THE FUND

During the month, the Fund appreciated by 3.1% as compared to the benchmark’s MSCI Pakistan Net (SEK)’s return of 5.6%. The out-performing exposures during the month were Consumer Discretionary and Staples while the under-performance stemmed from under-exposure in Energy and Financials. During the month, we increased our exposure in Cements and Financials sector and decreased our exposure in the Textile sector.

We increased the allocation to Cements as asset-values have become attractive because of margin contraction and fear of price wars. We see strong values in one of our top bets, DG Khan Cement, whose expansion in the Southern market, in our opinion, is being perceived more negatively than warranted in reality. The expansion in the South could very well be utilised for sea-bound exports thereby avoiding significant pressure in the local market, which is expected to grow respectably between 7-9% over medium term. Cost pressures, especially due to rising coal prices, have stemmed from China’s decision to halt output in order to combat pollution; and an inability of the gas infrastructure to cope with winters prompting growing use of coal to avoid heating crises.

However, in our opinion, this seems to be a temporary phenomenon, which will reverse reigniting investor interest especially in structurally deficient housing markets such as Pakistan and India. For instance, in India, insolvent troubled cement player, Binani Cement, was being sold to a Bain Capital-led consortium for USD 980m or ~+USD 150/ton, far higher than Pakistan’s cement companies. Similarly, the Fund reduced its exposure in textiles after Nishat Mills Ltd indicated its intent to reduce their stake in an auto venture by nearly 12%, which was later subscribed by DG Khan Cement and Adamjee Insurance. We believe, Nishat Mills Ltd is not a direct textile player and any textile policy aimed at curtailing CAD would benefit cyclical industries that are trading at low asset-values in fear of rapid depreciation. The Fund would rather try to capture those consumption-oriented bets for you!

 THE MARKET

Investors in Pakistan’s Stock Market remained bewildered in February. KSE 100 declined 1.8% (in local currency) month-on-month, mired between the possibility of being put back on Financial Action Task Force (FATF) “grey-list” from June 2018, a list of countries with serious deficiencies in anti-money laundering practices, and the recent disqualification of former Prime Minister Nawaz Sharif from heading any political office. These factors also kept investors on the sidelines. Between 2012-2015, Pakistan had been included in the FATF grey list, however, this time the situation seems to signal worsening Pak-US ties which can dent the country’s economic progress, despite Chinese investments through the growing Belt and Road Initiative (BRI).

Former P.M. Nawaz Sharif reluctantly handed PML-N’s presidency, on an interim basis, to Shahbaz Sharif, his younger brother. Emotions are running high in the ruling party but how these will manifest will only become apparent after national elections. Disappointingly for PML-N, their candidates were only allowed to contest Senate Elections as “Independent” candidates thereby increasing the odds of horse-trading if the pendulum swings against the Sharif brothers. However, Jahangir Tareen’s recent victory in PTI’s home ground has been a boost. All things being equal, PML-N’s plea for public sympathy seems to be working well among the masses allowing them to remain on course as the single largest political party in 2018. That said, the PM nominee, Shahbaz Sharif, is facing attacks on several fronts: his main bureaucrat in Punjab was arrested; a confession of kick-backs in a CPEC project from a local contractor; and re-emergence of a police officer confessing to involvement in extra-judicial killings. The Sharif brothers are likely to face these stumbling blocks pre- and post-elections.

Economically, the Current Account Deficit (CAD) for January recorded at a whopping USD 1.6bn, negating the positive hopes of a 10% and 11% year-on-year increase in Exports and Remittances, respectively. The government remains on course to issue another debt instrument in this quarter and is about to offer amnesty on declaration of foreign assets at 4%, if not brought back, and 2%, if brought back into the country. These elements might just be enough to buy time until elections and cumulatively raise USD 2-3.5bn. Further rounds of smaller currency depreciation can be expected as the recently imposed regulatory duty has been challenged in one of the provincial courts. A point of relief is that the gap between Nominal Exchange Rate and Real Effective Exchange Rate (REER) has come down from ~20% in March 2017 to ~8% in February 2018 because of a decline in Dollar Spot Index and PKR depreciation.

In the near term, consistency in PML-N’s Senate candidates’ loyalty, revisions to the Free Trade Agreement (FTA) between Pakistan and China, and reduction in the energy tariff may act as positive triggers. On the other hand, falling reserves, if not cushioned by inflows from bond-issuance and amnesty revenues, will keep investors jittery as we head to elections in July/August 2018. With this in mind, Lisa Curtis’ recent trip, a Senior Director for South and Central Asia with the National Security Council, followed by a statement from US CentCom Chief General Votel on “positive indicators” from Pakistan was comforting. In addition, a much needed decision from Afghanistan’s President for “unconditional talks with Taliban” and “forgetting the past” in relationships with Pakistan were key geo-political developments keeping investor interest alive in Pakistan’s market.