During April the fund outperformed the MSCI Emerging Markets Total Return index by 0.6%.
The outperformance was primarily driven by South Korea with additional contribution from Brazil, China and the UAE. The largest drag on performance this month was Taiwan. We did not make major changes to overall allocations this month, with Taiwan, Korea and the UAE remaining our largest positive exposures. We remain underweight on China although have been switching some of our positions in this market.
Our Korean portfolio had a good month. This was helped by an interesting confluence of two themes that we had written about in the past. A key long term development in the market is that companies are being forced into better allocation of capital by the National Pension Service which owns around 10% of the market. This pressure is forcing them to consider more substantial dividend pay-outs and share buybacks rather than hoarding cash and using it to build overly diversified conglomerates. We have always said that this change would be a slow process, but the direction has been in place for the past decade.
A second theme in Korea is the abundance of discounts – in particular the ability to own preference shares at half the price of ordinary shares or sometimes cheaper. These offer the same economic rights as ordinary shares, sometimes with a slightly higher dividend but without voting rights. They are typically also less liquid which does justify some price discrepancy. The discounts can get very large and vary over time. There has never been much reason for them to close – at times you could be forgiven for thinking there was no economic link between the share classes!
In April Hyundai Motors announced a maiden formal dividend policy with a 25% pay-out target, alongside the cancellation of treasury shares. This follows on from numerous other companies in the banking and telecom sectors that have made such commitments in recent years. Using consensus expectations, this would translate into a 5% annual dividend yield. However, as we own the preference shares at a 50% discount, we should be seeing a 10% annual dividend yield, or a “free” 5% outperformance over time against anyone owning the ordinary shares. Given the potential for such a premium return, we expect there will be increasing interest in the preference shares and over time the discount should narrow, further adding to relative performance.
We also own preference shares in other Korean companies – some have narrowed significantly since we have owned them (Samsung Electronics has gone from 40% to 15% discount), others remain at very attractive levels. We believe that more disciplined capital allocation and shareholder return policies may end up benefitting preference shareholders disproportionately. As always, we remain on the lookout for opportunistic value added to fund returns.
