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The Asia Frontier Fund USD A-shares lost -2.3% in December 2017, finishing the year with a performance of +0.2%. The fund underperformed the MSCI Frontier Markets Asia Net Total Return USD Index (+6.1%) the MSCI Frontier Markets Net Total Return USD Index (+3.1%), and the MSCI World Net Total Return USD Index, which was up +1.4%. The performance of the AFC Asia Frontier Fund A-shares since inception on 31st March 2012 now stands at +70.7% versus the MSCI Frontier Markets Asia Net Total Return USD Index, which is up +98.0%, and the MSCI Frontier Markets Net Total Return USD Index (+60.7%) during the same time period. The fund’s annualized performance since inception is +9.7% p.a. The broad diversification of the fund’s portfolio has resulted in lower risk with an annualised volatility of 8.91%, a Sharpe ratio of 1.07 and a correlation of the fund versus the MSCI World Net Total Return USD Index of 0.32, all based on monthly observations since inception.

This month was overshadowed by profit taking in Mongolia as the MSE Top 20 Index corrected by 11.8%. There was no major change in the country’s fundamentals, but the 88.7% rally through the end of November 2017 was bound to lead to a small correction. One of the fund’s larger holdings in Mongolia, a cashmere producer, witnessed a heavy amount of profit taking as the stock had rallied by more than 200% through November 2017. This was one of the major drags on performance, however the outlook for this company continues to be positive with a valuation which is not stretched, having a trailing 12-month P/E of 13x.

Pakistan continued its volatile trend due to political noise, with most of the month being weak as the KSE 100 Index was down by 5.2% for the month at one point. However, with valuations at very attractive levels, the market rebounded to close the month in positive territory with a gain of 1.1%. However, the USD currency return was impacted by the much awaited depreciation of the Pakistani Rupee which slid by 5% during the month. Given the rise of the current account deficit over the past year, the depreciation of the currency has been anticipated for the past few months with expectations of another 5% depreciation in the first half of 2018. This currency move is expected to be viewed positively by foreign investors as the currency, besides the politics, is one of the factors that has led foreign investors to remain on the sidelines over the past year.

With respect to Pakistan’s politics, there were also developments which can be viewed positively, namely the Supreme Court not giving its permission for going ahead with investigations against the Sharif brothers, while also not disqualifying Imran Khan from holding political office which has led to a consensus that the upcoming national elections will be a competition between the Sharif brothers’ PML(N) and Imran Khan’s PTI. The currency depreciation and the positive political developments, along with heavily discounted valuations, have given some legs to the market, with the KSE 100 Index up 12.9% in local currency terms since 19th December 2017 (a one year low).

On the economic front, activity continues, despite the political uncertainties, with industrial production growing by 8.8% in October 2017. Geopolitically, the U.S. continues to put pressure on the Pakistani government with respect to Afghanistan. The recent cut in U.S. military aid, could dampen investor sentiment, but the economic impact of this is debatable given the economic relationship Pakistan now shares with China. However, further improvements in the security environment due to pressure by the U.S. could be a longer term positive for Pakistan.

Vietnam ended the year on a positive note with the government divesting part of its stake in Sabeco to Thai Beverage at a premium valuation of around 44x trailing 12-month earnings, while macro related numbers remained robust with 2017 GDP growth at 6.8%, its highest growth since 2007. The foreign direct investment (FDI) story remains strong as FDI commitments increased by 44% in 2017 to USD 35.9 bln and FDI disbursement reached USD 17.5 bln, a growth of 10.8%.

The best performing indexes in the AAFF universe in December were Cambodia (+4.1%), Vietnam (+3.6%), and Iraq (+3.1%). The poorest performing markets were Mongolia (-11.8%) and Laos (-3.0%). The top-performing portfolio stocks this month were all from Mongolia: an oil producer (+101.9%), a duty-free shop (+29.7%), a copper and gold mining company (+28.3%), a bakery (+22%), and a construction materials company (+21.9%).

In December, we added to existing positions in Bangladesh, Mongolia, Pakistan, and Vietnam and we partially sold two companies in Mongolia.

As of 31st December 2017, the portfolio was invested in 114 companies, 1 fund and held 0.8% in cash. The two biggest stock positions were a pharmaceutical company in Bangladesh (8.2%) and a pump manufacturer from Vietnam (3.5%). The countries with the largest asset allocation include Vietnam (28.0%), Pakistan (20.8%), and Bangladesh (18.1%). The sectors with the largest allocations of assets are consumer goods (30.1%) and industrials (16.2%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 15.32x, the estimated weighted average P/B ratio was 2.67x, and the estimated portfolio dividend yield was 4.13%.

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