Aberdeen Emerging Markets has announced its interim results for the six months ended 30 April 2020, during which stock selection was positive, showing that the managers backed the right funds. However, the period includes the market collapse following the outbreak of the pandemic in March, followed by a partial recovery in April and, reflecting this, AEMC’s NAV total return for the period was -11.4% and it share price total return was -9.6% (the discount narrowed a little over the period), both of which underperformed the company’s benchmark, which it says returned -8.0%.
The company points out that, in the earlier part of the period, emerging markets made reasonable progress, recording gains of nearly 10% by the third week of January. However, over the next two month period, the benchmark index fell by more than 25% as the potential economic implications of the spread of virus became evident. However, within the portfolio, the contribution from fund selection was positive, with a number of funds performing well, although asset allocation detracted from performance, with the Company’s underweight exposure to China, in particular, having a noticeable impact. AEMC also suffered from the widening of closed end fund discounts, caused by a decline in investor sentiment as the pandemic crisis took hold.
Managers comments on holdings performance
“Amongst the holdings that performed well, relative to benchmark, were the Company’s investments in Korea through Weiss Korea Opportunity Fund and Korea Value Strategy Fund, the former investing in deeply discounted preferred shares and the latter adopting a deep value strategy. Romanian private equity focused holding Fondul Proprietatea delivered strong relative returns as did the value biased Emerging Europe (ex Russia) specialist, Avaron Emerging Europe Fund. Fidelity China Special Situations also performed well with its focus on “new economy” sectors proving helpful, while in the Gulf region, Diversified Growth Company QIC GCC Equity Fund’s tilt towards the domestic consumption theme enabled it to outperform the regional benchmark. Dividend focused strategies in Asia (Schroder Oriental Income Fund and Aberdeen Asian Income Fund) were amongst the negative contributors, while holdings in Neuberger Berman – China Equity Fund and Schroder International Selection Taiwanese Equity Fund also failed to match their respective benchmarks.
The Chinese and Taiwanese markets were the only two to deliver a positive return during the period, helped by remarkable resilience in the face of the COVID-19 sell off. Despite the Company having more than 40% of NAV invested in these two markets, this reflects an underweight position relative to a Benchmark in which the Greater China region now represents more than half the overall index. Being less exposed than this was a material detractor from relative performance in the period. Elsewhere, positioning in Romania and Colombia detracted from relative performance while India, South Africa and Mexico contributed positively.
Closed end fund discounts proved a further headwind, with discount widening reflecting a general decline in investor sentiment as the COVID-19 crisis took hold. The two largest detractors were Gulf Investment Fund and Weiss Korea Opportunity Fund which suffered from a sharp widening of discounts; the former experienced its discount widen by 14.5% compared with the start of the period while the latter experienced a 6.5% widening. For the period as a whole the weighted average discount to NAV of the Company’s closed end holdings widened from 10.3% to 11.4%.”
Manager’s comments on the portfolio
“Most significantly, the Company moved from a position of having borrowings equivalent to 8.0% of NAV at the start of the period to a small net cash position by the end of April. The move to a net cash position was made during the final weeks of the period as we took advantage of the rally in markets to reduce the portfolio’s overall exposure. While the global policy response to the current crisis has been impressive, markets are potentially underestimating the longer term impact of the pandemic on corporate earnings and we considered it prudent to adopt a slightly more cautious stance. Sales made to achieve this encompassed all regions and included several redemptions from open ended funds as well as reductions in a number of closed end fund holdings on either discount or asset allocation grounds. The allocations to both of those categories were lower at the end of the period as a result. The Company’s £25 million revolving credit facility was fully drawn until late April when we used the proceeds of sales to repay half of the facility.
The most significant changes during the period were an increase in China’s weighting and the move to a modest net cash position. The former was due to the country’s resilient performance during the period and the latter reflects sales made as markets rallied in April. Exposure to China increased to 33.5% during the period, while India declined to 4.4% as a result of a tender offer from JPMorgan Indian Investment Trust, which is discussed below. Allocations to Indonesia, Taiwan, the Middle East and Latin America also fell over the period as a consequence of redemptions we instructed from open ended funds. The weighting in South Korea increased to 11.1% after strong relative performance from the portfolio’s investments in that market. We continue to believe that many frontier markets offer compelling valuations as they remain extremely attractively valued and overlooked by mainstream emerging market investors. At the end of the period, 14.3% of NAV was allocated to frontier markets, including Romania, Nigeria and Kenya.
The weighted average discount to NAV of the Company’s closed end holdings widened from 10.3% at the beginning of the period to over 15% in late March, before narrowing to 11.4% at the end of April. We endeavoured to take advantage of volatility amidst the COVID-19 panic to add to existing closed end fund positions at some of the most attractive discounts seen for a number of years. As a result, we purchased additional shares in Aberdeen Asian Income Fund, Aberdeen New India Investment Trust, Asia Dragon Trust, Fidelity China Special Situations and Schroder Oriental Income Fund. Earlier in the period we participated in the placing of a significant block of shares in BlackRock Latin American Investment Trust, purchasing stock at what we considered an attractive discount in the mid-teens. The company affords investors the potential benefit of a tender offer should performance or the discount not meet certain criteria over the four year period to the end of 2021. In the meantime, the portfolio is managed by a team we hold in high regard, who adopt a high conviction and often contrarian stock-picking approach.
Our portfolio construction process seeks to deliver a focused list of actively managed holdings run by talented investment teams. One consequence of this has been that the number of positions in the portfolio has decreased over recent years and now stands at twenty-nine, the fewest it has ever been. Exits made during the period included a number of small positions in closed end funds where we considered the likelihood of sustained discount narrowing to be low (China Fund Inc, Taiwan Fund Inc, JP Morgan Russian Securities), a residual holding in JP Morgan Indian Investment Trust post its tender offer and several exchange traded funds. At the end of the period the Company held just one passive vehicle, accounting for less than 1% of NAV.
The Company participated in several accretive corporate actions during the period. JP Morgan Indian Investment Trust completed a tender offer for 25% of shares in issue in February. With a surprisingly low participation rate, there was substantial scaling-up and we exited 60% of the Company’s position at a significant premium to the prevailing market price. The Company also benefitted from a modest tender offer in Romanian holding Fondul Proprietatea in which we exited 6% of the Company’s position, also at a large premium to the market price on the transaction date. We also took advantage of a liquidity window provided by a share buyback by Russian private equity specialist Baring Vostok that was conducted at a price materially higher than it had traded at over prior months.
The allocation to funds managed by Aberdeen Standard Investments increased from 11.9% to 18.0% over the period. A significant element of that is accounted for by positions in open ended funds investing in the China A Share Equity Fund (5.5%) and Frontier Market Bond Fund (5.6%) with the remainder spread across several closed end funds focused on Asian equities. For all investments into “in-house” managed funds, there is no double charging of management fees which is a valuable tool in making the Company as cost-effective as possible in an environment where this is increasingly a concern for investors. All investments in “in-house” products are subject to the same in-depth diligence as external funds and a rigorous conflicts of interest procedure.”
Manager’s comments on outlook
The primary driver of the recovery in markets from the March low point was the massive global fiscal and monetary policy stimulus implemented by policymakers. While this has served to alleviate investor panic in the short term, longer term considerations around the emergence from the COVID-19 pandemic and its ultimate cost remain. As countries begin to emerge from lockdown, economic activity will pick up quickly but not to a level that can rapidly replace the lost output of the first half of the year. Corporate earnings in emerging markets are clearly going to suffer and analysts’ estimates of earnings for the year have declined significantly since the start of 2020. Dividends may also suffer cuts as companies prioritise balance sheet strength over returning capital to investors. Governments globally will exit the crisis with increased levels of debt and difficult decisions to make in terms of how and when to unwind the measures already taken.
While we are confident that emerging markets retain their long term appeal and that the Company is well placed, with a differentiated and diversified portfolio, the range of economic and market outcomes from this unsettling episode remains broad and uncertain. We expect further bouts of volatility and remain alert to the risks of any “second wave” virus resurgence. We have positioned the portfolio accordingly and will seek to take advantage of any such volatility wherever possible, ideally by adding to well managed closed end fund exposure at attractive discounts to net asset value.