THE FUND
The fund rose 5.2% during the first month of the year, compared to MSCI FMxGCC Net TR (SEK), which rose 1.7% and MSCI EM Net TR (SEK) which rose 3.5%. The fund’s largest markets in Egypt, Vietnam, Pakistan, and Nigeria all performed well and the fund’s stock selection amplified the results in all four markets.
In Vietnam, the relatively newly acquired Lien Viet Post Bank rose more than 30% after moving from the smaller share exchange UpCom to the Ho Chi Minh City Stock Exchange. Its new listing allowed more investors to notice its low valuation relative to other Vietnamese banks. Even after its recent performance Lien Viet is valued at a P/E of just below 10 and P/BV of 1.1x. It is close to 50% discount to the sector as a whole despite having better growth prospects than most of its peers. The foreign ownership quota is now filled but it may reopen at a later date. Our position in Lien Viet Post Bank amounts to just over 3% of the fund’s assets. The fund’s holding in Ferozsons Laboratories, a Pakistani pharmaceutical company, rose almost 40% as investors concluded that earnings have bottomed out after adjustment problems arising from one of its licensed Hepatitis C medicines to a generic version. The company has a very strong position in medication for Hepatitis C. This is a serious problem in Pakistan where, potentially, more than 10 million people are Hepatitis C carriers, while less than 100,000 are undergoing treatment. The fund’s position in three of the leading Nigerian banks (Zenith Bank, United Bank, and Access Bank) also made a good contribution with increases of between 16-20% each. Likewise, the fund’s positions in Egypt are developing positively, with GB Auto’s, in particular, showing an 11% increase. In our eyes, the company is perfectly positioned as a local vehicle manufacturer as the Egyptian government tries to reduce vehicle imports by deploying new tax proposals and incentivising local production. The devaluation of the Egyptian pound in November 2016 created new competitive conditions. However, GB Auto’s had a challenging first year given its relatively high indebtedness and significantly higher interest rates. Now that interest rates are expected to fall in 2018 (consensus forecasts point to 3-4% lower interest rates from the current rate of 18.75%), GB Auto’s results will get a boost, especially as the demand for vehicles returns and GB Auto positions itself as the leading auto manufacturer. Harsher lending requirements for banks in Bangladesh impacted one of the fund’s largest holdings, BRAC Bank, which in 2017 was one of the Fund’s best holdings. BRAC Bank fell over 10% over the course of the month. We consider it a much-needed correction for one of Asia’s most innovative banks. The bank’s crown jewel is bKash, a mobile payment service, that now has more users than the more widely known Mpesa (owned by Kenyan Safaricom).
During the month, the fund sold Grupo Supervielle its last holding in Argentina. We concluded that the valuation was too optimistic given future risks. The fund also sold its position in Egyptian Egypt Kuwait Holding after the company resumed its gas exploration activities, which fall outside the fund’s permitted scope of investing. The sale was undertaken after a thorough investigation by our ESG analysts including a conference call with company management. We concluded that there were no intentions or willingness to divest the business so we decided to divest our entire shareholding amounting to 0.3% of the company. Our investment yielded an absolute return of just over 40% since the investments were made in January and May 2017.
During the month, we added three new holdings in Sri Lanka. We are very positive about the development of Sri Lanka’s economy. Despite some less “business friendly” measures such as tax increases, we see sound political development which will have a positive impact across income brackets. The increased tax base is being used for infrastructure investment and to further improve education. Sri Lanka has robust literacy rates >90% of the general population. Further, Sri Lanka’s unique position as a growing tourist destination provides a good boost to the current account balance. Tourism revenues account for 4% of the GDP and are expected to grow by 12-15% per year. Despite strong growth, the number of tourists per year is just above 2 million currently, 1/3 more than Mauritius which is 1/30th Sri Lanka’s size. The comparison with Mauritius is relevant as we feel both countries focus more on the high-end tourism segment. We, sometimes, refer to Sri Lanka as “the next Singapore” with its strategic location outside of India, increased investments in ports and industrial zones as well as a rapidly expanding service sector. With a GDP per capita which is 1/15th of Singapore’s, there will several years of interesting growth opportunities provided Sri Lanka continues on its current path. Our new holdings in Sri Lanka include two banks, Commercial Bank and Hatton Bank. We have known about them for some time but found better opportunities in other markets. Now that we are in a position where investors take a cautious view of the companies, which are both valued about 1x the book equity, compared to about twice book value across frontier markets as a whole. In our view, financing the purchases from the sale of our Argentine banks, which are now valued at between 3-5x book value, makes sense.
MARKET
MSCI FMxGCC Net TR (SEK) rose 1.7% during the month, compared to MSCI EM Net TR (SEK) which rose 3.5%. We noted, the strongest developments in Nigeria, Vietnam, and Romania with increases of 8-9% each. Argentina and Bangladesh were the weakest markets both losing around 3% each. In Argentina, some confusion arose when the central bank unexpectedly lowered the interest rate by 75 points (from 28%) on January 23rd, despite the fact that at the end of December the inflation target for 2018 was increased to 15% from a previous band of 8-12%. The dollar weakened a significant 4% vs the Swedish Krona during the month, which reduced the return in Swedish Krona proportionally. In the short term, a weak dollar hits most of our stock markets, as most of these countries’ currencies follow the dollar closely. Taking a longer perspective, a weaker dollar means that these countries export to Europe’s benefit. Egypt and Vietnam’s exports to Europe represent about 25% of total exports; Pakistan just over 30%; while nearly 50% of Bangladesh exports go to Europe. In Pakistan, we noted a month of inflows from foreign investors amounting to almost USD 100m. In Vietnam, the strong inflows continued. After the inflow of just over USD 1bn to the stock market in 2017 (closer to USD 7bn including investments from strategic investors (specifically Thai Bev’s USD 5bn acquisition of Sabeco), an additional USD 400m net from foreign investors was invested in January. We would expect a correction in Vietnam before the Vietnamese New Year (Tet) as local investors are expected to increase their cash position before the celebrations. The Ho Chi Minh stock exchange is closed from 14-22 February. For the year as a whole, Vietnam is looking strong with continuing high interest from foreign investors who want to position themselves in what is currently the fastest growing frontier economy.
ESG OVERSIGHT
Three new companies were added to the Sustainable Frontier fund this month. We have concluded our initial buying for 2 of them. Commercial Bank of Ceylon PLC founded in 1920 and headquartered in Colombo, Sri Lanka, the bank offers personal and corporate banking; international operations; investment banking and dealing; and treasury services. It has 255 branches locally and 19 in Bangladesh. The bank reports aligning its strategy with all the Sustainable Development Goals (SDGs) and runs outreach initiatives in education, healthcare, and community. It also carries out financial literacy programmes and has organised one session especially for women entrepreneurs. Hatton National Bank PLC provides banking and related services including insurance and property. Based in Colombo, Hatton National Bank’s sustainability focus is on education, health, environment, and empowerment of entrepreneurs. They report integrating climate change mitigation into the bank’s business strategy. Awareness campaigns aside, Hatton Bank involves employees in environmental ethics by adopting a “Green Pledge” to integrate environmentally friendly practices into daily operations.
Two companies were divested during this month. Egypt Kuwait Holding Company was in breach of the Sustainable Frontier Fund’s parameters because of its decision to resume previously dormant gas exploration activities. The company was flagged earlier this month after reporting forays into gas production. Following a call with a company representative, it was confirmed that in Q1 2018, they were planning to consolidate Middle East Oil & Gas operations, a gas concession resulting in a clear breach of the fund’s parameters. The fund also divested of Grupo Supervielle for financial valuation reasons.
