest Central Banks to start cutting in August 2023, we have now seen six consecutive rate cuts to 10.75%. Despite inflation falling, the pace of cuts has created two issues: 1) real rates have fallen, from over 10% to less than 7% today (still elevated); and 2) spreads to Treasuries have compressed from 11.25% at the peak in April 2022 to 5.5%. Whilst this remains a healthy level, especially in the context of improved macroeconomic indicators, the marginal reduction has put pressure on the Real, -6.7% ytd, and domestic equities, -11.1% year to date (in USD – i.e. including the devaluation). Indeed, flows have been extremely weak: foreigners have been selling Brazil to buy China (BRL34bn of outflows) and locals remain in fixed income products (local equity funds have continued to see redemptions, at an accelerated pace in March vs. February). Simply put, Brazil has almost had the worst possible start to year: coming off relative highs given a strong climax in 2023 we have had 100bps of rate cuts priced out of the US Treasury curve; local terminal rates reprice >10% vs. a low of 8.75%; iron ore fall 19%, pressuring Vale and the sector; and renewed debate around special dividends at Petrobras. The valuation comfort on the market – 7.2x 2025e P/E – has been the main protection.

The breakout of Chinese equities on the back of better macroeconomic data was the other major event of April, drawing flows from other Emerging Markets. Stronger domestic growth (GDP grew 5.3% Q1 2024 year-over-year, ahead of 4.6% expected) was the trigger, supported by further policy changes to unblock the key bottleneck: property inventory. As the consumer recovers, against a backdrop of extreme under-ownership and lowest decile valuations, there is room for the rally to continue. We have seen that in the past and China also has the benefit of one the best performing local currency bond markets, underpinning equity valuations.

China has also been held responsible for the record gold rally in April as buying on the Shanghai Futures Exchange overtook London and New York. There are various possible interpretations for this, neither is particularly positive: stockpiling physical bullion indicates a distrust in fiat currency, and usually predicates either a devaluation (RMB? Expectations for the USD?) or conflict. And whilst the data is backward looking, Q4 2023 results (reported last month) showed that 30% of Chinese companies missed consensus – the highest number in five years. So whilst equities rally – for now – we temper the improved tone with the reality that not much has changed – yet.

Against China’s rally we saw weak performance from Asian markets – Taiwan (-1.3%), Korea (-5.4%) and Indonesia (-8.5%) – barring India as the country headed to the polls (+2.3%).

Geopolitics was the other major issue with tensions between Iran and Israel spilling over. As such, GCC markets were weak (UAE -3%, Qatar -2.5% and Saudi Arabia -2.3%) with Egypt down 11.8% and Turkey the standout winner, +14.5%. The Gulf states are grappling with containing the conflict in the context of their ambitious efforts to reform their economies. The local major powers Saudi Arabia and UAE understand that escalation is bad for business and avoiding conflict is the priority for them and the US. Qatar’s Emir and Saudi Arabia’s foreign minister have been in direct contact with Iranian counterparts (note the reinstating of diplomatic relations between Iran and the KSA in 2023). Commentators spill much ink on geopolitics which is generally of no value. Our time in the region this year reflected 1) business as usual in key economies and 2) historically markets were impacted by conflict were those directly involved. We were encouraged by muted reaction of the oil price and news that structural projects are continuing unaffected, such as QatarEnergy’s announcement of the North Field West LNG project.

Fund Performance & Positioning

Fund performance was disappointing in relative (-72bps) terms. From a sector contribution perspective, Consumer Discretionary, Communication Services and Industrials were the positive contributors. Financials, Consumer Staples and Information Technology were the detractors.

In the discretionary sector, Lemon Tree Hotels in India was the biggest positive contributor. Here the lack of bed capacity, prudent expansion plans and scaling up of occupancy at new assets (e.g. their Mumbai hotel) with improving pricing have all helped to drive better returns.

Naspers, the South African internet investment conglomerate, was another key contributor. The company has undergone a strategic overhaul since 2022 when management began their buyback program to reduce the discount to listed assets (mainly their investment in Tencent). The discount sits at 38% currently, from the wide of c. 55% - so whilst we have seen significant positive moves, there remains more to go in our opinion. Further discount narrowing is likely to be driven by the ongoing repurchase and cancelling of shares and the revision of sub-sector valuations – with Meituan, Trip.com and DeliveryHero up 25-75% in the last 3 months. There is the potential for an additional catalyst of a special dividend. As management continue to demonstrate M&A discipline, Prosus, of which Naspers owns 40%, has accumulated $19.8bn of gross cash (including Meituan) but only $2.2bn of debt maturing to 2027.

Bharti Airtel remains our only Communication Services investment and delivered another month of solid returns. Subscriber growth data remained solid in an increasing duopoly and tariff hikes are widely expected after elections. Growth is thus driven by volume, price and mix with product extension from the roll-out of fibre-to-the-home, all while capex normalises after the heavy 5G investments.

Mytilineos’ share price recovery after a weak first quarter positively contributed to the industrials sector performance. The rally was driven by the announcement of 2 Gigawatt solar project with Greek utility PPC, solid first quarter results and the announcement of a strategic review of capital allocation.

The financials sector was the biggest detractor, costing the portfolio almost 100% of its relative performance. Despite being the Fund’s biggest weight in absolute terms, we are c. 5% underweight versus our benchmark. The main reason was weakness in Bank Rakyat – an Indonesian micro-lender which suffered from both a material deterioration in credit quality and a hike in funding costs which, whilst isolated to a specific portion of the loan book, will take some time to unravel. This led to a material downgrade in company guidance and given that the stock extremely well held by international investors we see likely waves of sell-side downgrades coming through likely putting pressure on the company’s valuation. We trimmed the position. Secondly, Itau Unibanco – the best-in-class full service Brazilian bank – cost over 20bps as it suffered from selling due to higher rates (above). From our perspective there are few fundamental issues with the bank – and indeed it benefits from a net interest margin perspective if rates remain higher for longer – but it suffered in the broad based sell-off. Today, Itau is trading on ~7x 2025 earnings (versus, for example, a trough of 6x during Covid) but we see the improved credit cycle, better NPL trends and loans having grown. What was equally frustrating in the month was that some of our large positions which are positively geared to higher rates failed to demonstrate the historical correlation, particularly GCC banks where we have seen earnings upgrades on changes in the shape of the yield curve.

In consumer staples, Atacadao – the leading food retailer in Brazil – was the main culprit, costing the Fund 40bps.Driven predominantly by top down factors: the business has a relatively high degree of leverage and local investors expected food inflation in fall (our models suggests otherwise). Fundamentally we saw improvements in line with our thesis: Q1 sales were ahead of expectations with better than expected same store sales dynamics, helped by more in-store services and food inflation. Converted Grupo BIG stores even saw a 21% SSS (same store sales) growth – indicating that the conversions are on track. Retail closures – a key driver of profitability – have run ahead of trend; and Sam’s Club saw a 33% increase in active member base. On the balance sheet, the renegotiation of the debt to the parent is another bottom line kicker and timely given the movement in bond yields. With valuations, in our opinion, also nearing trough, we added.

	New Capital Emerging Markets Future Leaders Fund	Solactive Emerging Markets ex China Custom Net Return USD Index	Difference
1 Month	-2.43%	-1.71%	-0.72%
3 Month	+2.16%	+1.86%	+0.3%
6 Month	+16.31%	+16%	+0.31%
YTD	-0.48%	-0.61%	+0.13%
1Yr	+14.55%	+15.43%	-0.88%
3Yr Annualized	-	-	-
5Yr Annualized	-	-	-
Since inception annualized	+3.73%	+2.12%	+1.61%
Since inception 28.03.2022	+7.96%	+4.49%	+3.47%

Past performance is not necessarily a guide to the future. The value of your investments and the income from them may fall as well as rise as a result of market as well as currency fluctuations and you may not get back the full amount invested. Fund performance is net of fees and representative of the USD I Acc Share Class and shows a maximum of five previous calendar years and current year to date (computed on a NAV to NAV basis). Where share class inception begins prior to the five previous years the chart has been rebased to 100. Where the Fund has fewer than five full years of performance, returns are shown from the inception date. Source: EFG Asset Management, Bloomberg. As at 30 Apr 2024.

Outlook

We continue to churn through a high volume of company meetings. Much of this has been focused on Latin America, where we have been testing thesis of existing positions and refreshing thesis of names we have done work on but not yet bought. Equally in Asia we have done a huge amount of work on the implications for supply chains from the latest product launches at Nvidia. Our process leads us to focus on the incremental returns on capital a business is likely to earn. Despite the differing share price returns year to date, we believe both Asia and Latin America (and EEMEA) offer several good opportunities. Competition for capital is healthy and whilst always operating with information asymmetry, we are trying to allocate to the best opportunities at a given time.

Brazil has struggled so far this year, as discussed above, and languishes second bottom of stock market returns, equal to Bangladesh. Only Egypt has delivered worse returns given their currency devaluation in March. Looking forward, however, after the moves in local and Treasury curves, and the soft-easing (end of quantitative tightening) from the Federal Reserve’s latest announcement, we see at least the prospect of some technical recovery. Whilst Chinese equities have performed strongly this month, the macro-economic recovery is likely to feed through to their largest trading partners (of which Brazil is one). Against this, domestic economic data is tracking fine – e.g. the latest Manufacturing Purchasing Managers Index (PMI) reading for April was well in expansion territory at 55. We have some companies in the portfolio that are in our opinion in oversold territory and the first signs of local investors dipping their toes in the market.

Given the resurgent commodity complex and reflationary narrative in markets, it is worth sharing our commodity views. Oil has been front and centre of discussions given the Middle Eastern tensions. At the margin, we’re less positive: whilst the recovery in Chinese economic activity is underway and the US continues to rumble on at pace, elections mean supply discipline is a low priority for the US and despite the best efforts of the Saudis they are no longer the marginal supplier. This does not mean we are negative, just a $80-85 / boe range suits most parties – a spike does not.

Copper has got market participants hot under the collar. Persistent supply disruption against solid demand means the bull thesis seems to be manifesting, particularly galvanised by downgraded production expectations from large producers as ore bodies deteriorate. For us this remains a key long via the undervalued Grupo Mexico. Elsewhere, silver, aluminium and uranium all have the most attractive supply vs. demand dynamics (with an honourable mention for manganese). The latter two have been aided by recent bans or supply issues in Russia. We have small exposure to iron ore at the moment – something we have discussed as enjoying increasingly cartel like characteristics. But the demand environment is at best luke warm (temporary boost from Chinese property inventory thaw?) and the position remains relatively low conviction.

Fund Manager

Fergus Argyle

Portfolio Manager
London

Equity

Detail

Chris Chan

Portfolio Manager
Hong Kong

Equity

Detail

Find out more

Disclaimer

MARKETING COMMUNICATION

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