Over the month the fund gained 7.5% (USD terms), led by Taiwan and South Korea, with Technology and Industrials the standout sectors. China and Brazil were the heaviest detractors, whilst Real Estate and Communications were the weakest sectors.
Since the start of the conflict in the Middle East, we have in effect run two portfolios in the fund. One reflecting the ‘real’ economy, which before the oil shock was signalling a broad and optimistic outlook for 2026. The other driven by the AI super-cycle and concentrated almost entirely in the South Korean and Taiwanese hardware supply chain. With oil above $100 consumer and producer sentiment across the US and much of Asia has deteriorated, feeding into a more cautious outlook for spending and growth expectations. This in turn has exacerbated the ‘squeeze-in’ to technology.
The scale of this shift can best be seen at the index level. Korea and Taiwan made up 110% of index returns in May, whilst the technology sector now accounts for 40-45% of the MSCI EM index, most of which is in three stocks – an unprecedented level of concentration that far exceeds the peak of the ‘Mag 7’ in the S&P.
Whilst the scale and speed of AI gains since April have been dramatic, particularly in the memory names, so has the growth in earnings. There are mid-tier names where valuations appear to have lost all relevance, but the larger names have seen relatively little multiple expansion. Consensus puts three-year tech earnings growth near 60%, which is heavily front-loaded with roughly 180% in 2026 declining towards 14% by 2028. So far this is an earnings bubble, not a valuation bubble.
Whilst this technological revolution clearly has further to go, for an income fund we see deteriorating risk-reward in our technology exposure, with higher volatility and diminishing yields.
The elevated volatility is driven by the fact it’s become an extremely crowded trade, which has been amplified by new levered ETFs aimed at retail clients and corroborated by anecdotal evidence of retail investors taking leverage to maximise exposure, and in turn de-rating sectors outside the AI complex.
The evolution of US hyperscaler funding sources has also become more questionable, from ‘circular reference’ investments amongst key players to a broadening array of issuance. Alphabet being the first with a $90bil capital raise, something not seen since 2006 and before that the IPO in 2004. These certainly don’t indicate any kind of market top – that will be clearer and come from the credit markets – but they are classic warning signals. It’s interesting to see that token expenditure, a useful real-time proxy, has begun to roll-over in line with the hyperscalers’ own share prices.
As noted in previous commentaries we are trying to square the circle of paying a real yield (in what is likely to be higher inflation environment), whilst moderating volatility from the tech sector, keeping up with index returns and maintaining our philosophy for diversification.
We remain happy with the yielding AI exposure through discounted holding companies and preference shares. The capital return from these will be significant this year with Samsung looking at returning at least KRW100trl (c5%) on top of the existing dividend of 1.6%. Our preference shares have significantly under-performed the ordinaries and are now at a 40% discount (a level not seen since 2013) which in effect increases the yield by roughly half. SK Inc the holding company for the group has a double layer of discounts to SK Hynix. SK Square which owns Hynix trades at a c40% discount, whilst SK Inc has a further 60% discount to its listed holdings. They have already cancelled 20% of outstanding shares this year and we expect further measures to lower this discount as the year progresses. Combined these are ‘latent’ sources of performance which will either cushion in a correction or converge higher to more sensible levels.
Fortunately, with signs of de-escalation in the Middle East the market and economic activity appear to be broadening back out again. The corollary of AI performance has been that valuations in other areas now sit at cycle lows which has also helped with the prospective yields. At time of writing the estimated gross forward yield stands at 6.2%.
With some dramatic price moves this month we have had to recycle a number of positions into better value and yielding markets, which has meant we temporarily have more holdings than usual, but has now normalised. For the first time in a long time we are finding attractively valued positions in India and the de-rating in Brazil has been notable. Peru has just elected a right-wing President making it the seventh country in the region to do so over the past few years. If Brazil follows suit later this year the re-rating will be significant.
