During 2023 the strategy outperformed the MSCI Emerging Markets total return index by 11.8%. During Q4 the outperformance was 0.6%, as Emerging Markets recovered from their mid-year swoon. This marks the 8th consecutive year of outperformance for our All-Cap strategy.
During the fourth quarter, our stocks in Taiwan and Mexico provided the largest contribution to performance. Our underweight position and stock selection in China also helped relative to the index. The largest draw on a relative basis was the lack of exposure to India as that market remained strong despite stretched valuations. We also had a pullback in our Middle Eastern positions as a result of the conflict.
On a sector basis, technology stocks were the key driver thanks to continued rerating of the IT supply chain. Energy stocks were the biggest drag on relative performance as oil prices dropped sharply from September’s highs.
During the quarter we added to Poland and Argentina following elections of market friendly governments. We also increased our exposure to China somewhat further while taking profits on some positions in Brazil and the UAE.
Although we have been adding to China and reducing our underweight position against the index, our absolute exposure is actually lower than in recent years. This is because the market’s weight has shrunk over this period. Chinese stocks’ weighting has fallen from approximately 40% to 25% of the MSCI Emerging Markets index during the last three years. At the same time India’s weight has surged from 9% to 16%.
We continue to see headwinds for China but also believe that it offers significant scope for relative performance through stock selection. Our Chinese portfolio was down by less than half the decline of the market last year. Navigating the uncertainty remains tricky – an instructive episode was the issue of draft regulation on the gaming sector on the day before Christmas. The proposal would have curbed online game publishers’ ability to monetize their products and caused a sharp selloff in internet stocks. A few days later, the head of the regulatory body was unceremoniously fired and the proposal is highly unlikely to be implemented. This illustrates how in the current political setup bureaucrats are trying to second guess the leadership’s wishes and risk losing their job or worse if they get it wrong. No surprise then, that investors apply such stingy valuations to the market even where there is some growth. While a turnaround in the economy or sentiment remains elusive for now, the market has potential to surprise low expectations at some point.
Looking ahead to 2024 we are facing a series of elections with around half the world’s population participating. We normally do not expect much market impact from elections but as Poland and Argentina demonstrated last year, there are exceptions to this rule. The election calendar already started with Taiwan which did not bring major surprises – a DPP president but loss of control in the legislative assembly. Relations with China are unlikely to improve as a result but these will probably be more dependent on Chinese domestic imperatives anyhow. Votes in India, Mexico, Korea and Indonesia are also likely to provide policy continuity. Ultimately the most important election for Emerging Markets is likely to be that in the USA but even that may be trumped by the evolution of Fed policy.