Aberdeen Emerging Markets Investment Company’s (AEMC’s) managers, Andrew Lister and Bernard Moody, note investors’ new-found enthusiasm for emerging markets, now that they have been outperforming for a while. Their long experience tells them that now is a good time to be cautious. They have been taking profits on some positions and reallocating funds to areas that they believe are yet to feel the full benefit of the change in sentiment toward the sector.
The managers consider that valuations are not demanding and the US dollar weakness that has been supporting the case for emerging markets may persist for a while yet. They believe that the long-term case for allocating money to the sector is undimmed. The managers may be cautious, but they are still optimistic.
Aims for consistent outperformance of MSCI Emerging Markets Index
AEMC invests in a carefully selected portfolio of both closed- and open-ended funds, providing diversified exposure to emerging economies. It aims to achieve consistent returns for its shareholders above the MSCI Emerging Markets Net Total Return Index in sterling terms.
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AEMC is designed to provide investors with a one-stop-solution to gaining emerging and frontier market exposure and a range of what the investment managers consider to be ‘best-of-breed’ managers, many of whom are inaccessible for most UK-based investors. These managers are investing in some of the most dynamic and fast-growing countries in the world. Investments are made through both closed- and open-ended funds, blending liquidity and access to a wider range of managers with the opportunity to add value through discount contraction.
Whilst benchmarked against the MSCI Emerging Markets Index (MSCI EM Index), AEMC’s asset allocation may differ markedly from the benchmark and this is one potential source of alpha generation.
Manager selection is also key to the success of the fund. The ability to add value from narrowing discounts and corporate actions in the closed-end fund holdings is another potential source of alpha. The fund also offers a dividend yield of 3.3% (at the time of publication), which is paid quarterly from a combination of income and capital.
AEMC’s AIFM is Aberdeen Standard Fund Managers Limited (Aberdeen Standard) and it has delegated the investment management of the company to Aberdeen Asset Managers Limited (AAML). Both companies are wholly-owned subsidiaries of Standard Life Aberdeen Plc.
Andrew Lister and Bernard Moody (the managers) have been the lead managers of the fund since 30 June 2014. They have been involved with the management of the fund since October 2000 and
August 2006, respectively. They are assisted by Omar Ene. All of the senior members of the team have personal investments in the fund. Aberdeen Standard has considerable depth of investment management and analytical resource, in both emerging market equity and debt.
The team works closely with members of Aberdeen Standard’s multi-asset investing team, including Alistair Veitch, Margaret Ismond and Chris Paine. They provide inputs into the asset allocation decisions.
Time for discretion
AEMC’s managers observe that interest in emerging markets is picking up following a good run of performance and, to them, that signals that a note of caution is required. They have been taking profits from areas such as China and redeploying the proceeds into areas such as Eastern Europe and frontier markets. The managers are adding to closed-end fund positions but, given their caution, they are focusing on funds where they believe there is something to mitigate the possibility of a widening discount.
COVID-19 has had a profound effect on markets around the globe. The success or otherwise of efforts to control the virus, the degree to which economies have been hit by lockdowns, and the strength of national balance sheets following government stimulus are all distorting returns.
Asia, especially North-eastern Asia, scores highly on these criteria. The Taiwanese, Chinese and Korean stock markets have been particularly strong, driven largely by a few very large tech-focused companies such as TSMC and Samsung Electronics. These three markets dominate the MSCI EM Index. Just about every other emerging and frontier market underperformed the MSCI EM Index over the 12 months to the end of February 2021.
Brazil is a notable underperforming market. COVID-19 is still out of control in that country, possibly fuelled by a more virulent strain of the virus and failures in its government’s response.
On average, emerging markets have been outperforming the MSCI AC World Index over the past nine months, recovering some of the ground that they lost over the previous two years. However, frontier markets have continued to be relatively weak and remain more lowly-valued despite what the managers consider to be their superior long-term earnings growth potential.
One tailwind for emerging markets may have been a weakening US dollar. The managers raised AEMC’s gearing in November in anticipation of this. President Biden’s election, the likelihood of increased fiscal stimulus and an associated ballooning of US debt are likely factors in driving the US currency lower. There has been a flood of money into emerging market ETFs, but the managers suspect that one reason for China’s strong run of performance is that investors are using it as proxy for the emerging market asset class.
In the face of this, the managers have been taking profits on some positions. The proceeds have been used to reduce AEMC’s gearing once again. The trust also still has a position in emerging markets fixed interest securities; the implication is that the equity portfolio is currently ungeared. The fixed interest exposure is to US dollar and Renminbi-denominated bonds for the most part. Dollar weakness has been a drag on returns, therefore, but the exposure will be retained for now. While emerging market debt is underperforming emerging market equity, it is clearly less correlated and the managers think that it may prove defensive in the event of falling equity markets.
The managers say that they dislike the Indian market less than they did. The country has had a bad experience of COVID-19 and the market de-rated in the face of that. However, they think that things are starting to improve. They say that the country is well positioned with respect to vaccines and has the infrastructure to roll these out relatively quickly.
As the economy rebounds, Indian GDP growth could look quite high (potentially in the low double digits). Consequently, the managers felt less comfortable about their underweight, especially when compared to a frothier Chinese market.
The managers are enthused about the Russian market and have been adding to AEMC’s exposure. They see signs of improved corporate governance in the country and, helped by an improvement in the oil price, a stronger sovereign balance sheet. The managers are wary of additional sanctions. However, they think the rouble is undervalued and may strengthen.
Chile and South Africa look good on the managers’ quant model (see page 7). It suggests that, relative to its benchmark, AEMC should aggressively take an overweight exposure to eastern Europe and Latin America, while having an underweight exposure to Asia.
The managers are comfortable with AEMC’s exposure to frontier markets, many of which they say offer quality and value for good stock pickers. Redemptions from frontier market focused funds have reduced the opportunity set. For example, there are very few African-focused managers left. Nevertheless, many African companies are trading on historically low multiples on what appear to be cyclically depressed earnings. They feel that it makes sense to have exposure to these.
The managers note that the Q4 2020 rotation into value was very skewed to a handful of countries and has already unwound in some of them.
The managers believe that there is a margin of safety in emerging market valuations. However, they would highlight that markets are already pricing in a new commodity super cycle; there are elections coming up in many markets; and there could be fiscal problems in some post-COVID. Given this, a more defensive stance is appropriate in their view.
Investment philosophy and process
AEMC’s managers seek to construct a portfolio of both closed- and open-ended funds that give a diversified exposure to emerging markets. Outperformance of the benchmark can come from asset allocation decisions, fund selection and, in the closed-ended fund part of the portfolio, value can be added through discount contraction and corporate activity.
The managers believe that value-based, active investing can deliver outperformance of market indices over the long term. They say that closed-ended structures have some structural advantages over open-ended structures. However, the inclusion of open-ended funds within the portfolio gives access to talented management teams that might not be available via closed-ended funds, allows for improved liquidity and offers protection against the possibility of discount widening.
Asset allocation – a contrarian approach
In what can be quite volatile and unpredictable markets, the managers stress that it makes sense to prioritise caution over greed. Therefore, they try to avoid taking excessive style and factor risk within the portfolio. However, asset allocation is seen as an important potential source of alpha generation and therefore the distribution of the portfolio may differ markedly from the benchmark.
Asset allocation decisions are based on a detailed assessment of prospects for different regions and the opportunities available. The underlying managers, experts in their fields, are a valuable source of information. The managers leverage the expertise of Aberdeen Standard’s multi-asset team as well as the portfolio managers for the various regional and country-specific portfolios. In addition, the managers use a multi-factor quantitative model to help check their assumptions. Essentially, the approach is a contrarian one, favouring markets that are undervalued relative to their peers and cheap relative to history. The board has not imposed any prescriptive limits on the geographic breakdown of the portfolio.
Fund selection – looking for best-of-breed
The managers conduct extensive due diligence on prospective investments, including a comprehensive assessment of operational issues by the eight-strong operational due diligence team at Aberdeen Standard Investments. When selecting the underlying funds, the managers’ focus is on the ‘four Ps’ – people, process, portfolio and performance. The team conducts between 400 and 500 meetings with managers each year. They want to identify underlying managers with strong stock-picking skills and relevant experience, who are prepared to engage in an ongoing dialogue with the team, and whose interests are aligned with those of investors, often through significant personal investments in their own funds.
The investment process should be understandable, repeatable and consistently applied. The team is looking for evidence that the underlying managers are carrying out extensive research on their investments. The team will analyse the underlying portfolios and determine their risk and return characteristics. They will interpret the portfolio’s performance track record in the light of this analysis.
Fees charged on the underlying funds must be competitive. The managers are often able to secure terms not available to other investors.
AAML has been a signatory of the UN-linked Principles for Responsible Investment since 2007. ESG factors are taken into consideration when selecting investments for AEMC’s portfolio. The managers seek to assess the risks and opportunities presented by any investment. This includes the way in which any third-party fund manager incorporates ESG issues into its decision-making and the rigour with which it is applied, as well as the degree to which ESG issues are formally embedded in the process before and after investment and the approach to reporting on these aspects to investors.
AEMC may invest in funds with problematic ESG issues with the intention of engaging with the underlying managers to improve the situation. Indeed, AEMC’s managers continue to engage on a regular basis with the underlying fund managers of all of its investments and seek to encourage the adoption of current best ESG practices. Repeated ESG failings may be grounds for selling an investment.
Engagement with closed-end fund investments is intended to encourage them to be managed responsibly to the long-term benefit of investors. The promotion of good corporate governance has been a central theme since AEMC’s inception in 1998. The managers adopt a constructive approach with the aim of encouraging improvements to the benefit of all shareholders. To reinforce its messages, the team votes actively at all shareholder meetings.
Topics on which the team engages regularly with boards and managers of closed end funds include:
- board composition, independence and effectiveness;
- discount monitoring and controls;
- compensation structures and time-horizons for fund management staff, as well as overall costs;
- structural issues, including capital structure and the use of leverage; and
- transparency and shareholder communications.
The managers can switch the balance of the fund from open- to closed-ended and vice versa depending on the availability of discount narrowing opportunities. The inclusion of listed closed-ended funds within the portfolio allows the manager to seek to add value through discount narrowing. In these situations, the preference is for funds where they can identify a catalyst for a rerating.
The principle that asset allocation should make a meaningful contribution to returns ensures that the portfolio differs significantly from the make-up of the benchmark. The only formal constraint imposed on portfolio construction is that no holding will exceed more than 15% by value of net assets at the time of investment. The managers believe the portfolio should demonstrate the conviction that they have in their manager selection and aim to have fewer than 30 holdings in the fund. The managers take the degree of diversification within investee funds into account when selecting funds, so that AEMC’s exposure to any one underlying company should never be excessive. In practice, the look-through portfolio will be much more diversified than that of most other funds in the peer group, which should help reduce the volatility of AEMC’s returns (see Figure 20 on page 16).
At the end of January 2021, AEMC had 30 investments and the 20-largest of these accounted for 87.6% of the portfolio, reflective of the managers’ focused approach. The average discount on the trust’s closed-ended fund positions was 10.3%. At the end of February 2021, net gearing was 4.3% and this has fallen since.
The portfolio is split roughly half and half between open and closed-ended funds, with a small allocation to market access products such as ETFs. Relative to the benchmark, it remains biased to smaller and medium-sized companies.
The portfolio remains underweight Asia relative to the benchmark, but more so than it was when we last published (using data as at the end of July 2020).
The managers have been taking profits on positions in Chinese-focused funds and AEMC has moved from close to a market weight in the country to a 7.6% relative underweight exposure. However, that underweight exposure is less acute than this today, as AEMC has recently been building a position in Naspers (see page 12), whose main asset is a stake in Tencent.
As Asia has been outperforming other regions within EM, the index’s exposures to EMEA and Latin America have fallen over the past six months. The managers have been adding to some positions in these regions, seeking to take advantage of their relative undervaluation. In particular, the managers have been adding to Russia.
As we discuss on page 11, the trust’s holding in Fondul Proprietatea has been sold recently, consequently the trust’s exposure to Romania has been falling.
Top 10 holdings
Many of these 10-largest holdings have been discussed in previous notes. A list of these is available on page 21. Since we last published, Fondul Proprietatea has dropped out of the top 10 and been replaced by Verno Capital Growth.
Fondul’s discount narrowed significantly, possibly as investors anticipated a new attempt at an IPO for Hidroelectrica – its largest position – and a post-COVID recovery in trading for Bucharest Airport. The managers decided to sell out of the position as the discount narrowed to single digit levels. The IPO is uncertain – both as to timing and whether it will be permitted at all.
Verno Capital Growth Fund
Verno Capital Growth Fund is a feeder fund for the Verno Capital Growth Master Fund, a long-only, actively-managed fund invested in Russian equities. The portfolio is benchmarked against the RTS Index and aims to produce long-term capital growth. The fund operates with a relatively concentrated, high-conviction portfolio (but the opportunity set of listed Russian stocks is relatively small in any case).
Weiss Korea Opportunity
Weiss Korea Opportunity was one of the best-performing of all investment companies in 2020 yet it remains exposed to a portfolio of South Korean preference shares that trade on a meaningful discount to the equivalent common shares. We recently published a note on the company. Both it and Korea Value Strategy have been outperforming the MSCI Korea Index.
After China’s strong run of performance, Fidelity China Special Situations moved to trading at a premium and the managers took some profits from the position. Dale Nicholls’s stock selection decisions have been paying off for the Fidelity fund. NB China has not done quite so well, as it does not hold much of the highly valued tech stocks that have been driving markets. The managers have also reduced the position in Schroder Asia Pacific following strong price performance.
Conscious of the portfolio’s significant underweight exposure to China, the managers have partially offset this by making an investment in Naspers. This stock offers exposure to Tencent, the largest component of the MSCI China Index, but at around a 55% discount (at the time of acquisition).
Outside of the top 10, the managers are keen on Baring Vostok. In NAV terms, the fund has benefitted considerably from the IPOs of two of its largest positions. Ozon (www.ozon.ru) is a Russian ecommerce business and KASPI (ir.kaspi.kz) a Kazakh payments and online marketplace. The IPOs came at a premium to earlier valuations, but both stocks also rose in price in the secondary market. However, Baring Vostok’s share price has not kept pace with its NAV and it sits on a wide discount. Market perception of an overhang of stock might account for this. The fund has also been impacted by legal disputes, which now look to have been resolved. The fund is committed to returning a proportion of realised profits to investors and could do that via a buy back. The lock up periods for the two IPOs expire in Q2 2021.
Ashoka India Equity
To take advantage of India’s post-COVID recovery, the managers have bought a position in Ashoka India Equity. This trust, which launched in July 2018, is managed by Prashant Khemka, former CIO and lead portfolio manager of India equity and global emerging markets equity at Goldman Sachs Asset Management. The AEMC team have been following him for a while. Unusually, AEMC’s position has been acquired at a small premium to NAV. However, the managers are comforted by the trust’s commitment to offer an annual cash exit. There is no base management fee on this fund, but there is a 2% performance fee, calculated as 30% of the outperformance of the benchmark index over three years.
AEMC’s entire position in JPMorgan Emerging Markets has been sold after that trust moved to trade at a premium. AEMC still has a position in Genesis Emerging Markets and could benefit as poor performance from that trust may trigger a tender offer. Genesis Emerging committed to tendering for up to 25% of its outstanding shares if it failed to beat the benchmark over a five-year period ending 30 June 2021. Over the five-years to the end of February 2021, it was lagging by an annualised 1.1%.
Another fund that has been sold is Gulf Investment Fund. It offered investors a cash exit opportunity at NAV less costs. The money freed up was reinvested in open-ended Middle eastern funds. The managers have also been buying BlackRock Frontier Markets to take advantage of the opportunity that they feel exists in this area.
AEMC has been fighting a number of headwinds in recent years. The underperformance of small cap relative to large cap, value versus growth and frontier versus emerging markets have likely weighed on returns. Nevertheless, it has held its own against the benchmark, and has done particularly well since the depths of the COVID-19-related panic last Spring.
Its recent results, covering the 12 months ended 31 October 2020, showed the trust beating its benchmark by 0.7% in NAV terms. Shareholders also benefitted from a narrowing of the discount, leaving them 4.0% ahead of the MSCI EM Index.
Since AEMC’s financial year end on 31 October 2020, it has experienced a noticeable step up in its absolute and relative performance. In some respects, the managers say that this defies the odds – small cap was underperforming until recently, as was value. Asia, to which the fund has a significant underweight exposure relative to its benchmark, is still outperforming other emerging markets. What appears to be working for AEMC is its fund selection – picking good managers and benefitting from discount narrowing.
As discussed above, notable contributions came from Weiss Korea, Fidelity China Special Situations, Korean Value Strategy Fund, Fondul Proprietatea and Baring Vostok.
AEMC is a constituent of the AIC’s global emerging markets sector. For the purposes of this note, we have excluded Africa Opportunity, Baring Emerging EMEA Opportunities, Gulf Investment Fund and Utilico Emerging Markets, all of which have stylistic or regional specialisms that render them poor comparators to AEMC.
Even within the remaining members of the peer group. AEMC’s investment approach makes it distinctive.
AEMC’s track record looks pretty good relative to the peer group over most time periods.
Shifts in the general trend of closed-end fund discounts will have an effect on AEMC’s relative performance but the most significant factor influencing the performance rankings within the sector is usually asset allocation. Fundsmith’s longstanding overweight to India has been a drag on its returns, for example.
As Figure 19 illustrates, AEMC is a reasonable size, but trades on a wide discount, despite having an above-average dividend yield and relatively low ongoing charges ratio.
Figure 20 suggests that, on a risk/reward basis, AEMC offers returns close to those of the sector leaders but with much lower volatility.
Since July 2017, AEMC has been paying dividends topped up from distributable capital reserves. The board believes that investors are placing an increased emphasis on the income available from investing in emerging markets. The distribution policy overcomes the constraints imposed by AEMC’s historic revenue losses.
Over the company’s financial year ended 31 October 2020, dividends totalled 22p. AEMC has announced that it is anticipated that the total dividends for the year ending 31 October 2021 will be no less than 23.0p per share, a 4.5% increase on the previous year.
Over the year ended 28 February 2021, AEMC’s discount moved within a range of 19.2% and 8.8% and averaged 15.1%. At 24 March 2021 the discount was 14.1%.
The company takes powers at each AGM to buy back up to 14.99% of its then-issued shares. The company has not made any repurchases in recent times.
Fees and costs
AEMC’s management fee is charged at an annualised rate of 0.8% of net assets. There is no performance fee. For the purposes of the calculation of the management fee, any investments in funds managed by Aberdeen Standard are excluded from net assets. The investment management agreement can be terminated on six months’ written notice by either party.
Vistra Fund Services (Guernsey) Limited is the administrator and secretary to the company. It receives a fee of £40,000 per annum plus certain additional fees. PraxisIFM Fund Services (UK) Limited acts as administration agent in the UK. It receives a monthly fee equal to one-twelfth of 0.1% of NAV, but this was capped at £151,736 for the year ended 31 October 2020 and the cap is increased annually in line with the UK Retail Price Index.
Northern Trust (Guernsey) Limited, receives fees for depositary services calculated at the rate of 2.95 basis points per annum, subject to a minimum annual fee of £20,000 plus fees for custody services.
There is continued emphasis on cutting costs where possible. An increase in exposure to in-house managed funds is helping in that regard. It is unusual for AEMC to make investments in holding companies, but when it bought Naspers recently, the managers say that part of the attraction was that this roughly 3% of NAV is not subject to a management fee.
AEMC’s ongoing charges ratio for the year-ended 31 October 2020 was 1.02% (down from 1.07% for the prior year).
Capital structure and life
There are 45,965,159 ordinary shares in issue as at the date of the publication of this note and no other classes of shares. There are also 8,653,348 ordinary shares held in treasury, which can only be reissued at a premium to NAV.
The company is permitted to borrow, at the point of drawdown, up to 15% of its net assets. AEMC has an unsecured multi-currency revolving loan facility with The Royal Bank of Scotland, for an amount of £25m and termination date of 26 March 2021. The board has stated that it is in discussions with its bankers and expects to renew the facility on similar terms in March of this year. Gearing was 1.3% at 19 March 2021.
The company’s year-end is 31 October and, typically, AGMs are held in April. AEMC does not have a fixed life, but does hold regular continuation votes. At the 2018 AGM, shareholders approved the continuation of the company. Another vote will be put to shareholders at the AGM to be held in 2023 and every fifth annual general meeting thereafter.
The number of shares which are deemed to be held in public hands (based on the definition in the Listing Rules, which deems the holdings of the four largest shareholders to be not in public hands because they hold more than 5%) is below the minimum 25% threshold. In September 2019, AEMC announced that the FCA had agreed to modify the relevant Listing Rule for the period up until 21 August 2020 to permit a reduced level of shares in public hands. Significant efforts have subsequently been made to increase the shares in public hands through additional marketing efforts, but progress has been hindered by factors such as the COVID-19 pandemic. AEMC sought and received the agreement of the FCA to extend the period of the Listing Rule modification to 21 August 2021. During this time AEMC continues to monitor its share register, is keeping the FCA informed of any relevant developments and is working towards increasing the number of shares in public hands.
AEMC’s board has five directors currently, all of whom are non-executive, independent of the manager and who do not sit together on other boards.
John Hawkins intends to retire as a director of AEMC at the forthcoming AGM in April 2021.
Mark Hadsley-Chaplin (chairman)
Mark founded RWC Partners Ltd (formerly known as MPC Investors), a London-based fund management firm specialising in hedge funds, long-only funds and UCITS strategies, in 2000. He was its CEO until 2006 and chairman until 2010. Prior to this he was vice chairman of UBS Securities (East Asia) Ltd, based in Singapore and responsible for the management and development of the bank’s Asian equity business worldwide.
William Collins (senior independent director)
William has over 45 years’ experience in banking and investment. From September 2007 he was employed by Bank J Safra Sarasin (formerly Bank Sarasin) in Guernsey as director – private clients, retiring at the end of 2014. Prior to that, he worked for Barings in Guernsey for over 18 years. In 1995 he was appointed a director and from 2003 until August 2007 was managing director of Baring Asset Management (CI) Ltd.
Helen Green (chair of the audit committee)
Helen is a chartered accountant and has been employed by Saffrey Champness, a top 20 firm of chartered accountants, since 1984. She qualified as a chartered accountant in 1988, and became a partner in the London office in 1998. Since 2000 she has been based in the Guernsey office, where she is a client liaison director, responsible for trust and company administration.
Helen is a director of CQS Natural Resources Growth and Income Plc, Landore Resources Limited, UK Mortgages Limited and JP Morgan Global Core Real Assets Limited.
John is a Fellow of the Institute of Chartered Accountants in England and Wales. He was formerly executive vice president and a member of the Corporate Office of the Bank of Bermuda Limited. He was with The Bank of Bermuda for 25 years, of which approximately 15 years were based in Hong Kong. John is also a director of Raffles-Asia Investment Company Limited.
Eleonore de Rochechouart
Eleonore is a partner of Res Familiaris LLP, a wealth management advisory boutique designed for families looking for a dedicated and independent service covering all aspects of their global wealth, including financial and non-financial assets. Prior to joining Res Familiaris in 2010, Eleonore spent 20 years in the financial services industry as an economist, researcher and asset allocator in both the traditional and alternative investment arena.
Readers interested in further information about AEMC may wish to read our earlier notes. You can read the notes by clicking on them in Figure 25 or by visiting our website.
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