In August the fund gained 1%, led by Korea and Taiwan. China was the weakest market, driven by disappointing macro data. At the sector level Technology and Materials rebounded, whilst both consumer sectors were the weakest.
August may be a holiday month, but it is also a busy period for earnings reports. Considering the second quarter was the first full quarter reflecting the impact of the Middle Eastern conflict, results has been more positive than one might have expected. On an index-weighted basis, EM companies beat consensus by around 14%, the strongest outcome in more than a decade. Operating profits grew 88% year on year, nearly double the 46% delivered by the US, but importantly this is not simply a reflection of the AI memory sector. Excluding technology earnings grew 28%, and operating margins have now surpassed their previous cycle peak.
However, China continues to be under a dark cloud. Retail sales growth slowed to just 0.4% year on year, and fixed-asset investment fell 7.2% year to date, extending the familiar ‘strong supply, weak demand’ imbalance. A number of our consumer-exposed holdings reported underwhelming Q2 numbers, and even those in-line results were unable to overcome the negative sentiment. In this context we remain mindful of value traps, where even good businesses are challenged by the weak macro environment. Seasonally we are moving through the period when if there are any stimulus measures they would become apparent by now, so policy appears to be in a ‘neutral’ position. Equally, experience tells us the best time to buy good businesses is when they face headwinds and market scepticism.
Capital returns continue to be the most relevant factor in Korea with both SK Hynix and Samsung clarifying their policies. The most relevant for us is Samsung who sized the 2026 capital returns at up to KRW 110tn. Our preference shares benefit from this disproportionately having been trading at a c35% discount to the ordinary and resulting in the Q3 quarterly payment of 2.5% cash yield alone (versus 1.6% on the common). The split between cash and buyback for the full year remains unclear but the total shareholder capital return yield looks like it will be in the order of 9%. Prioritising cancellation of the prefs would lift this further while narrowing the discount. SK Hynix, by contrast, opted for a KRW 40tn buyback and cancellation (c.3.3% of shares), so its near-term return is almost entirely accretion rather than cash.
Probably the strongest headwind to returns continues to be the ongoing rise in the cost of capital from major sovereign bonds and applies to all markets. It is unclear how far this yield pressure might run as real yields in the US are now quite attractive, and looking at breakevens, the pressure does not appear to be coming from inflation. The relevant factor is the feedback loop into fiscal balances and cost of debt at the corporate level. EM countries are mostly in a better position in the fiscal position whilst EM corporate leverage is low with net debt to equity down to 0.1 against 0.5 in the US.
Taken together, August reinforced rather than resolved the tension we have been describing for several months. On one side is an earnings-led recovery, spearheaded by an AI hardware complex that continues to deliver upside surprises and supported by a broader EM earnings base that remains solid. Against this sits continued demand weakness in China and the downdraft from rising rates. EM remains underpinned by lower leverage, further progress on shareholder returns and a valuation discount to the US that, despite this year’s rally, is still around a third.
