Bah, humbug! Emerging-market investors will be happy to close the books on 2018, which was mostly a year of disappointment. After starting off well, the combination of rising trade tensions, a strengthening dollar, and localized drama sent the sector sliding.
Those familiar with emerging markets know that volatility is part of the package, but that knowledge is little comfort when you follow up a tremendous 2017 – in which your MFAM Emerging Markets Fund was up 26% — with a double-digit decline in 2018.
We can take some solace, but only some, in knowing that your fund fell less dramatically than the benchmark. For the year, the MFAM Emerging Markets Fund was down 12.2%, largely because of a painful 9.3% drop in the fourth quarter. But while we closed out the year in a depressing manner, we were still able to beat the benchmark by 2.3 percentage points for the year.
As I said, small comfort.
Speaking of small, over the last six months of the year, small emerging-market companies underperformed their larger counterparts by more than 7 percentage points. That isn’t particularly surprising, since smaller companies tend to be considered riskier. So when investors are looking for safe havens, they often abandon smaller companies for the comforting embrace of international giants. Since the companies in your fund tend to be smaller than those in the benchmark, we surely suffered at least a little from our size preference.
Our exposure to Mexico also hurt in the fourth quarter, as newly elected President Andres Manuel Lopez Obrador startled the markets by scrapping a plan to expand the Mexico City airport and briefly supporting a plan, since abandoned, to limit banking fees. With over 9% of your fund in microfinance company Gentera and airport operators Grupo Aeroportuario del Surest and Grupo Aeropuerto del Pacifico, we have far more exposure to Mexico than the benchmark, which has a 3% weighting in the country. These three positions fell 24%, 27%, and 25%, respectively, in the fourth quarter.
The full-year performances for those stocks weren’t quite so dramatic thanks to a strong third quarter, and we don’t believe any of the policy changes made so far have permanently damaged the companies’ operations or competitive advantages. However, we’re watching how things develop with the new president and don’t view the current share prices as the clear opportunities we normally would, given the political risks at play.
While the concerns around Mexico and its new president have some merit, that wasn’t the case for all the companies in your portfolio. The two largest positions going into the fourth quarter, Middle Eastern hospital group NMC Health and South Korean software developer and data-center operator Duzon Bizon fell 19% and 15%, respectively, in the quarter despite no material changes to their operations or prospects. As painful as the fourth quarter was, though, NMC is up 77% and Duzon Bizon 142% since the end of 2016, so this recent retrenchment isn’t overly concerning, and we’re content to keep holding the shares.
The quarter’s top performers were South African telecom Telkom SA, up 22.5%, and Indian bank HDFC, up 10%. As for the full-year performance, the top holdings were Malaysian rubber-glove manufacturer Top Glove, up 40%, and Duzon Bizon, up 56%.
Your MFAM advisors aren’t big on making short-term forecasts, so I’m not going to pretend to have great insight into where emerging markets will go in 2019. Many of the issues that upset markets in 2018 remain unresolved, although we may have some updates on U.S.-China trade matters later in January. On the other hand, valuations in emerging markets already reflect much of the fear and uncertainty in the air.
Forecasts aside, your MFAM Emerging Markets Fund team remains focused on investing in the highest-quality companies we can find and holding them for many years. We’re constantly looking for companies with long growth runways, strong management teams, and durable competitive advantages. We believe that by building a portfolio of high-quality companies – ones that take advantage of downturns to strengthen their competitive positions – and by having the patience to stick with them over the years, we can offset the volatility inherent in emerging-market investing and deliver superior long-term returns for our investors.
Here’s to 2019 and beyond. Way beyond.