Review
The fourth quarter of 2017 saw the MSCI Emerging Markets Index outperform the MSCI World Index by 1.9%, extending emerging markets’ outperformance against the developed markets to 14.9% for the 12 months ending 31 December.

The 7.4% return of the MSCI Emerging Markets Index for the quarter was largely driven by South Africa (up 21% on Cyril Ramaphosa winning the leadership race of the African National Congress), India (up 11% after the government announced plans for a major recapitalisation for state-controlled banks) and South Korea (up 10% on China’s effort to re-establish diplomatic relations between the two countries after South Korea’s missile deployment).

Performance
The fund underperformed in the quarter, but solidly outperformed the MSCI Emerging Markets Index for the 12 month period by 3.2%.

The fund’s underweight positions in South Africa, India and South Korea were the primary reasons for underperformance during the quarter. This was partially offset by the stock selection, as noted below. (Note that with regard to our geographical positioning, we build our portfolio on a bottom-up basis.)

The biggest contributors to relative performance of the portfolio during the quarter were VIPshop, NetEase and Vakrangee.

-VIPshop (up 33% for the quarter), operates as an online discounted brand retailer in China, utilizing the online flash sales model to push off-season products to customers. It was the fund’s top contributor for the quarter and was driven by a surprise announcement on December 18th, that Tencent and JD.com would invest a combined USD863 million into the company, thereby solidifying the partnership between the three China Internet players. Tencent and JD’s investment represent a 7.0% and 5.5% stake in VIPshop, respectively. VIPshop continues to show significant upside to our estimate of intrinsic value and remains a top 10 holding in the fund.

-NetEase (up 31%), is a leading online games company headquartered in China. It also provides various online services such as advertising, e-mail and e-commerce. Q3 2017 results reported revenues increased 35% YoY. This was driven by the 80% YoY growth in the e-commerce business. The online gaming revenue grew 23% YoY. Margins were satisfactory. On December 17, the company held its Annual Game Conference in Shanghai, where it unveiled an exciting pipeline of games across genres. NetEase is a top 10 holding for the fund due to it trading significantly below our estimate of intrinsic value.

-Vakrangee (up 74%) operates a convenience-service chain of Kendra stores in India, assisting the Government of India with its financial inclusion plan for the portion of the population that is unserved and unbanked. It is the leading services provider of government-to-citizen services, real-time banking, insurance and financial services and assisted e-commerce to consumers in 5,000 postal codes. It recently entered into a partnership with Amazon India, allowing them access to more than 10,000 of Amazon’s 12,000 assisted e-commerce stores in rural India.

Magnit and Banco Bradesco were among the biggest detractors from performance for the quarter.

-Magnit (share price down 33% for the quarter) is a leading Russian food retailer, holding an 8% market share, with over 10,500 convenience stores and 230 hypermarkets across Russia. The company reported below consensus revenue and profitability in Q3 2017. This was on the back of an ongoing refurbishment programme, which saw some stores closed for 24 days on average, and its continued expansion plan in a structurally formalising Russian food retail market. We expect that 2018 will see Magnit start to show a growth reacceleration as the refurbishments have a lesser impact on the near term results and the Russia consumer environment improves. The company represents a top 10 holding for the fund and we are comfortable to remain holders based on its valuation.

-Banco Bradesco (down 8%) is a Brazilian financial group covering all areas of financial intermediation ranging from individual and corporate credit, credit cards, insurance, leasing, payment collection and processing, asset management and brokerage services. The company reported Q3 2017 results with recurring net income increasing 8% YoY, slightly ahead of consensus estimates. This was mainly driven by lower loan provisions in light of improving asset quality and controlled expenditures which offset weak loan activity and compressed net interest margins, culminating in a stable return on equity of 17.7%.

Outlook
Emerging markets continue to benefit from a combination of low valuations, relatively stable political climates, improving business sentiment, and central banks that in most cases have room to reduce interest rates to stimulate growth if needed.

Investing is a long-term endeavour and we are confident that our bottom up approach of constructing the portfolio will see the patient investor richly rewarded. We focus on companies:

-with strong sustainable competitive advantages;
-which generate returns well above their cost of capital;
-which generate significant free cash flow; and
-which are trading at significant discounts to their intrinsic value.