During August the fund lagged the MSCI Emerging Markets index by 2.9% despite delivering a positive absolute return. This has somewhat reduced our year-to-date outperformance after a strong start to the quarter.
Unusually, this disappointing performance was widely spread with all major markets proving a drag, led by China. We had been most concerned to not inadvertently position ourselves on the wrong side of the AI hardware trade, but this was not at all the issue in August.
The underperformance was almost entirely due to stock selection, with numerous unrelated individual positions across various sectors seeing significant sell-offs. Around two thirds of this occurred outside the AI space.
Thin summer liquidity may have contributed to some moves. A number of our stocks with exposure to consumer spending reported underwhelming Q2 numbers. In other cases we saw a reversal of previously solid performance on relatively in-line results as markets pivoted away from previous winners. Still, we find it hard to identify a strong common thread – it appears to simply have been an unfortunate month.
While we have put a number of our stocks on review, we do not see a wholesale change in fundamental value and have not made major changes to the portfolio. An ongoing rise in cost of capital driven by global bond weakness is probably the strongest headwind but this should be true of the market as a whole. Our focus on near term cashflows and strong balance sheets should actually provide resilience in this context.
We do remain mindful of being caught in value traps. Currently the risk we see are good businesses being squeezed by a stubbornly weak macro environment, especially in China. In such cases recovery may lie beyond a reasonable investment horizon and deeper discounts might be warranted than we had previously assumed. At the same time, our experience has shown that the best time to buy good businesses is when they are facing headwinds and market scepticism. Balancing this risk and opportunity is at the core of what we do.
