BEXIX – Q1 2018 Commentary
The Baron Emerging Markets Fund underperformed relative to its benchmark during the first quarter. This relative performance was driven by poor stock selection, particularly in India. The team believes it is positioned for a rise in market volatility and would look to capitalize on opportunities that tend to arise in such environments.
Market Overview:
– EM Equity Index gained 1.42% during the quarter
– Early in the quarter, emerging market equities continued the powerful advance of 2017
o Performance reversed at the end of the quarter with marginal gain
– Concerns regarding monetary and liquidity support deflated optimism
o Additionally, re-emergence of trade protectionism stunted positive returns
– China’s emphasis on gaining market and profit share form Western multinationals in high value-add sectors is well placed
o Presents attractive long-term investment opportunities
Performance Overview:
– During the first quarter, the fund moderately underperformed its benchmark
o Relative performance improved later in the quarter as January gains were given back
– The largest drivers of adverse relative performance was stock selection in financial sector driven by the India wealth management theme
o Bank holdings in Southeast Asia were sensitive to rise in global bond yields
– Adverse performance in India driven by surprise introduction of modest cap gain tax, rising commodity prices, and bond yields
– Stock selection in the tech sector was positive
o Geographically, top performers were geographically diversified
– Top performer was Kingdee International Software in China
– Largest single detractor was Tata Global Beverages in India
– Two early stage themes took shape over the past quarter
o In India, they have been following and researching the restructuring of Tata Sons
o New management should help to reduce leverage and improve profitability and they now have investments in four Tata Son companies
o Second, in China, added another investment in the China SOE bank sector
o Gained conviction that recent improvements in asset growth net interest margins, and credit quality are sustainable
Market Outlook:
– At the beginning of the year, global equity markets began a marked correction
o Short term spike in volatility drove speculative moves in related ETF securities
– Baron believes the early February decline likely foreshadows the consolidation phase they expected given the high correlations of market positioning and trade-oriented strategies centered around low inflation expectations
– Do not conclude this risk-on environment has ended, but rather it is the first time since the financial crisis they questions its sustainability
– Baseline expectation for 2018 has been that solid economic and earnings momentum measures would necessitate incremental tightening and liquidity withdrawal by central bankers
o Have suggested that renewed policy tightening in China may represent drag on economic growth and earnings expectations at some point
– New baseline has changed after the first quarter:
o Have observed several signs that forward looking indicators of global activity may be peaking; slowing of credit growth and trade flows in several countries
o U.S. administration has brought up protectionist measures, illuminating the risk of slower growth and higher inflation
– Record low volatility environment of recent years cannot persist
o Return to more normalized volatility is not necessarily a bad thing and would likely present attractive opportunities
Performance Review:
Peter Malone, CFA
Research Analyst
Direct: 617.226.0030
Fax: 617.523.8118
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