THE THIRD QUARTER of the year (Q3-20) saw the Strategy up 4.9%, as the recovery off the March lows continued. Year to date, the Strategy has returned -11.2%, with the MSCI Frontier Markets Index down 8.8%. As a reminder, the Strategy performance numbers include the write-down of the in-country Zimbabwean (currently 61 basis points [bps] of Strategy) and Nigerian (159bps of Strategy) assets, as currency challenges persist in both markets. The index continues to use the official exchange rates. While the Strategy sold off significantly less than the market in the first quarter of the year, it has lagged the recovery seen in the second quarter of the year and in Q3-20.
Since inception, the Strategy has returned 0.5% p.a. against the index, which is flat. This is certainly well below our long-term, through-the-cycle expectations for the Strategy and reveals just how tough a period the last three years have been for these markets. Unlike developed markets, which have largely recovered back to 2019 levels and seem to go from strength to strength, propelled by free money provided by the large central banks of the world, many frontier markets trade at multi-year lows.
Over the past three years, not a single African market has shown a positive US dollar return, while across Global Frontiers, 10 of the 17 markets we follow are negative. Of the seven that are positive, only Ukraine (which has recovered from the Russian ‘annexation’ lows) has generated a good return of 17.1% p.a. The somewhat dubiously classified ‘frontiers’ trio of Qatar (+5.9% p.a.), Kuwait (+4.7%) and Saudi Arabia (+4.4%) are the next-best performers over this period.
For the quarter, the performance of the most significant markets for the Strategy was generally strong, with Bangladesh (+24.4%), Pakistan (+19.0%), Vietnam (+9.8%) and Egypt (+4.7%) all positive, and Kenya (-0.7%) largely flat.
The largest contributor to the Strategy’s performance for the period was Dragon Capital, the largest position in the Strategy, which added 1.9% over the quarter. The next two largest contributors were Bangladesh’s Beximco Pharmaceuticals (+1.0%) and VNV Global, an investment company focused on businesses with network effects (+0.7%).
The largest detractors were Tanzania Cigarette Company, which detracted 0.5% as a large block went through at well below market prices, and QNB Al Ahli (-0.3%).
During the quarter, the major buys were gold (via a miner and the metal), Vietnam (a basket of stocks) and Eastern Tobacco. We sold out of VNV Global due to valuation concerns, trimmed Turkey on concerns around a devaluation of the lira and finally exited our holdings in Argentina.
PANDEMIC EMPHASISES NEED FOR DEEP ANALYSIS
Having recently met over 40 corporates (virtually) at a conference, one of the standout themes has been how the local impacts of the global pandemic have differed so vastly across countries, sectors and even companies. We mentioned in the last commentary how Vietnam has emerged as one of the very best countries globally at containing the spread of the virus. This remains true.
A slightly different example this quarter is a comment from an Egyptian banking CEO who mentioned that 2020 isn’t even in the top three most challenging years of the past decade. He considered 2011 (Arab Spring), 2016 (forex shortages) and 2017 (large currency devaluation) as far tougher operating environments than 2020. I doubt many US, European or even South African corporates feel the same. Understanding these nuances is an essential part of our investment philosophy.
Deep-dive, bottom-up fundamental research is key to understanding the impact of the pandemic on each country and each corporate in the Strategy. Only by performing the detailed work can we confidently identify those corporates best positioned to sustainably grow earnings through the cycle and buy them when valuations are compelling. Over time, this Strategy should bear fruit for the long-term investor.
Thank you for your continued support.