Aberdeen Emerging: underlying managers struggled in 2018 – Aberdeen Emerging Markets underperformed the MSCI Emerging Markets Index over the year to the end of October 2018, returning -12.4% in NAV terms against -9.0% for the benchmark. The discount widened, leaving shareholders with a return of -15.7%. total dividends of 21p were paid in accordance with the trust’s enhanced distribution policy, whereby a large part of the dividend is paid from capital rather than revenue.
The chairman points out that the worst of the market falls occurred in the final quarter of the period. He attributes this to the effect of a rising US Dollar as the US economy continued to strengthen, concerns over trading relationships between the US and China as well as a slowdown in economic activity in China.
The manager’s report notes that gearing was unhelpful and contributed to the underperformance of the benchmark. Asset allocation was positive – the fund had an overweight exposure to Russia and a position in Romania (which isn’t part of the benchmark index). Asian positioning also added value with the underweight allocation to China the most notable contributor to relative returns. In Latin America, an underweight position in Brazil and off-index exposure to Argentina detracted from relative returns. The fund benefited from discount narrowing in some of its investment company holdings, notably Edinburgh Dragon Trust, Fidelity China Special Situations (but the trust had a bad year overall – see below) and Weiss Korea Opportunity Fund Limited.
The problem was with the performance of some of the underlying managers. They say managers in all regions struggled to beat benchmark returns. part of the problem is that these stock-picking managers tend to like smaller and medium sized companies – these underperformed (MSCI EM Small Cap lagged the benchmark index by almost 5%).
Extract from the manager’s report
“Material underperformance by an underlying manager necessarily prompts a review of the case for remaining invested. In the vast majority of cases our conversations with such managers have revealed sound explanations for benchmark relative underperformance. A couple of examples may serve to demonstrate the kind of issues that have been faced.
The Brown Advisory Latin American Fund is the Company’s largest standalone exposure to Latin America, accounting for 6.5% of net assets. The management team comprises two of the most experienced stock pickers in the region, and is one of very few teams to survive intact what has been a brutal 7-8 years for markets in the region. Their approach is differentiated from rivals in that they allocate solely to high quality growth companies with a focus on the domestic economy. The strategy of selecting companies with high returns on invested capital is one that has delivered handsomely in most equity markets over the long term. We are comfortable with this approach, believing it delivers a high quality portfolio that ought to perform strongly over time. Over the last few years however, this has not been the case, and in the period under review, it underperformed sharply (fund -15.7% vs MSCI Latin America +1.5%). We should stress that the managers do not build their portfolio relative to a benchmark, but invest with the goal of generating absolute returns over the long term. To illustrate how different the portfolio is we note that the “active share”(1) against the index is almost 95%. The major source of relative underperformance during the period was that the managers actively avoid state owned and influenced companies as well as commodity or energy producers. Vale (iron ore and nickel producer) and Petrobras (state influenced energy producer), which together represented 16% of the MSCI Latin America Index at the end of the period, rallied by 61.7% and 53.2% respectively. Not owning these two companies alone explains half the relative underperformance. While this performance is disappointing, we do not consider the long term proposition to have been impaired; the team is stable (and well aligned with investors), the process has been consistently employed and the portfolio is attractive on quality, growth and valuation metrics. If anything, we believe the fund has become more compelling, as it also provides exposure to materially undervalued currencies and an attractive asset allocation that differs significantly from the Latin American index (10% Argentina, 33% in the Andean markets of Chile, Colombia and Peru, 50% in Brazil and only 6% in Mexico). For these reasons, we continue to hold the fund despite the recent headwinds to performance.
In Asia, Fidelity China Special Situations is another core holding, accounting for 5.6% of the Company’s net assets at the end of the period. It too had a difficult year, delivering a NAV total return of -19.2%, which lagged the MSCI China Net Total Return Index by 5.8% as a combination of gearing, losses on index shorts and several stock-specific issues proved costly. Despite last year’s underperformance the fund’s long term performance remains impressive with a NAV total return of 101.6% over the last five years compared with an index return of 58.3%. The fund is managed by the twenty year Fidelity veteran Dale Nicholls, whose entire career has been focused on Asian equities. Dale draws on a deep pool of research analysts based in the region. Like Brown Advisory Latin American Fund the approach is highly active and index agnostic. The process focuses on identifying competitive, cash generative companies with good long term growth prospects. Strong governance is vital in China and Fidelity looks for highly competent management teams that are aligned with minority investors. This leads the manager to typically favour private companies (as opposed to State Owned Enterprises) which often operate in “new economy” areas such as e-commerce and social media or are beneficiaries of emerging middle class consumption trends in areas such as healthcare and financial services. The approach also leads the manager to have a significant bias towards small and mid-sized companies where the opportunities to add value are greater given the lack of sell-side research. By way of illustration, some 30% of net assets is invested in stocks with a market cap of less than GBP1 billion although such stocks account for just 0.5% of the China index. The trust fully exploits the benefits of the closed end structure by investing to a modest extent in unlisted stocks (an area in which the manager has historically added significant value) and makes active use of leverage and the ability to take short positions. While the last year has been uncomfortable we retain confidence in the differentiated approach and the manager’s abilities to add value over the long term.”
[QD comment: We recently published a note on this trust – A reversal of fortune – which talks through some of the issues that Aberdeen Emerging has been facing and the outlook for the trust.]
AEMC : Aberdeen Emerging: underlying managers struggled in 2018
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