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The Asia Frontier Fund USD A-shares declined −4.5% in May 2018 to a NAV of USD 1,563.33. The fund outperformed the MSCI Frontier Markets Asia Net Total Return USD Index (−9.4%), the MSCI Frontier Markets Net Total Return USD Index (−9.2%), and the AFC Frontier Asia Adjusted Index (−7.2%), but underperformed the MSCI World Net Total Return USD Index, which was up +1.0%. The performance of the AFC Asia Frontier Fund A-shares since inception on 31st March 2012 now stands at +56.3% versus the AFC Frontier Asia Adjusted Index, which is up +36.0% during the same time period. The fund’s annualized performance since inception is +7.5% p.a. The broad diversification of the fund’s portfolio has resulted in lower risk with an annualised volatility of 9.12%, a Sharpe ratio of 0.78, 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.

Global risk off sentiment impacted almost all global frontier and emerging markets this month as a combination of factors led to a heavy correction. Macro uncertainties in Argentina (a large weight in the global frontier index) and Turkey, a stronger US Dollar and its impact on frontier and emerging currencies, continued uncertainties over the economic impact of the US-China trade war, the US backing out of the Iran nuclear deal and the resulting impact on oil prices and the lack of clarity on possible US-North Korea negotiations were all factors which led to a heavy sell off in frontier and emerging markets, with Asian frontier markets not being spared.

Despite the heavy correction in the MSCI Frontier Markets Asia Index over the past two months, the fund’s relative performance was better given the diversified approach and also due to lower exposure to Vietnamese large caps which have a heavy weight in the MSCI Frontier Markets Asia Index.

From the fund’s larger markets, Vietnam bore the brunt of the global sell off given the fast run up in the market, especially in 1Q18. The Ho Chi Minh VN Index has lost around 19% from its high on 9th April 2018, led by large caps as valuations for these companies had a significant run-up over the past year, as has been discussed in previous manager comments, while valuations for small and mid-cap companies remain attractive after the recent market correction. Post correction, valuations of some of the large cap companies are looking more reasonable compared to the start of the year and thus the fund invested in a consumer conglomerate which is beginning to show very robust results for its consumer business. We used this market weakness to increase our position in the country’s airport operator, which is a good proxy for tourism and the economic growth of Vietnam. The fundamentals of the Vietnamese economy remain stable relative to other frontier and emerging markets with industrial production, export growth, and tourist arrivals continuing to be strong.

The Pakistani market remained weak on the back of macro concerns and political noise in the run-up to national elections which have been scheduled for 25th July 2018. The ruling PML (N) is going into the elections in a weak positon given the political issues surrounding the former Prime Minister, Nawaz Sharif. However, the PML (N) still remains the strongest party in Punjab which accounts for the most seats in the National Assembly. The consensus is for a coalition government to be formed, led by either the PML (N) or Imran Khan led PTI. We believe that if the next government is a PTI led coalition, then this could be a near term negative for the market as the PTI is still untested when it comes to managing various aspects of the country, i.e. economic and foreign policy. We have therefore been reducing our exposure to Pakistan over the past few months and will re-assess the country post elections. On the macro front, the State Bank of Pakistan raised benchmark interest rates by 50 basis points, in addition to the 25 basis point increase in January 2018. The reversal of interest rates was expected due to the anticipated increase in inflation on the back of higher oil prices and Rupee depreciation.

The Bangladeshi market remained weak, as it also faces an election later this year, with banking stocks leading the market lower due to continued meddling by the central bank in trying to manage the banking sector’s loan growth and interest margins. The latest move by the central bank, nudging banks to reduce their spreads, seems more like a move to reduce interest rates to appease voters in the run up to elections. We have used the weakness in bank stocks to initiate a positon in the country’s largest bank by market cap as we believe it is well placed to build a retail and consumer banking business, which as a market segment is still nascent in Bangladesh. Further, this bank is expected to continue to build out its mobile financial services platform which recently received a financial investment from Alipay of China.

In Sri Lanka, the consumer spending recovery could be impacted by the increase in fuel prices which were raised last month and as per a new government policy which will see fuel prices be adjusted every two months. Though worries over the near-term impact on consumer incomes remain, this is a positive reform from the government. The fund exited its investment in a consumer conglomerate at a good return, while we continued to increase our positon in a telecom operator which is now the fund’s biggest position in Sri Lanka. This company has had a good run of results for the past few quarters, led by data growth on the back of increasing smartphone penetration while valuations remain at a discount to regional players and further consolidation in the sector could be a possibility, which would help larger players consolidate their market position.

The fund initiated a position in a Singapore-listed Myanmar play which has interests in real estate, food & beverage, automobiles, and financial services. This company is reducing its exposure to the real estate business as its consumer facing businesses are growing from a low base and have a large market to tap including the mobile financial services business which can grow significantly from its current position.

We also recently visited Kazakhstan, Kyrgyzstan, and Uzbekistan and as a result of the trip, initiated our first position in Kazakhstan, buying shares in the country’s largest bank by assets. Kazakhstan is seeing an economic recovery after the oil price collapse of 2014 hurt the largely resources-focused economy. Higher oil prices over the past year have helped create a more stable macro environment for economic growth and the country is expected to play a pivotal role in the land transport route from China to Eurasia as part of the One Belt One Road Initiative (OBOR). More on Kazakhstan, Kyrgyzstan, and Uzbekistan in our upcoming travel reports.

The best performing indexes in the AAFF universe in May were Mongolia (-0.1%) and Laos (-0.4%). The poorest performing markets were Vietnam (-7.5%) and Bangladesh (-6.9%). The top-performing portfolio stocks this month were: a holding company from Myanmar (+20.0%), a Mongolian construction product trading company (+14.9), a Mongolian real estate company (+14.9%), a Mongolian trading company (+14.8), and a Vietnamese pump producer (+12.6%).

In May, we added to existing positions in Cambodia, Laos, Mongolia, Myanmar, Sri Lanka, and Vietnam.  We added as a new position in the portfolio a holding company from Myanmar, a Vietnamese consumer goods conglomerate, and a bank from both Bangladesh and Kazakhstan. We exited a Sri Lankan holding company, a Bangladeshi paint company, and in Pakistan we sold a bank, a cement company, and a pharmaceutical company.

As of 31st May 2018, the portfolio was invested in 106 companies, 1 fund, and held 9.4% in cash. The two biggest stock positions were a pharmaceutical company in Bangladesh (7.2%) and a pump manufacturer from Vietnam (4.1%). The countries with the largest asset allocation include Vietnam (24.7%), Bangladesh (17.8%), and Mongolia (15.9%). The sectors with the largest allocations of assets are consumer goods (28.1%) and industrials (17.0%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 13.14x, the estimated weighted average P/B ratio was 2.54x, and the estimated portfolio dividend yield was 3.69%.

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