During August the fund outperformed the MSCI Emerging Markets index by 0.8%.
The main contribution to outperformance came from Taiwan through a combination of AI excitement and relief that the inventory digestion phase in the electronics supply chain was easing. Our positions in the UAE also contributed positively while China and LatAm proved a slight drag relative to the index.
During the month we invested in a logistics and transport company in Mexico that we have been following for a long time. This business should benefit directly from the ongoing nearshoring trend and the stock now has improved its liquidity which brings down the cost of capital. We funded this by exiting one of our oil producers in Brazil where we felt the long term free cash-flow outlook had deteriorated.
Among all types of geographic equity mandates, Global Emerging Markets probably offers the greatest opportunities for active managers to outperform a passive index investment. This is thanks to the low degree of correlation among EM markets. Over the last 12 months MSCI Brazil has had a correlation of below 0.1 to Taiwan or the UAE (where 1.0 means the markets move in unison and -1.0 means they move in exactly opposite directions). Indonesia has had zero correlation to Mexico and South Africa and a negative correlation to China. Apart from Japan and Switzerland’s relatively low 0.33, major developed markets have shown much higher correlations between 0.4 and 0.9 during this period.
This should not be surprising given the increasingly wide differences in economic and political structures that are lumped together in the EM space. Developing countries with widespread poverty jostle with wealthy ones like the UAE or Korea, whose populations enjoy higher life expectancy than the US. Top-down authoritarian governments like in China mix with lively democracies such as Korea or Taiwan. Businesses operating in these markets face varying challenges and opportunities at different times. In North of South parlance, we see divergences in the cost of capital among our countries.
A diversified portfolio helps the investor take a longer-term view without pressure to react to abrupt portfolio moves. This is helped by the aforementioned dispersion of returns – even if China is currently selling off, you may be offsetting losses through your Indonesian stocks. If your manager is able to sleep well at night, they will likely take better decisions on the portfolio.
It is undeniable that as a whole returns from Emerging Market equities have been disappointing over the last decade. And yet, experience shows that given a conducive setup like in 2000/01 the asset class can do extremely well. It therefore makes sense for investors to have a structural exposure to our markets. While we wait for the next favourable set of tailwinds, the ability to enhance performance through active manager alpha remains essential.
