THE FUND:

Gwadar: A cornerstone of CPEC in Pakistan.

During the month, the fund went down by 7.8% as compared with MSCI Pakistan Net TR (SEK), which fell 8.3%. The Index corrected sharply owing to pre-election volatility and continued foreign selling. There was demonstrably increased aversion to of risk in the wake of currency volatility and the enticement offered by rising US Federal Reserve Rates led to a selling spree by foreigners across the major Frontier and Emerging Markets. The out-performing exposures in May were underweights in Financials and Energy while our overweight in Materials cost in relative performance.

During the month, we increased our exposure in a blue-chip bank, Habib Bank Limited, owing to an attractive valuation gap versus mid-tier banks; and Pak Electron, a leading home appliance brand, because of attractive valuations in the peak sales season. We have gradually reduced our exposure to Utilities and Consumer Sector. Outperformers have been diverted to more mainstream companies with better liquidity and better earnings forecast ability.

THE MARKET:

Frontier and Emerging markets have their own charm. However, with this charm comes volatility. When screening for Tundra’s core markets, portfolio managers primarily look for ingredients for long-term success: structurally sound capital markets, high (preferably, young) population, adequate Human Capital and conducive government policies. This recipe is a textbook example of how ‘developed’ markets evolved themselves, albeit with fewer political shocks. Pakistan’s case is no different. Buoyed by strong earnings growth, a competitive democratic regime, cushioned by falling oil prices and massive infrastructure investments under China Pakistan Economic Corridor (CPEC) worth USD50-55bn, Pakistan’s stock exchange offered remarkable performance in the years 2012, 2013, 2014 and 2016 followed by a sharply “re-adjusting” bear market in 2017 coming in at the end of the cycle sweetened by the accolade of inclusion in MSCI Emerging Markets. Notwithstanding the fall, the risk-adjusted returns offered enough reward for foreign investors who have had to witness “negative interest rates” in the developed economies. The returning appetite of rich global citizens for the unchartered territories of Frontier Markets is premised on the understanding that this is a period of transition in economic development and an opportunity to monetize it thanks to the integration of the global markets.

At the moment, Pakistan is undergoing one such transition with the general elections emerging as an inflection point. Completing two difficult – but ultimately successful – democratic regimes in a decade, Pakistan’s maturing politics have compelled legislators to speed-up the pace of reforms or risk being out of power especially when 60% of the population is below 30 years of age. The emergence of PTI led by Imran Khan, as a third force in an otherwise two-party political scenario, has precipitated demands for electoral accountability, a somewhat unusual occurrence in under-developed countries, hitherto not seen before. Barring allegations, a mix of factually correct and politically vindictive, the pace of infrastructure spending in the form of 1700kms of roads, 10,000 MWs of electricity, a belated but stern focus on documentation of the economy, and a marked improvement in the law and order situation are key check-points that long-term and foreign investors want to see in a country where they have a financial stake.

Policy-making is an ongoing process that invariably offers learning experiences, which the government is learning. For instance, due to financial constraints, infrastructure spending has come at a higher cost than desirable. Improvements in energy generation and supply have on average been at regionally uncompetitive rates in order to bridge the deficit by attracting sufficient levels of foreign and local investors. It can be argued that aggressive infrastructure stimulus could have been enacted in a phased manner to avoid the concerns of debt-repayment which have surfaced as of late.

Excerpts from PTI’s economic manifesto, Pakistan’s second most popular party by vote (2013 elections), point towards a scenario of orchestrated growth stemming from labour-intensive manufacturing, agriculture and construction sectors. Efforts on documenting the economy would necessitate the need to pay taxes and decrease the fiscal vulnerability of the economy. Introduction of leveraged products, derivatives, ETFs and investor protection laws introduced by the Shanghai Stock Exchange-owned Pakistan Stock Exchange are crucial elements of market development. That said, broad-based structural reforms are required to increase export competitiveness in the manufacturing, agriculture and IT sectors to avoid repeating earlier crises. The government’s resolve to exploit indigenous coal reserves, along with substantial investments in the construction of dams, and push towards renewables will undeniably reduce the economy’s susceptibility to external shocks as the quantum of imported fuel declines as a % of GDP. However, sustainable growth in exports is not yet clearly defined and is unlikely to be clear until the advent of Special Economic Zones (SEZs) under CPEC’s umbrella.

In the previous economic cycle, some local start-ups and companies have shown remarkable entrepreneurial skills with a strong focus on corporate governance and a willingness to monetize the ~100m odd youth bulge. The government has also provided protection and tax incentives to businesses, who have capitalized on these opportunities. The next leg of the market turnaround will belong to risk-taking corporates as well as alpha-hunters. For investors awaiting signs of an attractive long-term case at an entry of P/E of ~9.5x, the needle is beginning to move from a low base. Looking back to October 2011, when we launched the Tundra Pakistan Fund, we see that despite the recent turbulence progress has been very clear: US dollar revenues of the largest 100 companies have risen 70%, profits before taxes have risen by 105% (USD), and valuation has risen from P/E 7.7x at the end of 2011 to P/E 9.5x for 2018 expected earnings. In Swedish kronor, the fund is up 157% giving an average annual return of just over 15% since its launch, 3% higher average annual return than the Swedish OMX index; 5% higher than MSCI Emerging Markets and MSCI Frontier Markets; and 2% higher average annual return than India (SENSEX index).

DISCLAIMER:
Capital invested in a fund may either increase or decrease in value and it is not certain that you be able to recover all of your investment. Historical return is no guarantee of future return. The state of the origin of the Fund is Sweden. This document may only be distributed in or from Switzerland to qualified investors within the meaning of Art. 10 Para. 3,3bis and 3ter CISA. The representative in Switzerland is ACOLIN Fund Service AG, Affolternstrasse 56, CH-8050 Zurich, whilst the Paying Agent is Bank Vontobel Ltd, Gotthardstrasse 43, CH-8002 Zurich. The Basic documents of the fund as well as the annual report may be obtained free of charge at the registered office of the Swiss Representative.