Dear Fellow Shareholders,
I am pleased to address you again on behalf of the Seafarer Overseas Growth and Income Fund. This report addresses the Fund’s 2014-15 fiscal year (May 1, 2014 to April 30, 2015).
During the fiscal year period, the Fund returned 12.76%, while the Fund’s benchmark, the MSCI Emerging Markets Total Return Index, rose 8.17%.1 By way of broader comparison, the S&P 500 Index increased 12.98%.
The Fund began the fiscal year with a net asset value of $11.59 per share. During the ensuing twelve months, the Fund paid two distributions: $0.075 per share in June 2014 and $0.282 per share in December 2014. Those payments brought the cumulative distribution per share, as measured from the Fund’s inception2 to the end of the fiscal year, to $1.031. The Fund finished the fiscal year with a value of $12.66 per share.3
The Fund’s performance during the fiscal year could be summarized as a tale of two halves. During the first half of the year, the Fund and its benchmark index surged higher, only to surrender the bulk of their gains by mid-year. The second half followed a different pattern: the Fund and the index rose again, but this time the gains were sustained, and the Fund outpaced its benchmark.
Early in the fiscal year, the emerging markets raced higher, driven by the twin prospects of political change in Brazil and economic stimulus in China. By early September 2014, the Fund and the index had gained 7.48% and 11.91%, respectively. However, that gain proved to be the short-term peak in markets, as September heralded the end to the markets’ run.4
During September, a series of economic reports indicated that the U.S. economy was growing faster than was broadly anticipated. That economic strength prompted investors to re-evaluate their expectations regarding the pace and magnitude of future interest rate increases, even as the Governors of the Federal Reserve cautioned that “conditions may . . . warrant keeping the target federal funds rate below levels [viewed] as normal” for some time to come.5 The resulting change in expectations for interest rates brought about a sharp decline in global stock and foreign currency markets.
Around the same time, a number of unwelcome events struck the emerging markets simultaneously. Economic reports revealed that the Chinese economy was unexpectedly weak, despite the government’s ongoing attempts to introduce economic stimulus. Meanwhile, Brazil’s presidential election sent stocks and the local currency swooning, as the incumbent – President Dilma Rousseff – won re-election by a narrow margin. President Rousseff was deemed by many observers to be less “market-friendly” than her opponent, and her victory spurred the Brazilian market’s decline. At the same time, Russia’s involvement in Ukraine re-escalated, triggering additional concern. At that time, reports suggested that Russia’s government might close its capital account to foreign exchange, and this caused the ruble and other emerging market currencies to tumble. Together these events caused the Fund and the index to slump, such that at the fiscal mid-year (October 31, 2014) the Fund had retreated to a 2.38% gain, and the index to a 3.96% gain.
From the end of October until December, equities in the emerging markets continued to decline, pushing both the Fund and its benchmark lower still. However, during the first three months of 2015, the trend was reversed. The Fund saw a number of its holdings in China, Korea, Japan and especially India contribute positively to performance. Then, in April, a sudden surge in Chinese equities pushed both the index and the Fund higher.
The impetus for the sudden rise in China-related shares is not known with certainty at this time. The prevailing speculation is that a new market trading mechanism known as the “Shanghai - Hong Kong Stock Connect” (“SHKC”) has unleashed a wave of new capital that has exited mainland China and bid up China-related stocks listed in Hong Kong. It seems as though a recent regulatory change allowed China-based mutual funds to remove capital from the mainland via the SHKC and shift it to Hong Kong. Prior to this change, the SHKC facility had seen little traffic on the “southbound route” (i.e., Chinese investors seeking to move capital from Shanghai to Hong Kong, as opposed to the “northbound route,” which describes global investors seeking to move capital from Hong Kong to Shanghai).
The common view is that this wave of Chinese capital has washed over Hong Kong shares, pushing them higher without much basis, except to align prices with the elevated valuations that exist within China’s A-share market. This explanation may hold some merit, but it is not fully satisfying, as it explains only a portion of what has transpired. The amount of capital that has turned over within Hong Kong in the past month is too large to be explained by the “southbound route” alone. Accordingly, the facts suggest that global investors have also played a role in the recent China frenzy, and other mechanisms – or machinations – are at work. As China liberalizes its economy, it is bound to induce large and unpredictable dislocations in markets around the world – the SHKC program is but one such example. We intend to monitor events around China carefully.
It is worth remembering that in only one year, the Chinese stock market has moved from pariah status to center focus within the emerging markets. China’s current economic and political transition is a complex one, and it is impossible to come to an informed, simple conclusion about whether the changes underway are “good” or “bad.” However, China’s development is vital to the world’s future, and it deserves your attention as an investor, regardless of your views on the country. For greater context, please refer to the discussion titled “Peering Over China’s Great Wall of Worry,” which was included in the Letter to Shareholders in the Fund’s Annual Report for the period ended April 30, 2014.
If you wish to review a more detailed discussion of the Fund’s performance and holdings, Seafarer publishes four portfolio reviews per year. Each corresponds to a standard calendar quarter. Please visit the Archives for further information.
A Milestone for the Fund
As of February 15, 2015, the Fund achieved an important milestone: it recorded its third anniversary. Accordingly the Fund produced a three-year historical performance record for the first time.
At Seafarer, we believe that investors should only utilize the Fund for long-term investment purposes. Seafarer would advocate a three-year investment horizon at an absolute minimum, and preferably horizons of five years or longer. However, as the Fund has now achieved a three-year record, it seems an appropriate time to reflect on whether the Fund has made progress with respect to its stated investment objectives. By Prospectus, the Fund has two objectives: the primary objective is to “[seek] to provide long-term capital appreciation along with some current income;” the secondary objective is to “[seek] to mitigate adverse volatility in returns.”
With respect to long-term capital appreciation: as of April 30, 2015 (the end of the fiscal year), the Fund’s annualized three-year performance was 10.86%, versus the benchmark index, which rose 3.60% on an annualized basis. The Fund ranked within the top 2% of the Morningstar “Diversified Emerging Markets” fund category (based on a universe of 557 funds and related share classes).6
With respect to the production of current income: from its inception to April 30, 2015, the Fund produced $0.534 in net ordinary income per share (out of $1.031 in total distributions per share).
With respect to the mitigation of adverse volatility: the Fund had an “up market capture” of 95.6% for the three year period ended April 30, 2015. (Up market capture, or “UMC,” is a measure of the average extent to which a given fund rises with its benchmark index, conditional upon the index rising. A measurement of 100% indicates the fund rises in prefect tandem with the index). The Fund’s UMC ranks at the 29th percentile of funds within the Morningstar “Diversified Emerging Markets” category (1st percentile is the “best,” and 100th percentile is the “worst”).6
Over the same three year period ended April 30, 2015, when markets declined, the Fund had a “down market capture” (or “DMC”) of 60.5%. This means that conditional on months in which the index fell, the Fund’s decline was on average only 60.5% that of the benchmark index. The Fund’s DMC ranks at the 94th percentile of funds within the same Morningstar category (in this case, 1st percentile is the “worst,” and 100th percentile is the “best”).6
The asymmetrical performance record of the Fund (capturing, on average, 95.6% of the upside versus 60.5% of the downside) indicates that, historically, the Fund mitigated a degree of adverse volatility.
Everyone at Seafarer is proud of the Fund’s performance since its inception, particularly in that the Fund appears to have made reasonable progress toward its primary and secondary objectives. However, we are acutely aware that the Fund’s historical out-performance is unlikely to persist.
As discussed at greater length in preceding commentaries, I believe that the developing world has recently undergone a period of anemic and disappointing growth. Corporate profits did not expand much, and consequently emerging market equities offered little in the way of positive gains over the past three years. Ironically, those same conditions have proven ideal for the Fund’s strategy. The Fund does not necessarily pursue high rates of growth, but rather seeks companies that can grow in a steady manner. Seafarer’s research suggests that, since the Fund’s inception, it has been successful in its efforts to invest in sustainable growth, as the underlying holdings produced profit growth that was considerably more reliable than that of the index portfolio. (For more on this topic, view the Portfolio Briefing video for the first quarter of 2015.) I believe the holdings’ sustained growth, during a time of otherwise anemic conditions, accounts for much of the Fund’s outperformance.
However, the next three years may be markedly different. I believe that profit growth will re-accelerate. If it does, the Fund might struggle to keep pace with equity markets. If history is any guide, investors tend to aggressively pursue reinvigorated growth; at the same time, they shed many of their concerns regarding valuation. When such conditions prevail, the Fund’s relatively conservative approach often acts as an impediment to its relative performance – especially if markets jump higher, quickly. In any case, I wish to caution shareholders that the Fund’s strategy is designed to produce only moderate outperformance over long periods of time. Given that the Fund has instead generated considerable outperformance over a short period of time, I suggest that the Fund’s recent history might not serve as a reliable guide to its future performance.
New Modes of Communication
I am pleased to report that Seafarer Capital Partners, the investment adviser for your Fund, continues to grow and evolve. One example of the firm’s evolution will soon be evident in the manner in which we communicate with shareholders.
Historically, the firm has utilized several modes of communication, including written commentaries and conference calls. However, as our company has grown, we have noted that shareholders and clients might prefer alternate modes of communication – particularly communication that is timely, interactive, accessible, readily searchable, and in a digital format. With these preferences in mind, Seafarer has recently begun an internal campaign to create more written content, and especially more video content. With respect to the latter, a new Video Library is available on the Seafarer website. The library features videos discussing the Fund, its strategy, and the emerging markets more broadly. Our aim is to create a library of materials that will grow over time, and which will address key topics of concern to the Fund’s shareholders. We encourage you to explore this new resource at your convenience.
At the same time, we have decided to discontinue the “Shareholder Conference Call” that Seafarer held semi-annually since the Fund’s inception. The conference call was a useful way to communicate with existing and prospective clients, but over time it became apparent to us that the format (a live call, followed by an audio replay available on the Seafarer website) was not sufficiently timely, accessible, or searchable. In our view, we can disseminate content of similar (or better) quality via our forthcoming videos and written commentaries, and these new content formats will prove more focused, timely, accessible and interactive than our past conference calls. We are excited to move in this new direction.
Thank you for entrusting us with your capital. We are, as always, honored to serve as your investment adviser in the emerging markets.
- 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.
- References to the “Fund” pertain to the Fund’s Institutional share class (ticker: SIGIX). The Investor share class (ticker: SFGIX) returned 12.55% during the fiscal year period.
- The Fund’s inception date is February 15, 2012.
- The Fund’s Investor share class began the fiscal year with a net asset value of $11.58 per share. The Fund paid two distributions: $0.072 per share in June 2014 and $0.272 per share in December 2014. Those two payments brought the cumulative distribution per share, as measured from the Fund’s inception to the end of the fiscal year, to $0.995. The Fund finished the fiscal year with a value of $12.64 per share.
- The short-term “peak” of the Fund and the index in the first half of the fiscal year was September 5, 2014.
- Federal Reserve Board of Governors, Federal Open Market Committee, Press Release, 17 September 2014.
- Source: eVestment as of April 30, 2015.