During May, the Fund outperformed the MSCI Emerging Markets index by 1.8%*.
The largest contribution to outperformance came from our stock selection in Taiwan, where second-tier AI beneficiaries caught up with market giant, TSMC. This was led by a reassessment of their prospects from the widening demand from data centre construction. We also benefitted from our more cautious positioning in India and Brazil. Some of this was offset by a widening of discounts on some of our Korean preference shares as underlying stocks were driven up by retail-led inflows.
While the AI-related portion of our book remains the dominant contributor to P&L on any given day, it is important to remember that the majority of exposure remains with traditional sectors. This is also true for the MSCI EM index as a whole, despite the shift towards Technology. Although we devote a significant portion of our time and resource into following AI developments, we are mindful that such a narrow focus can lead to opportunities in neglected areas. In particular, traditional quality-growth stocks are being abandoned as investors chase AI momentum.
Historically our value bias has largely kept us out of sectors such as Consumer Staples, even as we acknowledged the attractiveness of their stable cashflows and steady growth profiles. The MSCI EM Consumer Staples sector rerated after 2009 and consistently traded above 20x forward earnings during the decade after 2012. In recent years, despite a decline in the cost of capital across our markets, it has dropped towards mid-teens P/E valuations with many individual stocks seeing more dramatic de-ratings. While these multiples do not yet represent obvious value territory, these stocks benefit from a lower cost of capital given their relative stability and predictability. Even as we have concern about the longer-term durability of earnings among some of the semiconductor stocks we hold, we are reassured by the placid outlook for supermarket or soft-drink bottler earnings.
In a similar vein, we have been building up exposure to some of the higher quality Indian private sector banks. While not obviously cheap yet, we appreciate their superior return and growth characteristics that are no longer highly valued by the market. With the sector trading at the lowest valuations in at least a decade, we have a compelling opportunity to reduce our underweight position in the Indian market.
The paradoxical result of this is that stocks with modest earnings growth in the portfolio are trading on higher earnings multiples than those with the most explosive earnings growth (such as DRAM stocks). In our view this is not a market inefficiency – it reflects risks to the sustainability of peak earnings in some sectors. We need to balance the undoubted earnings and cashflow bonanza currently coming into AI supply businesses with an assessment of the long-term value those companies should be able to capture, once bottlenecks in supply are eased.
*Pacific North of South EM All Cap Equity GBP Z (USD)
