Asia Frontier Fund USD A-shares lost −3.5% in August 2017. The fund underperformed the MSCI Frontier Markets Asia Net Total Return USD Index (+1.9%) the MSCI Frontier Markets Net Total Return USD Index (+3.7%), and the MSCI World Net Total Return USD Index, which was up +0.1%. The performance of the AFC Asia Frontier Fund A-shares since inception on 31st March 2012 now stands at +71.4% versus the MSCI Frontier Markets Asia Net Total Return USD Index, which is up +50.0%, and the MSCI Frontier Markets Net Total Return USD Index (+49.1%) during the same time period. The fund’s annualized performance since inception is +10.5% p.a., while its YTD performance stands at +0.6%. The broad diversification of the fund’s portfolio has resulted in lower risk with an annualized volatility of 8.98%, a Sharpe ratio of 1.14 and a correlation of the fund versus the MSCI World Net Total Return USD Index of 0.33, all based on monthly observations since inception.
This was one of the toughest months since the inception of the fund and there were multiple contributing factors for this. The month started on a positive note but continued worries about political stability in Pakistan continued to impact the KSE100 Index which lost −10.4% this month. After the ouster of former Prime Minister Nawaz Sharif in July, any negative news is being given much more weight than earlier. The rising current account deficit has been an issue since the beginning of the year on the back of rising machinery imports and higher oil prices. As mentioned in previous manager comments, these machinery imports are related to the China Pakistan Economic Corridor (CPEC) power projects which will help improve future power capacity and aid economic growth. Therefore, though there could be some short-term pain with respect to the currency, the longer term economic trends and prospects for Pakistan are still positive which is also backed by an incentivized military to improve the security environment.
Market sentiment was further impacted when President Trump made some negative geopolitical comments about Pakistan’s role in the region. How much of these words can be put into action and the impact it can have on the country is debatable as Pakistan has aligned closer with China over the past few years. The end of the month saw further negative news flow as the country’s largest bank, Habib Bank, could potentially be fined USD 630 mln by the New York State Department of Financial Services for non-compliance related issues. As of writing, the bank has reached an out of court settlement and will pay a fine of USD 225 million which will have a significant impact on its profits for this year but this amount of fine puts the bank’s balance sheet in a relatively better position compared to paying the whole amount of the fine. The fund has never held this bank in its portfolio but holds another bank which has declared better results than its peers in the second quarter and has outperformed the index on a relative basis this year.
Though there was negative news flow in Pakistan during the month, economic indicators such as auto sales and private sector credit growth continued to be positive and both have shown double digit growth so far this year. The KSE100 Index is now down 22% from its peak in May 2017 and valuations have opened up across sectors and we believe given the longer term positive trends in the country, this could be a time to look at certain opportunities given the fear in the market.
Vietnam saw weakness during the month given the good run it has had so far this year while economic indicators such as manufacturing growth and retail sales continue to be positive. The Central Bank (State Bank of Vietnam) is looking to push further credit growth and has increased its credit growth target to 20-21% in 2017 from the earlier plan of 18%. This is being done with the hope of meeting a full year GDP growth of 6.7% in 2017. Higher credit growth is positive for the banks in the near term but in the longer run if pushing credit to meet GDP growth targets is a common theme, we would remind ourselves of the previous NPL cycle the Vietnamese banking sector went through and has only started recovering from.
The Sri Lankan index, the Colombo All Share Index, corrected by 3.7% this month on the back of weak quarterly results of most consumer related companies. This is not a surprise as the country has faced a drought and floods in the past few months which has impacted consumer incomes especially in rural areas. Further, the VAT increase from 11% to 15% has also led to price increases at a time when consumer incomes are stretched leading to weaker consumer spending. However, valuations for many companies in Sri Lanka are still attractive on a bottom up basis.
Mongolia’s economic situation continues to markedly improve, driven by rising prices and exports of coal and copper from the country, as well as improving FDI. This led to GDP growth of 5.3% during the first half of the year and 6.1% in Q217. However, since mid-July coal exports have slowed dramatically at the main border with China, Gants Mod. China has increased the processing time for customs which led to a 160km traffic jam on the Mongolian side of the border. There are rumours that China has done this in order to leverage Mongolia into expediting the approval of construction of a railway from the Tavan Tolgoi coal basin to the Chinese border, which would ultimately benefit Chinese companies, but would also add much needed stability to the Mongolian economy and likely attract further FDI. On 7th September the Mongolian Parliament voted to remove Prime Minister J. Erdenebat after the ruling Mongolian People’s Party was defeated in the July Presidential election. A new government is now expected to be formed within 30 days whereby we would expect to see the subsequent advancing of specific resource projects. The biggest positive contributor to performance this month was Mongolia where the fund’s holdings in the resources and consumer sectors performed well on the back of improving economic sentiment.
The best performing indexes in the AAFF universe in August were Mongolia (+13.4%), Bangladesh (+2.5%), and Laos (+1.1%). The poorest performing markets were Pakistan (−10.4%) and Sri Lanka (−3.7%). The top-performing portfolio stocks this month were (like last month) all from Mongolia: a coal mine (+42.8%), an oil exploring company (+20.7%), a concrete company (+19.2%), followed by a junior oil and gas exploring company from Papua New Guinea with +17.6%.
In August, we added to existing positions in Mongolia, Pakistan, and Vietnam. We added a leather company from Mongolia to the portfolio and exited three positions in August: a Pakistani hospital group, a Pakistani food company and a gold mining company we received from a corporate action (Mongolia) but which has its assets in the United States. Additionally, we partially sold two food and beverage companies in Mongolia.
As of 31st August 2017, the portfolio was invested in 118 companies, 1 fund and held 3.7% in cash. The two biggest stock positions were a pharmaceutical company in Bangladesh (8.1%) and an investment company in Myanmar (3.2%). The countries with the largest asset allocation include Vietnam (27.0%), and Pakistan (20.4%). The sectors with the largest allocations of assets are consumer goods (29.5%) and financials (14.8%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 15.15x, the estimated weighted average P/B ratio was 2.71x, and the estimated portfolio dividend yield was 3.93%.