Asia Frontier Fund USD A-shares gained +2.8% in November 2017. The fund underperformed the MSCI Frontier Markets Asia Net Total Return USD Index (+13.9%) but outperformed the MSCI Frontier Markets Net Total Return USD Index (+1.2%), and the MSCI World Net Total Return USD Index, which was up +2.2%. The performance of the AFC Asia Frontier Fund A-shares since inception on 31st March 2012 now stands at +74.6% versus the MSCI Frontier Markets Asia Net Total Return USD Index, which is up +86.6%, and the MSCI Frontier Markets Net Total Return USD Index (+55.8%) during the same time period. The fund’s annualized performance since inception is +10.3% p.a., while its YTD performance stands at +2.5%. The broad diversification of the fund’s portfolio has resulted in lower risk with an annualised volatility of 8.88%, a Sharpe ratio of 1.14 and a correlation of the fund versus the MSCI World Net Total Return USD Index of 0.34, all based on monthly observations since inception.

It was a good month for the fund, with most of our major markets doing well, but once again the fund’s closest benchmark, the MSCI Frontier Markets Asia Index, outperformed the fund by a large margin due to the concentration of this index in only a few names. After Pakistan was upgraded to the MSCI Emerging Markets Index, the mix of the benchmark has changed significantly with Vietnam now accounting for 74.3% of the index compared to 15.9% as of 31st May 2017, the last day on which Pakistan was part of the benchmark. Furthermore, Pakistan accounted for 63.0% of the benchmark as of 31st May 2017 but now has a zero weight in it whilst we continue to invest in Pakistan and the country accounts for 20.7% of the fund’s portfolio, since we follow a value and benchmark agnostic approach.

This was a peculiar month where most of the Vietnamese stocks in the benchmark did well, particularly Vinamilk and Vingroup, which saw a total return of 23.6% and 27.4% respectively and which account for 27.9% and 11.7% of the benchmark respectively.

Therefore, though the MSCI Frontier Markets Asia Index is the fund’s closest benchmark, we continue to follow a benchmark agnostic approach focusing on undervalued stocks which in the short run has resulted in a skewed relative performance, however in the longer run it is this benchmark agnostic approach which has helped us generate returns (especially in sideways and down-trending markets) which are superior to the benchmark.

Gains this month were led by Vietnam as the economic momentum continues. November industrial production growth came in at 17.2% YoY with the manufacturing sector leading with growth of 24.3%, while retail sales grew by 9.5%. Given the bullishness across the economy, the fund’s small and mid-cap Vietnamese holdings did well, however the large cap’s in the banking, consumer and real estate sectors have rallied significantly over the past month which led to the VN Index reaching levels previously seen in 2007 with a monthly gain of 13.5%.

The rally over the past month in the large caps has primarily been event driven. Vinamilk, the biggest company by weight in the VN Index, gained 23.6% during the month after Hong Kong-based Jardine Matheson’s Singapore subsidiary bought the 3.3% stake sold down by the State on 10th November at a price of VND 186,000, a 24% premium to the starting bid price and at a P/E multiple of 29x trailing 12-month earnings. This led to excitement amongst other investors leading the stock to rally.

Sabeco, the largest beer brewery by market share in Vietnam, has also been rallying over the past few months as the State looks to sell down its position in the company. The government hopes to sell its stake at a heady trailing 12 months P/E of around 47x for a company growing earnings at high single digit to low double digits. Though efficiencies and margins can be improved by a foreign acquirer, this may not be easy as the new owner will not have a controlling stake with the government still retaining 36% in the company after the sale.

Vietcombank led a rally in the banking stocks as talks surrounding a stake sale to a sovereign wealth fund resurfaced while the newly listed Vincom Retail witnessed strong buying interest which benefitted its parent company Vingroup (trading at a trailing 12 months P/E of 60x) as well.

The five companies mentioned above account for around 38% of the VN Index and when these stocks rally in tandem, index returns do get skewed. Strategically we prefer not to chase stocks and would look to enter some of the large cap names at a more opportune time and/or at more attractive valuations given that the fund’s Vietnamese holdings are trading at a trailing 12-month P/E of 12.2x compared to the VN Index trailing 12-month P/E of 18.9x.

Mongolia continued to do well for the fund this month with gains largely driven by an integrated cashmere producer. Year to date, the Mongolian Stock Exchange (“MSE”) is up 92% in USD terms making it the second best performing stock exchange in the world (behind Venezuela), bolstered by an improving economic climate rooted in the robust export of coal, copper, and oil. On 17th November 2017, Fitch revised the outlook on Mongolia’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to positive from stable based on reduced government debt, decreased refinancing risk and the IMF program moving ahead again. On 27th November 2017 the Financial Regulatory Commission passed legislation enabling dual listing of foreign-listed companies onto the Mongolian Stock Exchange and vice versa. This opens the possibility for a significant increase in liquidity and investor interest in the MSE as currently the majority of investors are local retail, with foreign funds yet to largely participate.

Bangladesh did well for the fund this month thanks to positive moves in a food products company which is focusing on building an ice-cream business in a hugely under-penetrated market. This company has already captured a 16% market share and continues to build its distribution network and capture market share from the two existing incumbents. Other positive moves for the fund came from a pharmaceutical company which declared good quarterly results and has the highest market share in the domestic pharmaceutical industry while the fund’s telecom holding in the country continues to do well on the back of growing data penetration. We continue to remain positive on the Bangladesh market, especially the consumer story, but near-term headwinds to profit margins could come in the form of currency depreciation as the Bangladeshi Taka has been slightly weaker this year and depreciated by 4% so far this year on the back of a rising but manageable current account deficit.

Pakistan had a good start to the month but the now normal story of political noise continued to impact market sentiment which led to weakness in the latter half of the month. A political protest by a right-wing party in the capital Islamabad led to tensions rising in the end of November, but with elections coming up next year such posturing by various parties does not come as a surprise as we have pointed out since the start of the year. Despite the political uncertainties, economic activity continues to expand with auto sales and domestic cement sales growing by double digits while private sector credit has also grown at high double digits this year which should lead to GDP growth momentum sustaining into 2018. Concerns on the Pakistani Rupee and the current account deficit remain but Pakistan is now the cheapest stock market in our universe, as well as one of the cheapest in the Emerging Asia region with the KSE100 Index trading at a trailing 12-month P/E of only 7.8x. The market correction has opened up valuation across sectors and five companies within our Pakistani holdings have a net cash position which is greater than 25% of their market capitalisation as the fundamentals of most companies in Pakistan remain strong.

Sri Lanka remained soft as the floods, drought, and VAT led price increases continue to impact consumer spending while the latest budget was also tabled during the month. The major change was the reduction of excise duties for beer while they were revised upwards for the hard alcohol industry which may negatively impact Arrack players since lower beer prices could eat into the market share of Arrack. A Nation Building Tax will also be imposed on the entire alcohol industry which may lead to price increases. Other possibly negative decisions were the debt repayment levy and cellular tower levy imposed on banks and telecom companies respectively which may be passed onto the consumer leading to higher prices. Further, duties will be levied on sweetened beverages and VAT will be imposed on condominium units which could also lead to higher prices for the consumer. On the positive side, the government continues to promote domestic manufacturing and plans to introduce tax concessions for domestic pharmaceutical manufacturing given that Sri Lanka imports a majority of their pharmaceuticals. The budget appears to be tough on the consumer but fiscal consolidation was expected given the fiscal deficit and government debt levels and although the consumer may face some headwinds due to the recent impact on disposable incomes, on a bottom up basis there continue to be opportunities in Sri Lanka with the Colombo All Share Index trading at a trailing 12 months P/E of 11.2x, lower than its five year average of 14.3x.

The best performing indexes in the AAFF universe in November were Mongolia (+15.7%), Vietnam (+13.5%), and Bangladesh (+4.8%). The poorest performing markets were Cambodia (−4.5%) and Sri Lanka (−3.1%). The top-performing portfolio stocks this month were: a cashmere producer (+42.0%), an agricultural company (+37.5%), and a ceramic producer (+32.1%) (all from Mongolia) and a Vietnamese cement producer (+26.9%).

In November, we added to existing positions in Bangladesh, Laos, Mongolia, Pakistan, Papua New Guinea, Sri Lanka and Vietnam. We newly invested in a Pakistani conglomerate and exited a Vietnamese consumer goods conglomerate, a Sri Lankan alcoholic beverage company and a Burmese holding company. Additionally we partially sold two companies in Mongolia and one in Vietnam.

As of 30th November 2017, the portfolio was invested in 115 companies, 1 fund and held 4.2% in cash. The two biggest stock positions were a pharmaceutical company in Bangladesh (7.8%) and a Mongolian cashmere apparel producer (3.2%). The countries with the largest asset allocation include Vietnam (26.5%), Pakistan (20.7%), and Bangladesh (17.4%). The sectors with the largest allocations of assets are consumer goods (29.9%) and industrials (14.9%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 15.99x, the estimated weighted average P/B ratio was 2.69x, and the estimated portfolio dividend yield was 4.18%.