THE MARKET

MSCI Frontier Markets xGCC Net rose 4.1% during the month, compared with MSCI Emerging Markets Net, which rose by 1.5%. The market was driven primarily by Nigeria (+16%) and Kenya (+14%). However, about 2%-points of the rise in MSCI Frontier Markets xGCC Net is an overestimate and should be corrected over the coming period. This is due to the fact that in Nigeria (9% of the benchmark at the official exchange rate), market practice among foreign equity investors is now to use the parallel exchange rate window for naira, where the price is almost 20% lower than the official rate. Tundra for example adjusted the valuation of our Nigerian holdings on May 5 (please refer to our website for more information). However, MSCI has not implemented the corresponding change. The rise in Nigeria during the past month was, in our view, entirely caused by investors’ access to cheaper naira via the parallel exchange rate. Given that MSCI has been so late in its response, it is likely that they will wait at least until June 20, when MSCI is supposed to announce Nigeria’s future in the frontier index. Given that foreign investors can now again trade the Nigerian naira relatively freely, we consider that the risk of a Nigerian exclusion has decreased.

After Pakistan’s exit from frontier markets (last trade day in the frontier index was May 31st) and given the likelihood that Argentina and Vietnam will be out of the asset class within a three-year period, it would be a particularly unfortunate decision to exclude Nigeria. The major subject of discussion this month was, of course, Pakistan, which, as of June 1, can now be found in MSCI Emerging Markets. Local investors have for a long time pushed up the prices of the prospective MSCI index shares, believing that they could sell them expensive to foreigners. However, it turned out that the foreigners did not buy that trap. Instead of an expected USD 500m inflow on the last day of the month, an outflow of just over USD 80m occurred. This caused panic among local investors who dumped their positions. The last trading days of May and the first in June, the MSCI Emerging Market constituents (Habib Bank, United Bank, MCB Bank, Lucky Cement, Engro and OGDC) all fell between 10-20%.

THE FUND

The fund rose 0.7% during the month, which was significantly lower than MSCI Frontier Markets xGCC Net, rising 4.1% and worse than MSCI Emerging Markets Net, which rose 1.5%. As we explained in the section on the market, we believe that MSCI Frontier Markets xGCC Net’s increase was overestimated by about 2%-points during the month as MSCI continues to use the official exchange rate for their valuation. We expect to get this relative return back after MSCI has adjusted its valuation, provided of course that Nigeria is not thrown out of the frontier index before. The fund also lost relative returns on its overweights in Pakistan and Egypt, as well as its underweight in Kenya and Romania. Good stock selection in mainly Bangladesh and Vietnam compensated slightly. During the month, the fund increased its weight in Vietnam just under 4%-points, adding to the holding in Vietnam Electric (subcontractor to the power industry) and re-entering the steel company Hoa Phat Group in its portfolio. The fund also added Kido Frozen Foods, which in July is making its stock market debut on the Upcom exchange in Vietnam. The fund also bought the Pakistani mid-cap Bank Allied Bank, whose valuation of about 7 times earnings and 8% yield is now too low given expected growth over the next few years.