Seafarer®

Pursuing Lasting Progress in Emerging Markets

Seafarer Overseas Growth and Income Fund

Portfolio Review Semi-Annual Report

Period ended October 31, 2012
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During the first six months of the Fund’s 2012-13 fiscal year (May 1 – October 31), the Seafarer Overseas Growth and Income Fund gained 7.13% and 7.16% for the Investor and Institutional classes, respectively. The Fund’s benchmark, the MSCI Emerging Markets Total Return Index, fell -1.01% during the same period. By way of broader comparison, the S&P 500 Index gained 2.16%.

The Fund’s policy for distributions, as stated in the Prospectus, is that it will normally pay dividends and net investment income, if any, on a semi-annual basis. The Adviser is pleased to report that the Fund paid its first semi-annual distribution to shareholders in June. The Fund distributed $0.04995 and $0.03484 per share for the Investor and Institutional classes, respectively.

Performance

During the past six months, stock markets in the developing world experienced substantial swings. They declined sharply between May and June, and then rose swiftly between July and September, before declining slightly once more in October. The net effect of all those gyrations is that markets finished the last six months just shy of where they began (as measured by the benchmark index).

A number of factors drove the volatility in emerging equities. Markets stumbled in May due to renewed concerns over Greece’s ability to remain a member of the Eurozone, fears over Spain’s solvency, and worries that China’s economic growth would falter. However, by July stocks began to march upwards again; in my view, these gains occurred primarily because of three interrelated events. First, markets recognized that, as grave as the situation in Western Europe was (and is), the substantial decline priced into stocks was overdone. Second, markets anticipated extended stimulus on the part of the world’s major central banks. Indeed, both the U.S. Federal Reserve and the European Central Bank maintained relaxed monetary policies through the summer. Third, equities gained because valuations were quite depressed in June, and yet second quarter corporate profits generally exceeded the (low) expectations of investors.

As markets fell through June, the Fund also declined, but less so than the benchmark index; and as markets recovered lost ground between July and October, the Fund managed to slightly outpace the benchmark. During the six month period, about two-thirds of the Fund’s positions contributed positively to the Fund’s performance. The Fund’s gains were relatively concentrated, though. The ten positions with the greatest contribution to performance were collectively responsible for over 80% of the Fund’s return.

The top contributor to the Fund over the past six months was its holding in a mid-capitalization company called Aselsan Elektronik. Aselsan is a Turkish firm that produces electronic systems and communication equipment for military and civilian markets. The company has existed for several decades, yet it has only recently undertaken efforts to operate on a truly commercial basis. In the past, the company operated essentially as a captive supplier to (and subsidiary of) the Turkish Army; consequently, Aselsan’s financial performance took a back seat. However, the company has recently begun to improve upon its commercial potential, expanding into new markets and accelerating its growth. Aselsan’s shares rose ostensibly in reflection of the company’s improved performance.

The Fund’s holdings in a small-capitalization company called Kingdee International also contributed to gains. Kingdee provides “enterprise management” software to small and mid-sized companies based in China. This software helps companies manage their accounts, track inventory and sales, and engage in online commerce. Kingdee has historically been a leader within its chosen niche. However, the company embarked upon an ill-fated expansion approximately two years ago, one which left the company’s finances stretched thin in light of slowing growth within the Chinese market. As a consequence, Kingdee’s shares dropped over four-fifths between their recent peak in April 2011 and their recent nadir in July 2012.1 Seafarer’s research confirmed that the company’s fundamental position has deteriorated, and that its near-term profitability is materially compromised. However, Seafarer also judged the extent of the correction overdone, and as such, the Fund began to acquire shares in the company in June. The shares have since recovered a portion of their former value, to the Fund’s benefit.

Another notable positive contribution to the Fund came from its holding in Cerebos Pacific, a Singapore-based purveyor of food and beverage products across Southeast Asia and Australia. The company is a closely-held subsidiary of the Japanese beverage company Suntory. In August, Suntory announced its intent to purchase the roughly 15% of Cerebos that it did not already own; Suntory agreed to pay a premium price in order to take the company private, and the transaction is now on the cusp of consummation. We are pleased to report that this is already the second time a portfolio holding has received such an offer in the relatively short life of the Fund (the first being a Hong Kong company called SinoCom).

The Fund’s two holdings in Mexico, Grupo Herdez and Kimberly-Clark de Mexico, also made prominent contributions to the Fund’s semi-annual gains. Both stocks performed very well, presumably in recognition of their strong financial results. However, I believe their gains also reflect the market’s belated recognition that the Mexican economy is much healthier than headlines convey.

The Fund’s holding in the Market Vectors Vietnam ETF was responsible for the largest drag on performance, by far. Vietnam saw its stock market lurch lower during the period as a series of scandals and reforms impacted its banking sector. To date, Vietnam’s banks have borne the brunt of the pressure arising from the country’s bloated state-owned enterprise sector. Like China, its large neighbor to the north, Vietnam’s government has propagated a substantial number of uncompetitive, state-backed enterprises; and as in China, those entities have borrowed excessively from compliant local banks. Some of the debts have come due, and the state-backed debtors have been either unwilling or unable to repay. This outcome has led to criticism and scandal within the country’s banking sector and throughout its various political circles. Vietnam appears to be redoubling its efforts to reform the sector, yet the market stumbled amid the political and economic strife. Nevertheless, we remain heartily enthusiastic. Much of the country’s private (non-state-backed) sector remains in good health, and valuations on selected stocks appear quite attractive. Seafarer will conduct “on the ground” research in Vietnam during the coming months, with the eventual intent to add individual Vietnamese equities to the Fund, as and when the Fund’s registration status allows.

Allocation

At the end of October, the Fund’s composition had shifted discernibly from that of April, particularly with respect to its regional allocation (more outside Asia), and also relative to company size (a marginal shift toward larger companies).

The Fund’s allocation to the Asia region declined about 16% (from 80% to 64% of net assets) during the semi-annual period, with offsetting increases in other regions, especially Eastern Europe (+12%) and Latin America (+5%). This shift toward Eastern Europe was driven in large part by attractive valuations in Poland; the portfolio’s holdings there appear to exhibit growth and valuation characteristics that are favored by the Fund’s strategy.

The Fund increased its exposure to Latin America during the period, notably by way of introduction of two new issuers in Chile and another in Brazil.2 In the months leading up to the Fund’s launch, we were quite cautious about Brazil: we were concerned the currency was too expensive; the valuations too dear; and the growth slowing too much. However, our research in the country has made us moderately more positive. Valuations on many stocks are still steep, and the immediate outlook for the economy is challenging, but we see signs that the country is gradually turning the corner for the better, and that stronger growth lies ahead. I personally believe that the Rousseff administration has exhibited a great deal of courage, undertaking a number of politically difficult measures that will most likely improve the country’s long-term prospects. However, for the moment, the market clearly thinks otherwise: the administration has attempted to inject competition into several inefficient sectors, and the shares of companies that have been singled out have slumped.

Regarding the Fund’s marginal shift toward larger companies (from 20% to 35% of net assets): since inception, the Fund has allocated the bulk of its weight toward mid-sized companies. This is because Seafarer typically finds more mid-sized companies that satisfy the Fund’s growth and valuation criteria. However, during the past three months, the Fund made a deliberate shift toward larger companies, due to concerns about rising valuations across markets. At the recent nadir in markets (June 4th), we felt that valuations were quite attractive, as we indicated in our July Shareholder Conference Call. However, from the lows of June, to the end of the semi-annual period, the emerging market benchmark index rose 14.4%.3 This pronounced, short-term gain has led us to be just a bit more cautious overall, which in turn has prompted us to favor larger companies, where we find valuations – and safety – to be marginally better. To be clear, valuations on emerging market stocks are not excessive at present, even if they are no longer especially attractive.

Andrew Foster Seafarer Capital Partners, LLC
  • The performance data quoted represents past performance and does not guarantee future results. Future returns may be lower or higher. The investment return and principal value will fluctuate so that an investor's shares, when redeemed, may be worth more or less than the original cost. View the Fund’s most recent month-end performance.
  • The MSCI Emerging Markets Index, Standard (Large+Mid Cap) Core, Gross (dividends reinvested), Total Return USD is a free float-adjusted market capitalization index designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 21 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey. Index code: GDUEEGF. It is not possible to invest directly in this or any index.
  • The views and information discussed in this commentary are as of the date of publication, are subject to change, and may not reflect the writer's current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. It should not be assumed that any investment will be profitable or will equal the performance of the portfolios or any securities or any sectors mentioned herein. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Seafarer does not accept any liability for losses either direct or consequential caused by the use of this information.
  • As of 9/30/2012, Aselsan Elektronik Sanayi Ve Ticaret AS comprised 4.0% of the Seafarer Overseas Growth and Income Fund; Kingdee International Software Group Co. Ltd. comprised 2.8% of the Fund; Cerebos Pacific, Ltd. comprised 1.4% of the Fund; Grupo Herdez SAB de CV comprised 2.2% of the Fund, Kimberly-Clark de Mexico SAB de CV comprised 2.8% of the Fund, Market Vectors Vietnam ETF comprised 3.2% of the Fund, and Corpbanca SA/Chile ADR comprised 1.6% of the Fund. Holdings are subject to change.
  1. Kingdee International shares closed at HKD 5.07 on April 27, 2011; and closed at HKD 0.85 on July 30, 2012. Source: Factset.
  2. One of the Chilean issuers referenced in this sentence (Corpbanca SA/Chile) consolidates two separate holdings, a common stock and an ADR.
  3. Performance based on the MSCI Emerging Markets Index, Standard (Large+Mid Cap) Core, Gross-of-Tax (dividends reinvested), Total Return USD. June 4 to October 31, 2012. Source: Bloomberg