During the second quarter of 2015, the Seafarer Overseas Growth and Income Fund returned 2.18%.1 The Fund’s benchmark, the MSCI Emerging Markets Total Return Index, rose 0.82%. By way of broader comparison, the S&P 500 Index gained 0.28%.
The Fund began the quarter with a net asset value of $11.90 per share. During the quarter, the Fund paid a semi-annual distribution of $0.060 per share. This payment brought the cumulative distribution per share, as measured from the Fund’s inception,2 to $1.091. The Fund then finished the quarter with a value of $12.10 per share.3
Stocks in the developing world were as volatile as ever in the second quarter. In my estimation, three factors induced most of the volatility in the emerging markets: currencies, Greece, and China.
Many emerging market currencies slipped again versus the dollar during the quarter, though the losses sustained were far less substantial than the first quarter of 2015. The Mexican Peso and the Turkish Lira were notably weak; both countries struggled with political scandals, and Turkey finished the quarter with an election that left the country in need of a coalition government. A number of Asian currencies – the Thai Baht, the Indonesian Rupiah, the Indian Rupee, and the Malaysian Ringgit – all saw their currencies slip a bit during the quarter, though the exact cause of their declines is unclear.
Meanwhile Greece’s economic woes brought further gyrations to global financial markets, particularly during the latter half of the quarter. Many stock markets within the emerging world gained during April, and rose a bit further in early May, only to see those gains dissipate as Greece’s travails made headlines. Poland’s stock market appears to have swung in sympathy with Greece-related news during the quarter. At the time of this review, it appears that Greece acquiesced to creditors’ demands as a precondition for remaining within the Euro. My speculation is that Greece’s financial management program will prove untenable in implementation, and the country will eventually exit the Euro – though I do not know when, or whether the exit will be voluntary or otherwise.
For all the volatility stemming from currencies and Greece during the quarter, China trumped both. Beginning in the summer of 2014, China’s domestic stock markets (known as the “A-shares,” and partially restricted to foreign investors) began to march higher. During the past six months, the gains became increasingly frenzied. In April, that frenzy spilled over to the Hong Kong market, where a number of China’s largest companies are cross-listed. Rather suddenly, any share listed in Hong Kong that had anything to do with China surged higher. Some commentators suggested the frenzy in Hong Kong was due to a new trading program called the “Shanghai – Hong Kong Stock Connect,” which allows domestic Chinese investors to trade Hong Kong shares through the Shanghai exchange. This explanation may hold some merit, but I believe the volumes that accompanied this frenzy could not have been the product of domestic Chinese investors alone – my best guess is that non-Chinese institutional investors (i.e., hedge funds from the western world) also stoked Hong Kong’s gains.
This surge in China-related shares pushed the benchmark index and the Fund higher. By April 28th – only four weeks into the quarter – the index and the Fund were 9.68% and 6.90% above where they began, respectively. However, by May the Chinese authorities attempted to rein in such aggressive speculation (more on this topic below), and the frenzy rapidly dissipated. China-related stocks fell sharply in June, and brought the broader emerging markets lower as well, such that the index and the Fund finished only a bit higher than where they began the quarter.
During the quarter, I undertook one major shift in the Fund’s composition: I reduced the allocation to the Asian region by roughly -8% versus the end of the preceding quarter. At the same time, I increased the allocation to Latin America and cash by +3% and +5%, respectively. The Fund’s allocations to other regions (Emerging Europe; Middle East and Africa) were unchanged.
It’s important to note that, for the most part, I accomplished this shift not by selling Asian securities, but rather by revising the portfolio’s construction during a period of pronounced growth in the Fund’s assets. During the quarter, the Fund’s assets under management grew 142% (from $147 million to $357 million). As new capital entered the Fund via subscription, I allocated marginally less to Asia, and marginally more to Latin America, while retaining a bit more cash along the way.
It would be reasonable to presume that the wild gyrations in China’s stock markets prompted a change in course. Not so. I do not believe that China has done irreparable damage to its financial markets or to its economy – at least not yet. To be sure, I am not pleased with how China has managed its stock markets; its efforts to stem rampant speculation and associated volatility have been clumsy and futile. Yet so far, I do not think the policy measures enacted constitute a substantive move backwards. I will return to the topic of China at length in the Outlook section below.
Returning to the portfolio’s construction: the movement away from Asia and toward Latin America represents a tactical shift, not a strategic one. For the past three years, Asian equities and currencies have performed substantially better than their counterparts elsewhere in the developing world. Conversely, Latin American equities and currencies have performed quite poorly. Seafarer conducts its research “from the bottom up” – our research process does not place great weight on macro-regional differences, and instead focuses on companies and their individual merits. At present, we find marginally more opportunity within Latin America: the region’s pronounced under-performance has rendered valuations more attractive than they were three years ago. Admittedly, Latin America’s markets have declined for good reason: the region’s economies are struggling with slow growth, corruption, and in some cases, heavy fiscal burdens. Yet I believe the Fund has discovered a handful of securities that nonetheless present attractive tradeoffs between valuation, growth and risk – and consequently I have increased the allocation to Latin America.
The Fund’s heightened allocation to cash is nothing more than a reflection of the Fund’s rapid growth and the recent market volatility. To be blunt: by late May, I believed that China’s markets were overheated and ripe for imminent correction. I did not know precisely when or how a correction might unfold (in hindsight, the decline I anticipated began in the first week of June, and the markets fell more violently than I imagined). Nevertheless, I took advantage of the Fund’s influx of capital to hold a bit more cash than usual, on the premise that the Fund might redeploy it later, at lower prices. The Fund did so so in July.
Four new positions were added during the quarter: Balkrishna, an India-based manufacturer of industrial tires; Iochpe-Maxion, a Brazilian maker of automotive wheels and railway equipment; Bolsa Mex, the stock exchange of Mexico; and Texwinca, a garment maker with assets in both Hong Kong and China.
One position was deleted: the Fund exited Ulker, a Turkish maker of snacks and biscuits. While Ulker is a well-run company with possibilities for expansion in the Middle East, I believed the Fund could find more attractive tradeoffs between valuation and growth elsewhere.
Returning to the topic of China: forty years ago, China was a poor and closeted nation. Its economy was centrally planned, and it was intentionally walled off from the rest of the world. Then, in the late 1970s, Chairman Deng Xiaoping initiated a series of reforms that opened up the country’s economy to private enterprise and foreign trade. Deng’s reforms culminated in 2001, when China acceded to World Trade Organization. The scale and growth of the Chinese economy was forever altered, and the world saw the rise of a major new trading power.
Amid this profound change, China’s capital markets languished, disconnected from the nation’s burgeoning economy. In order to spur economic growth, China’s government embraced sweeping trade-related reforms; yet it proved unwilling to relinquish control over the allocation of capital and other resources within the economy. Private financial markets represented a direct threat to the government’s ability to allocate resources, and consequently, financial markets were stunted by design. China funneled vast amounts of financial capital to the economy via a small number of very large financial institutions – policy banks that were under direct government control. China’s stock, bond and currency markets were left unreformed, and walled off from the rest of the world. They were little more than an irrelevant sideshow, detached from the country’s growth and progress.
However, about five years ago, China’s economy began to encounter limits to its growth. The economy had become too large for growth to be lifted by foreign trade alone. In mathematical terms, trade simply could not contribute enough marginal growth to sustain the overall rate of economic expansion. That China would encounter such a limit was inevitable; yet it posed a dilemma for the Chinese government, as continued growth required further liberalization of the domestic economy. Without deep, liquid and transparent markets to allocate capital and other goods, China lacked sufficient price-based signals to ensure that scarce resources were allocated efficiently.
To its credit, China’s government has recognized the impetus for change. The current administration has sought to liberalize a number of key domestic markets, placing particular emphasis on freeing up markets for equities, bonds and the domestic currency (the renminbi). The resulting reforms have not been perfect, but they are both necessary and welcome. However, during the past 12 months, the government’s awkward attempts to boost the primacy of the private financial market have come at a price: it induced rampant, unsustainable speculation by Chinese investors and brokerage houses, all eager to “cash in” on the presumption the government would offer unstinting support for the market. That speculation came to a head in early June, when the government made small moves to rein in the availability of margin finance (i.e., borrowed capital used to purchase securities). The mere possibility of such restrictions induced a decline in equity prices; the decline quickly became a rout. The market’s free-fall was arrested only when the government undertook dubious efforts to prop it up, mainly by allowing large swathes of stocks to undertake voluntary suspensions, and by directing government institutions to buy shares.
I do not agree with the government’s measures to arrest the market’s decline. I think the efforts will prove futile, and may exacerbate the market’s fall. Of all the measures undertaken so far, I am the most frustrated by the decision to allow stocks to suspend trading for unspecified reasons. This questionable practice is rampant throughout Asia: if a management team wishes, it can readily seek permission to suspend trading in a company’s shares. Exchanges will grant permission, often for an unspecified period, and often for an unspecified reason. The rationale is that suspensions are the only viable tool to prevent non-public, “inside” information from leaking out into the market. The exchanges presume that management teams are incapable of policing the flow of information within their own organizations; the suspensions are implicit recognition that securities regulators are not up to the task of enforcement. This practice, while routine, is intolerable. It gives cover to poor corporate governance, it robs investors of liquidity and it allows management teams to suspend stocks indefinitely with impunity. If I were Regulator-in-Chief, I would give management teams a maximum of 60 minutes to disclose anything pertinent, and then I would force trading to resume – whether or not the management was ready.
Obviously, I am no fan of what has just transpired in China. Yet the global financial media is replete with articles citing supposed experts who decry the Chinese for ruining their financial markets. I emphatically disagree. What irony! What shortsightedness! China’s government has moved deliberately, if clumsily, to liberalize its financial markets after forty years of neglect. Private market participants responded by speculating aggressively; they pushed the stock market too far, too fast. The government tried to rein in the speculation, and inadvertently triggered a panic – and then intervened awkwardly to ensure a panic did not morph into collapse. Yes, the government is far too involved in the mess; but the notion that China has somehow done permanent damage to its markets is silly. Recent events unfolded because of a deliberate plan to liberalize markets, not the opposite.
I cannot predict the government’s next step, and I do not know if China’s efforts will meet with success. What I do know is that I have seen nothing yet to suggest China is in retreat from its goal of open, global markets. China’s economic and financial reforms continue. Its stock markets are still open for business, and are set to open further to foreigners. Many of the spurious stock suspensions have ceased. The central bank is still pushing to internationalize the Chinese currency – a reform that is far more contentious within the country than abroad. Recent events are a setback for China’s efforts to liberalize its markets; but China has not yet reversed course. In my estimation, nothing whatsoever has been ruined beyond repair – save perhaps the egos of a clutch of eminently quotable financial strategists who were shocked to discover that China might deviate from their pre-conceived notions of what constitutes a proper securities market.
I encourage shareholders of the Fund to eschew the short-term nature of the financial media. Instead, adopt a longer-term view, one rooted in history. By doing so, you will better recognize China’s economic and financial transition for what it really is: a concerted effort to overturn nearly seven decades of centralized financial control and planning. None of this change means investing in China will be any easier, but it might be more worthwhile.
Amid such sustained market volatility, we appreciate your patience and your decision to entrust your capital to us. Seafarer’s work is dedicated to maintaining your trust.Andrew Foster,
- 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 Total Return Index, Standard (Large+Mid Cap) Core, Gross (dividends reinvested), USD is a free float-adjusted market capitalization index designed to measure equity market performance of emerging markets. Index code: GDUEEGF. It is not possible to invest directly in this or any index.
- The S&P 500 Total Return Index is a stock market index based on the market capitalizations of 500 large companies with common stock listed on the NYSE or NASDAQ. 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 June 30, 2015, Balkrishna Industries Ltd. comprised 2.0% of the Seafarer Overseas Growth and Income Fund, Iochpe-Maxion SA comprised 1.7% of the Fund, Bolsa Mexicana de Valores SAB de CV comprised 2.9% of the Fund, and Texwinca Holdings, Ltd. comprised 2.9% of the Fund. The Fund had no economic interest in Ulker Biskuvi Sanayi AS. View the Fund’s Top 10 Holdings. Holdings are subject to change.
- References to the “Fund” pertain to the Fund’s Institutional share class (ticker: SIGIX). The Investor share class (ticker: SFGIX) returned 2.08% during the quarter.
- The Fund’s inception date is February 15, 2012.
- The Fund’s Investor share class began the quarter with a net asset value of $11.89 per share; it paid a semi-annual distribution of $0.059 per share in June; and it finished the quarter with a value of $12.08 per share.