In July the fund declined by 3%. Currency markets continued to be a source of volatility which this month combined with weakness in technology. Taiwan was the weakest market followed by China, whilst the best performing markets were UAE and Greece. Technology was the worst sector whilst Telecom was the strongest.
With rate cuts becoming more prevalent amongst western central banks and some softening in US data, it’s clear we’re close to a sea change in the US interest rate cycle. Given the various imbalances that have built up in G7 countries it’s an unfortunate reality that significant turning points such as these can cause bouts of high volatility. This has been clearly illustrated by the recent unwinding of the Japanese Yen carry trade, which had permeated into many assets including higher yielding EM currencies.
The consensus is now that US rates are considered ‘restrictive’, with money markets forecasting around a percent of Fed cuts by the end of the year. This environment would typically be associated with positive bond returns (and lower yields) as well as dollar weakness, which is good for EM assets.
Insofar as this being a relative call on economic resilience, we’re less confident about dollar weakness against major currencies than we are about actual rate cuts. We’re therefore increasingly tilting exposure towards positions that directly benefit from lower rates, which fall into two silos:
Areas with secular or idiosyncratic growth, able to withstand a slower global growth environment. This includes bottom-up positions with specific drivers, certain geographic regions, or a sector such as technology. Evidence of strong AI demand is now materializing in earnings amongst the market leaders, but valuations have become stretched. However other more traditional areas in our holdings that have clear ‘moats’, have de-rated back to historic yields and valuations whilst visibility on demand is improving.
The other is companies with bond-like properties where yield spreads will increase as rates fall, and preferably in dollar-linked economies. These include the UAE, Singapore and Hong Kong, which is still in a recovery phase. Being pegged to the dollar historically meant rates were too stimulative and other cooling measures had to be deployed, particularly in the real estate market. Now the opposite is true and the positive impact of lower borrowing costs should be clear.
The other area we’re particularly drawn to is the Communications sector. You will notice telcos have increased from around 5% at the start of the year to 14%, making it now the second largest sector. Whilst each position has stock specifics, we’re drawn to the attractive yields, a general trend of easing capex cycles (end of 5G), lighter competition from consolidation and positive exposure to AI through increased datacenter demand. In the current environment the higher visibility of yields is already leading to a re-rating in our holdings.
At the portfolio level we’ve maintained our distribution yield to around 7% after withholding taxes, whilst inflation has continued to moderate (July UK CPI 2.2%). The attraction of this real yield spread should increase further as yields on alternative asset classes continues to fall given this general easing rate environment.
