Video Transcript
Natalia:
Hello. Thank you for joining us for the second quarter 2024 portfolio briefing video for the Seafarer Overseas Growth and Income Fund. I am here with Andrew Foster, CIO and portfolio manager and Paul Espinosa, portfolio managers on the fund. I'll go ahead and jump right in, and Andrew ask you for a performance of the fund over the quarter, as well as for the Bloomberg Emerging Market Index.
Andrew:
Yes. For the second calendar quarter of 2024, measured between March 28th and June 29th of 2024, the growth and income fund declined by 2.5%, whereas the Bloomberg Emerging Market Index rose by about 4.1%.
Natalia:
Thank you. Before we jump into the fund itself, there's been a lot going on in the quarter this year. Can you talk to us a bit about what's important and what is going on?
Andrew:
Yes, there are two major events that I think are shaping markets, emerging markets this year. They are basically an earnings recovery for corporate earnings, and second, emerging market currency weakness, really, I think, driven by at least in the short run, the fed's interest rate cycle and decision-making over whether or not to cut rates.
So to take the first part of that, I'm quite pleased to say and excited to say that for the first time in over a decade that I've been monitoring earnings growth in the emerging markets, there appears to be a fairly robust broad-based and genuine earnings recovery underway that is not really particularly focused on one country or one sector. It seems to be broad-based and it seems to be written on the back of at least a gradual demand in... Excuse me, a gradual recovery in demand from consumers and customers and so forth and second, by an easing in cost price inflation that's allowing margins to expand a bit.
I often talk to clients about the expectations for earnings growth from the sell side from large investment banks and strategists who publish numbers from the market as a whole and individual companies, and I measure it near January 1st of each year. When I did so this year, the expected earnings growth was 18%, which is a very aggressive growth rate. Some of that was driven from earnings being coming from a very low level. They had actually contracted in 2023 by about 12%, so some of it was a rebound effect, but it looked like still nonetheless a pretty aggressive rate of growth.
Historically, when the sell side has been this aggressive, they've often been very wrong. Often they'd say, "Oh, the market might grow 15%, 16%, 17% or in this case 18% and yet the actual results would come in far short of that. We admittedly only have one quarter to go on right now. We've only got earnings reported from the March 31st quarter, having just concluded the second quarter and we'll get the first reports in the next few weeks. But it looks to me like the earnings recovery is genuine this time and that 18% figure that I cited from January 1st remains intact as we speak today.
Typically, I would've seen deterioration in that number because again, the sell side was sort of cheerleading stocks or over promising with the stocks under delivery, but so far we seem to be on track for that. I read a lot of company's results, not just those we own in the portfolio and there seems to be a broader degree of health transpiring. So I think it's a very positive and that's what's lifting stock prices, at least one of the factors lifting stock prices in the emerging markets.
On the downside, the other big event that's happened is emerging market currencies have been at least modestly weak this year. By my calculations, the emerging market currency basket is down by about 1.5% year to date, not a huge amount, but it is a setback. Some currencies much more so than others. For instance, the Korean won has fallen by a lot more than that and some currencies better than others. The Indian rupee has been largely stable year to date. So there there's a variety of outcomes, but in aggregate and properly weighted the baskets down by about 1.5%.
Why is that? I don't know for certain. Currencies are awfully often very vague and perhaps the most unpredictable of all major asset classes, but I would argue that probably the leading culprit is the fed's pause in its decision to lower rates. There was a broad-based expectation in the late fourth quarter and early first quarter of this year. The fed would soon be cutting rates because of quiescence in inflation in the United States. The fed has not been able to do that and may not yet be able to do that because inflation is maybe only just cooling now as of mid-year and it hasn't been cool enough to warrant the fed taking an early action.
This pause, I think, has sent a shockwave through emerging market currencies, not a huge one, but somewhere between a ripple and a shockwave, something modest and it's set the currency basket back. Am I terribly concerned about that? No. I do think the fed has the power in the short run to cause knee-jerk reactions to emerging market currencies, but in the medium to long term, I would say the fed is not the decisive factor that it was 10 or especially 20 years ago. Consequently, before the fed's actions, the emerging market currency basket as of December of 23 was nearly at an all time high.
This, despite a huge fed hiking cycle in 22 and part of 23, and so that wasn't a setback for currencies. They were nearly an all time high. This year because there's been sort of a change in expectations, currencies have gotten a bit of a blow back, but it's not been huge. I think the combination of those two has created an offsetting set of conditions. Currencies have been weak, earnings have been stronger. Generally, when earnings are stronger, currencies eventually follow suit because people want to invest in and if you will, chase those earnings. But I don't want to get too predictive about it, but I just say that I'm not terribly worried about the currencies being a bit of a headwind this year.
Natalia:
That seems like a good amount of positivity, but what does all that really mean going forward?
Andrew:
Yeah, we'll have to see. I mean it's still early days in the quarter. I would say that again, based on an anecdotal and ad hoc reading of company's results across many different sectors, I think earnings are recovering pretty decently. That 18% figure, I don't know if we'll meet that or not, but I think it's going to be in the mid-teens if not even close to 18%.
Then again, I think talking about '25 is too far out to discuss, but again, there's a lot of signs that '25 could be a strong recovery year as well or strong growth year. We'd have a recovery this year and a growth year on top of that next year. Earnings are looking maybe more ebullient than they've been in a decade and it's being driven by sales growth, not just sort of temporary margin based effects. Sales growth looks like it's going to be about 8% for the market this year, as represented by the Bloomberg Emerging Markets Index. That compares to only 3% last year and I believe -4% the year before that.
We've had many, many years of a dearth of sales growth. For sales growth in aggregate, revenue growth to be really picking up is I think a healthy sign and a sign of something possibly more sustainable unfolding. Second, the cost inflationary pressures that were really plaguing companies all over the world and consumers in their own personal household expenditures, I can't speak to personal household expenditures in the United States, but inflationary pressures in emerging market corporate earnings are easing to the point where margins are expanding a bit. We're getting the uplift from revenue expansion and margin expansion and that's how sales can grow at 8%, but earnings can grow at 18%, because we're getting a margin expansion on top of the sales growth.
I think it's a very healthy set of conditions and if it continues in next year, it's really quite something given how forgotten this asset class is. It's really hard to say what the future holds. There's so much changing in the world, artificial intelligence, a lot of geopolitical events, but in my view, the emerging market asset class is relatively cheap. The same index we've been discussing, the Bloomberg Emerging Market Index is trading on about 14.5 times earnings, 14.6 for 2024 earnings. It's not terribly high given the kind of growth that's taking place and so I think it's pretty attractive after years, I mean really a decade in the wilderness for this asset class.
Natalia:
That is certainly an optimistic backdrop to the emerging markets. But to jump back to the fund itself, the fund has been struggling on the performance front. Can you talk to us about what exactly is going on there and why the fund isn't keeping up performance wise?
Andrew:
Yeah, if we just talk about performance of the fund, I've rarely been more frustrated. As I mentioned, the fund is down about 2.5% this quarter. The index is up about 4.1%. That's roughly a 6.6% percentage differential. That's quite a large amount to unfold in a very short period of time. I can anticipate that many of those watching this video are questioning if not somewhat frustrated with the fund. I can tell you I'm frustrated with the fund's performance, but we've been spending a lot of time as a team looking at the companies we hold.
We own 52 positions that trace back to 51 underlying companies because we own two securities from one of the same companies. That's how we get to 51. Most of them are in pretty good shape. By my reckoning, 41 of those 51 companies are set to either maintain or produce earnings growth this year that's pretty material and the fund's growth is accelerating right now.
At the beginning of the year, I measured it to be about 14% for 2024, I'm now measuring it at about 16%. Remember the index is at 18%. It has not accelerated, it's static. The fund is picking up from 14% to 16%, and meanwhile about 80% of the issuers are presenting stability or growth this year. Now, there are some of the holdings that look like they're going to have a little bit of an earning setback for one reason or another. That's always the case. It's not the case if you assemble a portfolio of 30 or 40 or 50 stocks that all of them will be great in health, but I'm pretty pleased to say the vast majority look like they're participating in this cycle pretty well. If anything, accelerating at the margin.
Now, again, we only have one quarter's results to point to, but I am not terribly concerned about the fundamentals of the fund at this juncture. What I think has happened is that we've failed to participate in the uplift that's been moving other stocks in the market. If I disaggregate the performance of the fund for the quarter, we are down about 2.5%. I have certain tools at my disposal that frankly it's difficult for folks to analyze outside the firm, but I can attest to the idea that about 1.5% of that movement is due to currencies.
We have to had a currency setback in the fund, arguably a worse one than the index. The index is down about 1.5% for the year in currencies. We're down a percent and a half for the quarter, and that's because some of the country tilts in our portfolio. We happen to own some of countries that have had worse currency outcomes.
Again, I'm not terribly concerned about that for the medium to long term, but it has been a setback in the quarter. I think the second part of our under performance, so about 1.5% from currencies, about 0.6% of the decline is due to the stock picking. We are down a little bit in stocks. We've had some stocks go through the roof. We've had some do middling really well. We've had some fall and we've had a few fall a lot. Net net, we're down about 0.6%. I'm not proud of that. I'd rather be up, but I also have to say just sheerly on stock selection across the quarter, we really haven't lost much money for clients. We're kind of roughly neutral.
Currencies have been a drag. We're almost neutral on stocks, maybe a little bit down. What we haven't done is produced the gain that other stocks have done and there I think it gets complicated. I am the last person to stand up and say, "I know what moved these other stocks forward," but we've been talking about a lot as a team and I think what's happening, what's definitely has benefited is the most obvious earnings momentum segments of the market. That would really be first and foremost, stocks that are at least presumptively linked to artificial intelligence. There's a handful of those and they have rocketed.
I admit that our portfolio doesn't have exposure to really most of those names. That would be Taiwan Semiconductor, there's a handful of memory stocks, there's some software stocks, et cetera. They have rocketed. We don't own those. We haven't benefited.
Second, there have been some other parts of the market, Taiwanese technology stocks in general, even if they're not really linked to AI, have been seen as sort of ancillary beneficiaries. We have some exposure to Taiwan, but not as much as the index and not as much as many other professional managers do and consequently, again, we've been left behind.
A third place where we've been left behind, we've done really quite well in India overall, but we have a less than benchmark weight and India has been a third place where there's been sort of stalwart earnings momentum.
So these three areas where there's either been strong momentum or a perception that it will be strong based on AI, have carried the market this quarter. We don't have as much or any of the exposure that would drive that kind of thing. We haven't gotten the uplift. We haven't lost a ton of money on stock selection, but we haven't made what others made or what the index has made.
We don't know why that is. Our earnings growth, if we're talking about fundamentally, remember the earnings of the index haven't seen an uplift this year. They've been static at 18%. It's not like AI or the grand awakening of what AI might mean for companies has suddenly changed the earnings profile of the marketplace. It's still growing about 18%. Your fund is actually maybe accelerating in the margin potentially, based on what we see happening in first quarter results, it might even be a better year than expected.
I tend to think it's just simply people are buying earnings they feel comfortable with, especially in the backdrop of this interest rate cycle. "Hey, the fed's not cutting. We're not sure if demand in the EM is strong. The one place we can count on demand is in tech, big cap tech, AI linked tech and India has been hot. So we'll pile into those places because earnings seems safe there."
Well, what I'm here to say is I think the recovery is much broader than those three things. I realize it's early in the year to say this, but I'm quite confident it's going to unfold for the market as a whole as well as for the holdings of the fund. What I think we might have is a bit of lead lag effect taking place. Our portfolio is lagging right now, but because the fundamentals are there, I don't have much concern that the performance will eventually, given enough time, follow suit.
If the fundamentals weren't there, I'd be saying something different. I'd say, "Oh my gosh, the portfolio is mal positioned. We really need to undertake major changes." But I don't see that happening. There's always a few stocks where we're working on improving them, like stocks that are misbehaving or the fundamentals are weak and we're working on upgrading them. That's always the case. But right now, I think we have a broader sort of market kind of rotation taking place that's left us behind, but because the fundamentals are strong, I'm confident.
I think I don't want to make excuses about it, but I also want to convey that I'm not terribly concerned because the fundamentals are there. If the fundamentals don't follow through, you will find me saying something different that we may need to undertake a more extensive reorientation of the portfolio. But for now, I'm happy with what I see and I think the fundamentals are following through.
Natalia:
Thank you for walking us through all those details, Andrew.
Andrew:
Oh, one more thing I would just say.
Natalia:
Yeah.
Andrew:
The portfolio is cheaper too, now. I think we are growing almost as much as the index. The index has gained about 8% on us year to date. I'm talking about both Q1 and Q2, but remember it's not growing a great deal faster. So basically, it's multiple has just expanded, from we were roughly at par with each other at the beginning of the year, so it's gone from 13% to 14.5%. We've stayed at 13%. Your fund looks to have almost as much growth as the index is a good 10% cheaper and has a better earnings yield. By my calculations, the fund has about a 3.6% gross yield right now. We're seeing a lot of dividend follow through from our stocks, which is wonderful. Real proof of the earnings being there.
The index dividend yield has fallen to 2.5%, because of that. The dividend was never as high to begin with and with a higher multiple, the yield compresses and so it's now down about 2.6% actually. We have a full percentage point more dividend yield coming to us than the index. Frankly, I see a lot to like in that. Again, time will tell, but as long as the fundamentals are there, better valuations, I'm happy for the most part with the fund. That notwithstanding, we're always trying to make upgrades.
Natalia:
Of course. Thank you. Paul, to throw a question over to you, have there been any changes at the portfolio level over the second quarter of this year?
Paul:
There have been. We've added Hong kong Land as a new holding and we exited Emaar Properties in the fund. Taking a cue from Andrew's discussion, I would say that basically Hongkong Land is I think cheaper multiples and a higher yield. The attraction of Hongkong Land, and this name is a subsidiary of a holding in the fund and existing holding, which is Jardine Matheson.
This subsidiary specializes in holding office and retail space. It owns it and it leases it. It has a small development segment to the business, but this is very different from a Chinese developer. This holds assets in Hong Kong and mainland China primarily, but also in Singapore and other countries. What we are really buying more than cash flows, which is the case with other stocks here, where the interest in this stock is truly to hold a real asset that is trading very cheaply.
We're purchasing it at 0.2 times book, talking about cheaper valuations. That is definitely cheaper than the market, and it's rare that you find this valuation anywhere in the world for a real asset. Not only that, but the asset is productive and it is paying a current yield, which is higher than average, like Andrew was saying for the portfolio. The current dividend yield in this stock is 6.8% and it is sustainable in my opinion.
Furthermore, it's a stock that again, talking about growth and very visible growth in AI. Here we have growth that is less visible and I think that is part of the reason amongst several, why the stock is cheap. It has barely grown over the past decade below single digits. I think the market probably ascribes the same growth for the next 10 years. Now, if you actually analyze the stock, you'll see that the net leasable area of this company will rise by about 61% over the next five years.
It is tilted more towards the backend of those five years, but it is not something very tangible for the market over the next couple of quarters. No? So it's given us growth, very high dividend yield and a very low valuation, which is the primary attraction.
We are selling by contrast, we are selling Emaar Properties, which is similar in the sense that Emaar also owns and leases retail and office space. It is located in Dubai and that operates in the United Arab Emirates.
But we're doing more than just changing geographic locations here. Emaar is a stock that has already done well for us. There's nothing wrong with it. It has in fact very good earnings momentum. But the idea here is that we are buying a similar current dividend yield. Emaar yields 6%, but we are gaining much higher future capital gains in my estimation. That's why we're substituting one for the other.
Keep in mind, that the investment is actually similar, in that we invested in Emaar back in 2021, when it was suffering from the pandemic and it was suffering from a misguided corporate restructuring that they were in the process of readdressing. We bought the stock at that time at a much cheaper valuation. The idea is similar here. It's a similar kind of asset. A real asset that is productive and yielding, but we're buying at a difficult juncture for the stock. This time it's in China and it's suffering from very negative sentiment around the country and from the stock's own history of low growth. On top of all of that, there's also negative sentiment around Hong Kong office leasing space.
Then we can get into a discussion of the quality of the assets of this company. In my opinion, it will, yes, the circumstance trading conditions are difficult in Hong Kong for office space, but it owns the prime office space in Hong Kong, meaning that it will suffer less than others. I think whenever the eventual recovery comes, it'll benefit more than others. No? That's a long explanation for this exiting one investment and reinvesting those proceeds into Hongkong Land.
Natalia:
Yeah, we appreciate the detail and the thought behind it. Thank you, Paul, and thank you Andrew. Thank you to our viewers for joining us for this second quarter 2024 portfolio briefing video for the Seafarer Overseas Growth and Income Fund. Please keep an eye on our website for the full portfolio review and all of our other commentary.
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