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The Asia Frontier Fund USD A-shares declined −2.7% in June 2018. The fund underperformed the MSCI Frontier Markets Asia Net Total Return USD Index (+0.3%) but outperformed the MSCI Frontier Markets Net Total Return USD Index (−3.5%) and the AFC Frontier Asia Adjusted Index (−4.2%), while underperforming the MSCI World Net Total Return USD Index, which was flat for the month. The performance of the AFC Asia Frontier Fund A-shares since inception on 31st March 2012 now stands at +52.1% versus the AFC Frontier Asia Adjusted Index, which is up +30.3% during the same time period. The fund’s annualized performance since inception is +6.94% p.a. The broad diversification of the fund’s portfolio has resulted in lower risk with an annualised volatility of 9.15%, a Sharpe ratio of 0.72 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.
Investor sentiment continued to remain weak this month on the back of trade tensions between the U.S. and China, while worries over a stronger U.S. dollar and its impact on emerging and frontier currencies continued to play out with the U.S. Fed expected to quicken its rate of interest rate hikes this year. Furthermore, weakness in the Renminbi over the past month also hurt frontier and emerging market sentiment similar to the second half of 2015, while the worries over rising U.S. interest rates are having a similar impact on sentiment as compared to June 2013. So far this year, besides the Pakistani Rupee which has depreciated by 10% and which was expected, most currencies in our universe have not seen a significant depreciation, unlike some other frontier and emerging currencies such as the Argentinian Peso, Brazilian Real, Philippine Peso, South African Rand, and Turkish Lira. Though some countries within our universe such as Mongolia, Pakistan, and Sri Lanka have large external U.S. Dollar debt positions as well as large current account deficits, these markets have either seen a devaluation of their currency already (Pakistan), have corrected and/or are cheap (Pakistan, Sri Lanka), and/or are going through an IMF-led reform process (Mongolia and Sri Lanka).
The Vietnamese market remained soft as large cap stocks continued their correction from the previous two months given that their valuations were beginning to look stretched by the end of 1Q18 as was discussed in previous manager comments. The recent correction, however, is making valuations of certain large cap companies more reasonable. Despite the market weakness, the fund’s Vietnamese holdings did well relative to the market and ended the month in positive territory due to good monthly returns from an industrial construction contractor, an insurance company with a strong position in the auto insurance segment, a cargo handling company operating in a duopoly structure at the Ho Chi Minh City airport, and an airport operator which has a near monopoly in the country. All of these names are neither in the fund’s benchmark nor in the large cap VN30 Index which reflects the fund’s benchmark agnostic approach.
On the macro front, 2Q18 GDP growth of 6.8% reflects the momentum in the manufacturing sector which grew by 12% YoY and strong consumer sentiment which helped retail sales increase by 8.7%, while foreign direct investment grew by 8.4% in the first half of 2018 to USD 8.4 billion. These numbers continue to suggest that the country is benefiting from positioning itself as a manufacturing hub due to lower labor costs as well as its large and young workforce. Trade war worries did not impact exports as they have grown by 16% YoY so far this year, leading to a heathy current account surplus. Though the U.S. has its sixth largest trade deficit with Vietnam, there has not been much pressure from the U.S. on this issue as most goods exported to the U.S. from Vietnam are garments, textiles and electronics which are still low tech or low-end goods which do not appear to face a trade barrier at this point in time. Furthermore, both countries appear to be building closer geopolitical relations and therefore any major trade barriers to Vietnamese exports to the U.S. would be a surprise.
Vietnam is also witnessing significant growth rates in inbound international travelers, which grew by 27% in the first half of the year to 7.9 million. Asian travelers are the fastest growing segment and account for the majority of arrivals into the country with China and South Korea being the two largest contributors. As infrastructure improves and there is greater air connectivity to Vietnam, especially from other Asian countries, companies linked to tourism should continue to do well and hence the fund’s investment in an airport operator.
The Pakistani Rupee (PKR) depreciated by 5% last month and this was not surprising given the rising current account deficit and a drop in foreign exchange reserves. The PKR has depreciated by 10% this year and by 15% since December 2017. Currency weakness along with higher crude oil prices is expected to lead to a pickup in inflation later this year and further interest rate increases from the State Bank of Pakistan can be expected. National elections are due on 25th July and this should provide some clarity on the country’s outlook as the fund has reduced its exposure to Pakistan over the past two quarters. As of writing, the former Prime Minister Nawaz Sharif was given a ten-year sentence due to the Panama Papers issue and this judgement has only increased the chances of victory for the Imran Khan-led opposition party, PTI. A PTI victory will be a near term positive for the market as this political uncertainty would be over, but in all likelihood the next government will be coalition led which could lead to uncertainty over policy making. However, valuations in Pakistan appear to be bottoming and are now very attractive. We will watch the moves made by the next government and adjust our exposure to Pakistan accordingly.
The Bangladeshi Finance Minister announced the annual budget which had no major triggers for the stock market while certain measures will be positive for the fund’s holdings. Foreign and local tobacco brands will now have similar pricing and duties in the low-end segment while previously local brands could sell at a lower price with lower duties. Local brands will no longer have this advantage and this equality in pricing and duties should benefit foreign tobacco companies due to their better-established brands. The fund holds the leading foreign tobacco player in Bangladesh. Custom duties were also reduced on inputs required to assemble and manufacture consumer appliances and this should benefit the leading consumer appliance company in Bangladesh which the fund also holds. Though the government plans to reduce corporate tax rates on financial institutions by 2.5%, the benefit of this could be negated by the pressure on banks and non-banking financial institutions to reduce their spreads, as was discussed in last month’s manager comment.
The fund invested in a mining company listed in Australia whose asset is based in Myanmar and this asset could have one of the better polymetallic deposits globally which could lead to major upside for this company as the project is located close to the border with China and has access to processing and logistics infrastructure. Similar mines to this have commanded significantly higher valuations than the valuation that this company is trading at.
The best performing indexes in the AAFF universe in June were Bangladesh (+1.2%), Cambodia (+0.5%), and Mongolia (−0.3%). The poorest performing markets were Kazakhstan (−3.6%) and Iraq (−3.5%). The top-performing portfolio stocks this month were: a junior mining company in Mongolia (+50.0%), a Vietnamese cargo handling company (+22.9%), a Vietnamese insurance company (+19.2%), a Vietnamese beverage company (+17.9) and a Vietnamese industrial construction company (+16.9%).
In June, we added to existing positions in Mongolia, Myanmar, and Vietnam. We partially sold two companies each in Mongolia and Vietnam.
As of 30th June 2018, the portfolio was invested in 106 companies, 1 fund and held 7.1% in cash. The two biggest stock positions were a pharmaceutical company in Bangladesh (7.2%) and a pump manufacturer from Vietnam (4.2%). The countries with the largest asset allocation include Vietnam (26.0%), Bangladesh (18.4%), and Mongolia (16.2%). The sectors with the largest allocations of assets are consumer goods (28.5%) and industrials (17.6%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 13.13x, the estimated weighted average P/B ratio was 2.56x, and the estimated portfolio dividend yield was 3.54%.

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