During July the fund lagged the benchmark by 0.2%.
The main positive contribution to performance came from Brazil, where the market continued to anticipate a rate cut cycle. Expensive markets like India and Saudi Arabia where we currently have no presence underperformed the index, also helping on a relative basis.
This was offset by some weakness among our South Korean stocks and a mixed performance in China where our non-internet stocks underperformed on continuing concerns of cyclical slowdown.
Over the month we have taken some profits in Taiwanese stocks that have started to look overvalued due to AI excitement while continuing to add to Brazil.
While news-flow tends to be subdued in the summer months, we have seen long awaited inflection point in Brazil over the last few days. The Central Bank has cut rates by a higher than generally expected 0.5% to 13.25% – its first reduction since September 2020. From our perspective, this was already being priced in as domestic 10-year bond yields had dropped from above 13.5% in March to just above 10.5% by the end of June. The country still retains very high real rates, given inflation at 3.2% and there is clearly scope for further declines.
Other markets such as Mexico also have potential to see a tailwind from falling rates, even as most developed economies are still trying to ascertain where and when they will see peak rates. Declining interest rates are of course a boon to corporate profits and equity valuations, but they do have the potential to undermine recent currency strength. Investors who have been buying the currencies for high income, will now see a lower excess yield against the US dollar.
We are generally not too concerned about short term flows driven by the carry trade and like to focus on inflation adjusted currency levels over time. The Brazilian Real for example, which has been strengthening in recent years still remains at relatively undervalued levels on this measure. This is because inflation has been contained unlike during previous episodes. Even the Mexican currency, recently dubbed the Super-Peso due to its rally, is broadly at similar levels to where it was 10 years ago. Still, many Mexican corporates would prefer their currency to weaken somewhat and there is pressure on the Central Bank to follow the Brazilians in cutting when inflation permits.
Falling rates and domestic cost of capital tend to have a more significant impact on equity valuations then they do on foreign exchange markets over the longer term. This means we view this new cycle as quite positive overall.
