Dear Fellow Shareholders,
I am pleased to address you on behalf of Seafarer Capital Partners (“Seafarer”), the adviser to the Seafarer Funds (the "Funds"). This shareholder report covers the Funds’ 2020-2021 fiscal year (May 1, 2020 to April 30, 2021).
The Future of China within the Emerging Market Asset Class
Over the past ten years, I have used shareholder letters in the Seafarer Funds’ Annual and Semi-annual Reports as a forum to opine on a handful of “big picture” topics.
In the autumn of 2015, I wrote a letter in which I discussed the challenges associated with the “emerging market equities” asset classification. A substantial portion of that letter was dedicated to emphasizing China’s unique status within the asset class: China’s scale, resources, advanced technologies, wealth, economic progress, and national ambition set its investment potential apart from the rest of the developing world. In my view, China has always held the greatest promise – possibly more than all other emerging markets combined.
In the autumn of 2017, I took up the topic of China again. I offered a summary of my “dream” for modern China and its development. For the past three decades, my academic studies and professional career have been heavily influenced by an abiding interest in China’s practical and largely successful effort to escape mass poverty. Over time, my understanding of the country’s economic progress had manifest in a formative idea of China’s emergent potential. However, that year I was forced to recognize that my hopes for China’s future were naïve. From 2013 onward, President Xi and his administration had explicitly imagined a very different “Chinese Dream,” and by 2017 the machinations of Xi’s Dream were transparent enough to reveal that my understanding of China’s future was outdated at best, and utterly misguided at worst.1 While I was alarmed and disappointed, I accepted that my dream had no relevance except as a personal artifact: who can legitimately construct a vision for China’s future but the Chinese themselves? Thus, as Xi’s Dream was ascendant, I wrote a requiem for my own, and adapted to the reality that was, rather than extend a futile dream for what might have been.
Playing a New Role
Much has changed and even more has been revealed in the intervening years since the publication of those two letters. My gut tells me that it is time to revisit China’s role within the emerging market asset class.
In the interim, China’s financial, economic and geopolitical heft have grown to the extent that the country’s global prominence is undeniable. China’s economy and its stock market are now the second largest in the world.2 Its domestic bond market has boomed, making it one of the largest as well.3 After a 15-year surge in initial public offerings (IPOs) the country has approximately 7,000 publicly-traded companies, and it boasts a new stock exchange dedicated to fostering innovative companies that advance new technologies.4 The country is home to the largest private equity and venture capital markets within the developing world, and financial reforms permit Chinese companies much improved access to international capital markets.5 In response, China’s stock markets have swollen to the point that the country typically constitutes nearly 40% of prominent benchmark indices that track the emerging market asset class – a far higher allocation than any other country within the developing world receives, and yet there is ample evidence that China is nonetheless substantially undercounted and underweighted.6
Meanwhile, Xi’s ambitious Dream to rejuvenate the Chinese nation has taken greater shape. At home, he has undertaken multiple purges against official graft and corruption, often sweeping up some of his perceived political rivals in the process. He has also reasserted the primacy of the state within the economy. State-owned enterprises (SOEs) have been given central roles within several industries, augmented by mega-mergers and enhanced access to capital. Meanwhile, ostensibly private companies have been required to adopt executive committees that answer to the Communist party. Abroad, Xi has reversed three decades of Chinese policy that favored domestic development over international entanglements. Xi has sought to extend the nation’s international reach peacefully, via his signature “Belt and Road” financial and development scheme, and more recently via “vaccine diplomacy” – China has sought to buy goodwill via the provision of domestically-developed vaccines to nations struggling with the Covid-19 pandemic.
Xi’s Dream has also manifest in assertive actions to curtail perceived threats to the nation’s security and sovereignty. On the international front, China has undertaken aggressive military maneuvers in the South China Seas and made provocative flights over Taiwanese airspace. At home, the government has sought to stamp out any source of domestic discontent. This has meant the mass suppression of the Uighur people in the Xinjiang Autonomous Region, in an utterly disproportionate response to a legitimate terrorism risk; and it has led to the subjugation of Hong Kong, seemingly in violation of the Special Administrative Region’s Basic Law. Even as such policies have stoked controversy and ire abroad, Xi’s China has not shied from deflecting all criticism, vigorously asserting its autonomy, and boldly laying claim to an expansive vision of its future.
Alone on the Stage
From the beginning of my career, I have understood that China was exceptional within the developing world. As such, I have always and actively questioned the merit of grouping China with other developing countries to form the “emerging market asset class.” I have long suspected that China’s scale, economic progress, and future potential would mean that it would one day stand apart from the rest and become an “asset class” unto itself – its financial and economic breadth and depth rivaling that of the United States (which likewise comprises its own single-country “asset class”). I imagined that if China’s stature ever rose to such a level, the event would mark a welcome moment in the country’s modernization and development.
In 2021, much of what I imagined has come to pass. China has grown and prospered, such that it dominates the emerging market asset class. The country now serves as the central economic “hub” around which many developing nations orient their trade and economic policies (notably supplanting the U.S.’s leading role as a trading partner for the developing world). Thus it seems fitting that many investors are beginning to openly wonder whether China should be carved out from the rest of the emerging markets to receive a distinct and prominent position in a global portfolio allocation.
Increasingly, I lean towards this view – but for a decidedly mixed and unwelcome set of reasons. The emergent scale, depth, breadth and complexity of China’s capital markets seem to favor specialist skills: to optimize China’s potential from bond markets, stock markets, venture capital and private equity markets, I recognize that it might be ideal to utilize dedicated investment capabilities trained solely on the country. But there is another, more difficult reason to prefer China as an independent asset class: the country has become fraught with legal, political, martial and moral morasses. Even as the country’s economic might has become starkly evident to all, the darker aspects of the Chinese Dream have forced many to question whether the country remains investable.7 Even as some may favor a dedicated capability that might maximize the country’s investment potential, others might wish to cleave China from the rest to manage its risks more directly, and if necessary, summarily excise it from their portfolios. Frankly, it disappoints me to contemplate the latter possibility given the dream I once held for China, a nation that I will always deem exceptional among its peers.
What will Seafarer do in response? Nothing will change in the foreseeable future for the Funds. We will continue to invest selectively within China, acutely aware of the risks posed by the darker aspects of China’s modern development. Likewise, Seafarer will not in the foreseeable future launch dedicated investment capabilities and related products for the Chinese market. The only residual, unanswered question before us is whether to pursue an emerging market strategy that excludes China. I am undecided. I find it difficult to contemplate the merits of an ex-China strategy: for the aforementioned reasons, China is home to many of the developing world’s best companies. To omit the nation from a portfolio is to forgo some of the most important potential sources of return; that which remains might be hampered with too much risk and offer too little reward to be worthy of dedicated long-term investment. Worse, the remainder might lack relevant scale for many global investors. Many investors tend to allocate a small portion of their portfolios overseas, and an even smaller portion to the emerging markets. If China – the largest and arguably most vital constituent of the asset class – is carved out, would the remainder be large enough to matter? The key question is whether the rest of the emerging markets will generate sufficiently numerous opportunities as to warrant a dedicated, long-term strategy. I wonder.
I plan to contemplate this question further, and I urge you to do the same. China’s emergence is so big, so critical and so fraught that it demands a deliberate response within your portfolio allocation. If you choose to continue to group China with other emerging markets, do so deliberately, and not because of a historical default. If you choose to carve China out from the rest, seek out the best dedicated capabilities you can find to pursue the full breadth of the country’s investment potential – and if suitable for you, consider asset classes beyond public equities. Lastly, if you have thoughts on whether an ex-China strategy holds ongoing relevance, let us know; it might be time for a new dream.
Expense Ratios and Economies of Scale
As described in the Letter to Shareholders as of April 30, 2017, Seafarer has committed to reduce expenses for the Funds, particularly as time and scale afford greater efficiency.
During the 2020-2021 fiscal year, the scale of the Growth and Income Fund was similar to that during the prior year. Accordingly, the operating expense ratios for the fiscal year were unchanged at 0.92% and 1.02% for the Institutional and Investor classes, respectively.8 As the Funds enter a new fiscal year, Seafarer’s intention remains the same: to offer shareholders positive economies, over time and with scale.
Compared to the Growth and Income Fund, the Value Fund’s smaller scale does not yield an equivalent degree of cost efficiency. However, Seafarer has established the same underlying expense structure for both Funds. Should the Value Fund’s assets grow over time, it is expected to achieve similar economies of scale. In the meantime, Seafarer continues to limit the Fund’s operating expenses via a contractual commitment, such that its net expense ratios remain 1.05% and 1.15% for the Institutional and Investor classes, respectively.9
Thank you for entrusting us with your capital during these difficult times. We are, as always, honored to serve as your investment adviser in the developing world.Andrew Foster,
- The views and information discussed in this commentary are as of the date of publication, are subject to change, and may not reflect Seafarer’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.
- “Xi Jinping and the Chinese Dream,” The Economist, 4 May 2013.
- Regarding the scale and rank of China’s annual economic output, see “GDP (current US$),” World Bank, measured on 20 May 2021. Regarding the scale and rank of China’s stock market, see “Market Capitalization of Listed Domestic Companies (Current US$),” World Bank, measured on 20 May 2021.
- As of 2019, China’s domestic bond markets were the third largest in the world, ranking behind only the United States and Japan. However, Euro-denominated regional markets likely collectively eclipse the yen and renminbi markets of Japan and China, respectively. See Kate Jaquet, The Evolution of China’s Bond Market, Seafarer Capital Partners, March 2019.
- Sources: Bloomberg, Seafarer. Data as of 20 May 2021.
- Tabby Kinder, Mercedes Ruehl and Yuan Yang, “Chinese Private Equity Targets Record Fundraisings,” Financial Times, 6 April 2021.
- Based on the weighting of China (excluding Taiwan) within the MSCI Emerging Markets Index. Sources: MSCI, Bloomberg. Data as of 20 May 2021.
- For more on the challenges associated with investment in modern China, please see my colleague Nicholas Borst’s white paper The China Investment Dilemma. Also see his writings on the U.S. push for divestment from and delisting of Chinese companies, and the policy and investment questions that surround state-owned enterprises (SOEs) in China.
- The Growth and Income Fund’s Prospectus (dated August 31, 2020) states that the Fund’s expenses are 0.93% and 1.03% for the Institutional and Investor classes, respectively.
- Seafarer Capital Partners, LLC has agreed contractually to waive and/or reimburse fees or expenses in order to limit Total Annual Fund Operating Expenses After Fee Waiver / Expense Reimbursements (inclusive of acquired fund fees and expenses, and exclusive of brokerage expenses, interest expenses, taxes and extraordinary expenses) to 1.15% and 1.05% of each Fund’s average daily net assets for the Investor and Institutional share classes, respectively. This agreement is in effect through August 31, 2021.