THE FUND:

Guaranty Trust Bank – now cheap enough.

The fund fell 7.2% during the month compared with the fund’s benchmark MSCI FMxGCC Net TR (SEK), which fell 10.3%. The lack of holdings in Argentina yielded a net positive contribution of almost 6%, while the fund’s positions outside of Egypt and Pakistan, as well as our overweight in Bangladesh, cost about 3% in relative returns. The crash in Argentina (-21%) and decline in Vietnam (-7%) during the month affected other frontier and smaller emerging markets. Egypt, for example, fell closer to 11% during the month, while Pakistan (-8%) also gave up most of its gains for the year.

The fund added the Nigerian Guaranty Trust Bank to the portfolio during May. We have a positive stance towards the Nigerian banking sector. Following the sharp fall in oil prices in 2014-2016, Nigeria experienced a financial crisis and subsequently implemented two major devaluations (2016 and 2017) where the currency fell almost 50% vs the USD. After easing currency controls in spring 2017, the economy, albeit from a significantly lower level than before, is slowly recovering. Many times, the most interesting period to own bank shares is just after the economy has undergone a crisis while interest rates are still high (higher net interest income) but the banks have had the chance to review their loan books, the market is still functioning poorly (higher spread in trading) and activity gradually increases again. The Nigerian banking sector has some similarities to Argentina’s 4-5 years ago (economic crisis followed by devaluation). The Argentine banking sector rose on average by 500% in USD from 2013 to the end of 2017. The valuations in the Nigerian banking sector are currently significantly lower than those for Argentinian bank shares in 2013. In the initial phase of the recovery in Nigeria, we focused primarily on the most affected quality banks primarily Zenith Bank and United Bank for Africa. After Guaranty Trust Bank’s recent underperformance we consider it a good time to add a quality Nigerian bank to the portfolio (4%). The company has an impressive history where earnings per share increased by an average of 20% per year (in USD) over the last 18 years, despite the fact that during the same time period Nigeria’s currency weakened by almost 8% on average per annum. The bank is a good example of the growth opportunities available to quality companies in troubled but rapidly growing markets. Nigeria today has a population of almost 200 million people, which by 2050 will have grown to almost 400 million (source: UN). Domestic credit to GDP is at less than 20% compared to 130% for the world on average. Most of the growth, in our view, lies ahead.

As Sri Lanka’s largest company, John Keells, fell sharply in conjunction with their exclusion from the Frontier100 Index (an index that is primarily tracked by ETFs), we took the opportunity to increase our position in the company to approximately 2.5% (previously 1%) at attractive levels. In May we added Sri Lankan ACL Cables, a leading manufacturer of electrical products (ranging from cables to power industry to switches and sockets for hotels and housing). We always reserve a small portion of the portfolio for what we view as long-term strategic positions. Although leaders in their specific areas these companies are often small, where liquidity can vary, consequently we accept a longer investment horizon (> 3 years). ACL Cables is a well-managed company with a very strong brand, market leader position and has demonstrated good historical growth. Their margins have suffered somewhat due to fast-rising prices for copper and aluminum. It always takes a certain amount of time before higher input costs can be fully passed on in the pricing of the company’s products. However, we believe that this will happen from here on and over the next few years, which will lead to margin improvements in addition to volume growth. We bought them at a valuation of just over 8x current profits, while we expect a profit growth of more than 20% on average over the next 3 years. We added just under 1% of the portfolio to the company to benefit from growing construction activity in Sri Lanka as a result of infrastructure initiatives and increasing tourism.

THE MARKET:

MSCI FMxGCC Net TR (SEK) fell 10.3% during the month compared with MSCI EM Net TR (SEK) which fell 2.4%. Just over 6% of the decline in absolute numbers was due to the crash in Argentina where the market fell 21%. Vietnamese equities, which at one time in May were down close to 12% (24% from the peak in early April) also contributed to the bad sentiment.

From time to time, discussion arises focusing on the risks associated with frontier and emerging markets often triggered by some type of traditional concern i.e. a market crash or something similar. Documented risks, such as currency fluctuations etc., suddenly become acute in the eyes of nervous investors when in fact they are established and are normally well discounted in current valuations. This time, the discussion focused on the fact that US bond rates have reached a level enticing international investors to abandon emerging and frontier markets and instead invest at home. These concerns were inflamed by the currency crises in Turkey and Argentina. The currency crisis in Argentina where the peso fell sharply (and rightly so) — we pointed out the risks in Argentina on multiple occasions during the last year — was an extreme example. The currency was kept too strong because of strong inflows after currency deregulation a few years ago. The peso thus failed to weaken enough in relation to continued high inflation rates. Before the crash, the currency was estimated to be somewhere between 60-70% overvalued. At the same time, the stock market rose close to 70% (in USD) in 2017 and at the end of the year, valuations were more than twice as high as the average in frontier markets. For many months the warning light shone red in Argentina. While it is virtually impossible to predict the exact time a bubble bursts since it builds up over time, such is the nature of bubbles, nonetheless, the fact that it burst was motivated by fundamentals. Relying on the same fundamental perspective, we do not see how Argentina can be compared to any of the markets we focus on, except perhaps Kenya, a market that we do not own at the moment. Based on our analysis, Vietnam’s correction was not unexpected. Unlike Argentina, however, macroeconomic assumptions remain intact, and earnings growth looks as good now as it did before the correction. In Vietnam it was a classic “greed vs. fear” scenario where some of the largest companies were driven up too far in the short term, and when they began to fall, the entire market was scared which led to forced selling by local investors (whose margin borrowing often rises in times of strong equity performance) which then exaggerated the correction not only in expensive blue-chips but across the entire market. Ironically the mid-cap segment, where we saw good value before the correction, suffered just as much in the downturn. The reason being that many of these companies to a large extent were owned by local investors and were more susceptible to the margin calls. However, this means that we see good value across the market at current levels. We live in times of fast information and limited patience. Sometimes, investors seem to forget what stock markets really are: a cocktail of companies whose operations, in most cases, grow yearly, sometimes faster, sometimes slower. At Tundra as an active asset manager focusing on stock picking, we adopt a measured approach avoiding overheated markets and individual stocks. Instead, we focus on finding a group of interesting companies that we believe will delight their shareholders over the next few years. We recently touched on this topic in an article on LinkedIn.

ESG ENGAGEMENT

Founded in 1990, Nigeria’s Guaranty Trust Bank PLC is the only new company to be added to the fund in May 2018. Operating across the corporate, commercial, retail, SME banking and public-sector segments, the bank provides products and services in West Africa, East Africa, and Europe. The company has its headquarters in Lagos. Guaranty Trust Bank reportedly integrates environmental and social risk management into its credit approval process. In 2017, the bank reviewed 19 clients in the energy and power projects and assessed their environmental and social practices against the country’s regulations and international best practices. Internally, the bank also monitors its own paper and diesel consumption and monitors its carbon emissions in-house. With a female workforce of 45% (in 2017), the company reportedly increased its expenditure on capacity building for female employees by almost 80%.

No companies were divested in this month.

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.