In September the fund gained 0.3% in GBP terms. The third quarter dividend payment was GBP0.2072 making a trailing dividend yield of 4.5% on a total twelve-month return of 30.3%. Over the month Taiwan and Brazil were the leading contributors whilst China was the heaviest detractor. At the sector level Technology and Energy led, with Consumer Discretionary and Materials the weakest. Overall Taiwanese technology gains were again offset by Chinese consumer weakness.
This bifurcation has been very typical of index returns this year, which have also been driven by fewer stocks than any period we can remember. The ‘EM-3’ (TSMC, Samsung Electronics and SK Hynix) started the year with an index weight of 18% and yet have delivered roughly three quarters of the year-to-date return. By sector the picture is even starker where Information Technology has returned 84% and accounted for effectively the whole of the index’s return. The other ten sectors added just half a percentage point between them, with Communication Services (-20%) and Consumer Discretionary (-19%) the weakest.
This performance spread is just as pronounced at the country level where Korea is +88% and Taiwan +77%, whilst China is -12%, India -14% and Indonesia -36%. Nine of the 24 index markets are in negative territory, even though the index itself is up more than a fifth. Amongst the six largest markets, the gap between best and worst is the highest on record and the second year running that it tops 100% which has not happened within the available data. The previous high was in 2009, but that was when every market rose post GFC and the worst performer was up 47%. What is highly unusual is to have major markets moving in opposite directions with this kind of spread.
The underlying positive driver continues to be an earnings boom rather than expanding valuation multiples. Consensus has MSCI EM earnings growing 83% this year, with Korea up more than 400% on the back of Samsung and SK Hynix. That has left Korea on a forward P/E of under 5x which means the market has derated whilst nearly doubling. At the index level, EM now trades at close to its widest discount to developed markets since the early 2000s, despite having outperformed.
Behind this sits the remarkable transfer of free cash flow from the top five US Hyperscalers, which are expected to be free-cash-flow negative for at least the coming few years, whilst Samsung and Hynix combined are likely to see a tenfold increase from $40b in 2025 to $510b in 2027. Naturally this is dependent on the sustainability of the capex cycle which is being questioned given many uncertainties including the increased use of debt and the web of cross-investments between frontier labs, chipmakers and cloud providers, just to name a few. This circular reference is a clear concern which has been heightened recently by the moves in credit risk spreads for some of the weaker players. But as recent deals have illustrated, credit is still available to the larger players (at a price) as well as both equity and hybrid capital, so it’s possible for this colossal capital migration to continue for longer than many may assume. We remain participants through positions that pay us to wait, but within our established allocation rules to ensure appropriate levels of diversification.
On our attribution, so far this year the fund has had an average technology weighting of around 12% (vs 40% for the index) which has helped to keep volatility down to around two thirds of the market volatility of 24%. The relative performance cost of this has been almost entirely offset by stock selection across the rest of the portfolio. Financials were the largest positive contributor, followed by Energy and Industrials. The most relevant point is that keeping pace with a market where three stocks account for three-quarters of the return, without owning a corresponding share of that risk, is what diversification is meant to deliver.
