The Asia Frontier Fund USD A-shares declined −2.2% in July 2018. The fund underperformed the MSCI Frontier Markets Asia Net Total Return USD Index (−2.0%), the MSCI Frontier Markets Net Total Return USD Index (+3.7%), the AFC Frontier Asia Adjusted Index (−0.1%) and the MSCI World Net Total Return USD Index (+3.1%). The performance of the Asia Frontier Fund A-shares since inception on 31st March 2012 now stands at +48.8% versus the Frontier Asia Adjusted Index, which is up +30.2% during the same time period. The fund’s annualized performance since inception is +6.5% p.a., while its YTD performance stands at −12.8%. The broad diversification of the fund’s portfolio has resulted in lower risk with an annualised volatility of 9.16%, a Sharpe ratio of 0.66 and a correlation of the fund versus the MSCI World Net Total Return USD Index of 0.33, all based on monthly observations since inception.

This month saw a continuation of the trade tensions between China and the U.S. with the latter planning to impose a 10% tariff on a further USD 200 billon of Chinese imports, in addition to the 25% tariff on USD 50 billion of Chinese imports into the U.S. which was announced in June 2018. If implemented, the additional tariffs would cover almost half of China’s exports to the U.S. and these trade worries continued to impact overall market sentiment. As noted in last month’s manager comment, the countries in our universe which are dependent on exports to the U.S. are Bangladesh and Vietnam, but the goods they export are low end or low tech such as garments, textiles, and electronics and are final consumer goods whose imports the U.S. is not putting a lot of pressure on so far. Furthermore, in the case of exports of intermediate goods to China which are then re-processed and re-exported to the U.S., 17% of Vietnam’s exports to China, which is less than 3% of total Vietnamese overall exports are intermediate goods which leaves it in a more comfortable position if Chinese exports to the U.S. do eventually slow down. More importantly, the long-term trend of low cost manufacturing jobs moving from China to Vietnam has been underway for the past few years and we expect this trend to continue in the future.

The Vietnamese market remained soft, given that the trade war worries as well as a weaker Renminbi have hurt sentiment, but the macro numbers continue to be healthy. Exports in the first seven months of the year have grown by 15.3% while industrial production was led by manufacturing growth of 13.1%. Retail sales continue to be strong with nominal growth of 11.1% this year and foreign direct investment has grown by 8.8% to reach USD 9.8 billion. However, one of the side effects of the trade war sentiment and a weaker Renminbi was that the Central Bank allowed the Vietnamese Dong to weaken by 1.5% this month. This should not be overly worrisome as Vietnam has foreign exchange reserves of greater than USD 60 billion and a healthy current account surplus. Quarterly results for most of the fund’s holdings in Vietnam have been positive with good growth seen in an airport operator, a cargo handling company, a consumer conglomerate, a commodity goods transporter, and industrial park developers.

During the month, the fund invested in an automotive holding company which owns equity stakes in the Vietnamese operations of Honda, Toyota and Ford. Toyota is the leading passenger car player in Vietnam with a market share of 29% while Honda is the leader in the motorbike segment with a market share of 72%. This company offers exposure to the growth of the Vietnamese automobile market, especially that of the passenger car segment, and is trading at an attractive valuation of 6.0x trailing twelve months earnings while offering an attractive dividend yield of 12.2%.

Market sentiment in Bangladesh remained soft as the country goes into elections later this year with banking stocks taking the biggest hit so far in 2018 due to worries over their net interest margins as the central bank tries to impose lending rate caps and the state owned banks face non-performing loan issues. However, some of the well-established private banks have declared stable quarterly results. The fund holds the country’s largest bank by market cap whose mobile financial services platform continues to make new inroads with the launch of a smartphone-based application. This app can be used for retail payments and is a way to diversify from the basic withdrawal and deposit services for which the mobile application is predominantly being used for at present. On the monetary policy front, the Central Bank issued its policy statement with no changes to benchmark interest rates and private sector credit growth.

The major event for the month in Pakistan were the national elections, held on 25th July, with the Imran Khan-led Pakistan Tehreek-e-Insaf (PTI) party winning the most seats in the National Assembly. The party is now in a comfortable position to gain a simple majority and form the next government with Imran Khan as Prime Minister. This better than expected victory for the PTI is a positive in terms of policy making as it would be the largest party within the coalition government and hence decision making should be more smooth. However, macro concerns such as the declining foreign exchange reserves and the wide current account deficit will take up the most attention in the near term. For more details on the Pakistan election and the outlook going forward you can read our Pakistan Election Note here.

In Kazakhstan, the fund’s only holding, the largest bank by assets completed the merger of the second biggest bank by assets into it and this combined entity will have the leading position in terms of market share of loans and deposits while also strengthening the combined entities’ retail banking presence. This merger should enable the bank to benefit from a stable macro environment in Kazakhstan as well as leverage the combined entities’ strengths in the greater Central Asia region.

The best performing indexes in the AAFF universe in July were Pakistan (1.9%), Iraq (0.5%) and Vietnam (-0.5%). The poorest performing markets were Cambodia (-4.1%) and Mongolia (-2.1%). The top-performing portfolio stocks this month were: a junior mining company in Mongolia (+29.6%), a Vietnamese commodity transporter (+12.5%), a Myanmar based junior miner (+11.1%), a Bangladeshi commercial vehicle producer (+11.0%) and a Bangladeshi consumer appliance manufacturer (+9.1%).

In July, we added to existing positions in Laos, Mongolia, Papua New Guinea, and Vietnam. We added a utility company in Kyrgyzstan (our first investment in this country) and a Vietnamese automobile distributor. We partially sold one Vietnamese company.

As of 31st July 2018, the portfolio was invested in 108 companies, 1 fund and held 5.9% in cash. The two biggest stock positions were a pharmaceutical company in Bangladesh (6.9%) and a pump manufacturer from Vietnam (4.4%). The countries with the largest asset allocation include Vietnam (25.9 %), Bangladesh (18.4%), and Mongolia (16.2%). The sectors with the largest allocations of assets are consumer goods (29.1%) and industrials (17.9%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 13.53x, the estimated weighted average P/B ratio was 2.63x, and the estimated portfolio dividend yield was 3.43%.