Market Overview
Despite expectations for rate cuts entering the year, few outsized movers emerged in emerging markets. Importantly, potentially concerning signals from employment and inflation data were largely offset by Federal Reserve commentary regarding labor supply. Emerging currencies declined during the quarter (-0.92%) as rate cut expectations were pushed out.
Top Performers
Taiwan was a standout emerging market during the quarter, as TSM (+31.24%) was increasingly viewed as an artificial intelligence (AI) beneficiary and investors reevaluated the geopolitical significance of semiconductor assets. India (+6.07%) continued its ascent ahead of national elections in April, despite increased Reserve Bank of India scrutiny of consumer unsecured loans and small-cap equities. Turkey performed well (+14.57%) as investors contemplated a return to orthodox monetary policy in the country and the potential for inflation to moderate. Indonesia (+2.1%) performed relatively in line with emerging market equities as a successful electoral outcome for Prabowo and likely policy continuity was largely priced in. Korea (+1.62%) also performed relatively in line with emerging markets despite semiconductor strength, as investors seemed relatively unimpressed by government efforts to support share prices through the “Value-Up” program.
Bottom Performers
Weak performers were not outsized and included Thailand (-8.21%), Brazil (-7.36%), and South Africa (-6.84%). China continued to lag (-2.19%) as the country’s industrial policies created overcapacity at home and complicated relations with key trading partners abroad.
Contributors and Detractors
Top contributors to performance for the quarter included graphics semiconductor company Nvidia (NVDA), Indian online travel company MakeMyTrip (MMYT), Southeast Asian e-commerce and gaming platform Sea (SE), Latin American online bank Nu Holdings (NU) (Nubank), and global payments’ leader Adyen (OTCPK:ADYEY) (OTCPK:ADYYF). Nvidia rose due to strong earnings, continued growth in AI investments around the world, and the announcement of next-generation products to be launched later this year. MakeMyTrip benefited from strong travel demand during the peak travel season, contributions from each of its three key businesses (air, hotel, bus), and a benign competitive environment. Sea benefited from narrowing losses, signs of a stabilizing competitive environment in Indonesia, and guidance for a return to profitability.
Bottom contributors to performance for the quarter included 3D design company Unity, social media platform Snap, Chinese health care services company Wuxi Biologics (OTCPK:WXIBF) (OTCPK:WXXWY), Chinese online pharmacy leader JD Health (OTCPK:JDHIF) (OTCPK:JDHIY), and Indian banking and financial services company HDFC Bank (HDB). Unity fell due to the announcement of a complicated restructuring that is expected to negatively impact revenue and earnings growth in 2024. Snap declined after reporting underwhelming revenue growth and providing guidance that continues to suggest a very gradual recovery compared to peers. Wuxi Biologics declined after the introduction of the BIOSECURE Act, which aims to block foreign adversary biotech companies from US federal contracts. JD Health fell due to business normalization post COVID and the possibility that the company is considering investments in the offline pharmacy sector. HDFC Bank fell amid continued net interest margin headwinds and expectations that lending growth will slow as the bank rebuilds its liquidity coverage ratio, though deposit growth remained healthy.
Market Outlook
While the outlook for monetary policy is a key input into the direction of emerging markets asset prices over shorter periods, changes in the price of money should not materially improve the trajectory of capital formation. Since capital formation is perhaps the key input in middle-class expansion, cyclical factors are thus unlikely to meaningfully alter the long-term trajectory for the asset class. Indeed, the classic emerging market story rests on a flawed assumption: that emerging markets will see widening economic participation over time. In fact, real per capita GDP (which we use as a proxy for growth in the middle class) has not increased in most emerging countries over time.
Portfolio Positioning
While 2022 was a difficult year for the portfolio, it resulted in a unique moment of low reinvestment risk to address our significant allocation to China. In 2023, the fruits of these efforts manifested themselves in the strong performance of many of our Passport Company holdings, notably those based in the United States, such as Nvidia and CrowdStrike (CRWD). We have in turn executed our investment program by taking capital back from these holdings while retaining residual positions, a process we call Value Capture. Since December 2022, we estimate that we have taken back 2022bps of capital from our Passport holdings in the United States and Europe and reinvested 1327bps into companies based in emerging markets, such as Nubank, MakeMyTrip, Apollo Hospitals, PayTm, and Grab.* Our weighting in India has increased from 3.12% to 12.52% over this period.
Investment Process
We seek to build, preserve and enhance a stream of compounded business value. We define this emphasis as follows:
*
Build:
Pair low penetration domestic demand with scalable and enduring businesses that are able to drive value creation and disproportionate outcomes.*
Preserve:
Preserve value creation and establish a forward-looking construct for managing risk.*
