FEM Q2 2023 Manager Letter

While the headline returns were negative for the quarter, there were several encouraging signals in the underlying performance drivers that give us confidence in the future:

1. The strategy’s Africa portfolio has finally contributed positively to returns after being the main drag on returns over the past 18 months.
   
   While there are still high levels of uncertainty looming over the economies of Egypt, Kenya, and Ghana, the prices of the securities we own there appear to have stabilised. We attribute this to valuations (a lot of bad news is in the price, in our opinion), apparent flushing out of forced foreign sellers, and early signs that these countries are emerging from their respective economic crises. We observed a tightening of credit spreads across the three African countries amid a weaker US dollar, moderating food and energy inflation, and signs that policy makers are starting to address some of the structural issues that have plagued their countries’ balance sheets and impaired the functioning of their foreign currency markets. We did not mention Morocco in the above list of countries, despite it being the strategy’s largest African country exposure. Morocco’s diverse economy helped it navigate the challenges that most countries in the continent have been dealing with, and so has not been a source of drag on the strategy’s returns.   
2. The negative quarterly returns were generated from two core holdings that we remain fundamentally bullish on in the medium to long term.
   
   In our previous letters, we discussed our investment thesis on Wilcon Depot (the leading Philippines-based home improvement retailer), and Indonesia’s Sido Muncul (an herbal medicine manufacturer). While the share prices of both companies were under pressure in the quarter, we see no fundamental reason to change our constructive view on these businesses. In other words, we are more bullish on these investments at current levels.
3. Our companies continue to invest in their markets, and insiders are buying stock.
   
   Across most of the portfolio, capital spending is growing at a faster rate than inflation and depreciation, and management teams are hiring and adding new products and services to further their value proposition to customers.
   
   A good example of this is HPS, the Morocco-listed payments technology company, which has just released version 4.0 of its flagship payment software product, PowerCard. Another example is Abdullah Al Othaim Markets, the Saudi discount grocery retailer that is winning the ~$40 billion size market by doubling down on its value-for-money proposition through the opening of 10 store a quarter, to take advantage of weakening competition, a shift in shopping behaviour to more value-for-money options, and the general growth in population in the central region, to which Al Othaim is over-indexed.
   
   In Malaysia, we were pleased to see buying by Tan Yu Ye, the founder and executive chairman of MRDIY, the value variety store chain that has seen a weakness in share price year-to-date on a souring of consumer stocks in the country, and a technical overhang from previous private equity ownership.

After nearly two years of unprecedented dislocation in frontier and certain emerging markets, we are seeing early signs that the opportunity set for the strategy is opening again. While these are early days, we are encouraged by the IMF’s approval of a $3 billion stand-by arrangement for Pakistan, Sri Lanka’s domestic debt restructuring, Egypt’s state asset sale program, Turkey’s market-friendly appointments at the Ministry of Finance and Central Bank, and its backing of Sweden’s NATO membership bid. In Nigeria, the abrupt removal of the crippling fuel subsidies and the liberalisation of the dislocated FX market by newly elected President Bola Tinubu are necessary remedies on the long road to restoring credibility with the market. These policy developments, along with early signs of a macroeconomic bottoming in the strategy’s core markets, and historically low valuations on a few portfolio companies, bode well for our ability to deploy capital, and for the strategy to seize on the long-term growth opportunities that these markets offer.

Vergent Asset Management LLP