The strategy generated a net return of -11.6% in the quarter ending March 31, 2022.

The strategy experienced a perfect storm of negative risk events during the quarter, starting with the unrest in Kazakhstan in January. This was followed closely by the Russian invasion of Ukraine at the end of February.

The unrest in Kazakhstan proved to be short-lived yet significant in terms of the changes it brought to the political landscape. Former President Nazarbayev was removed from the chairmanship of the National Security Council and several of his key allies were detained in what has been described as a targeted purge. Nazarbayev ruled Kazakhstan since its independence in 1991, before handing over the reins to President Tokayev in 2019. Nazarbayev’s “retirement” was largely cosmetic as he continued to rule behind the scenes, cultivating his status as the father of the nation, and enriching his family and friends in the process (even the capital city, Nursultan, was renamed after him in 2019). Galvanised by the protests, President Tokayev and his camp turned on their old boss, swiftly eliminating him from Kazakhstan’s political life and offering up a range of compromises to protesters under a reformed “New Kazakhstan” agenda. Naturally, with these seismic shifts in the political environment, our investment in Kaspi.Kz suffered, losing 57% of its value in the quarter. In fact, Kaspi.Kz accounted for nearly a quarter of the strategy’s returns in the period.

So, what did we do in response to these changes and how do we feel about our investment in Kaspi.Kz today?

As the events unfolded, we took the decision to reduce risk first and sold approximately 30% of the investment at a price of ~$110/share (for context, Kaspi.Kz GDR shares closed March 2022 at $50/share on the London Stock Exchange). It is important to explain why we didn’t sell more of the stock: the Kaspi app is one of the few true “super-apps” globally, whereby each separate business (payments, e-commerce and consumer finance) combine to create a powerful network effect. This has two key benefits. First, that Kaspi are able to earn on multiple parts of the transactions that take place through their ecosystem, thus supporting strong unit economics. Secondly, they are able to attract new customers at very low cost. More services on the platform naturally draws in more customers and drives higher engagement, which makes Kaspi the ideal ecosystem in which to launch new products. Standalone businesses seen in developed markets such as food delivery, ride hailing and travel ticketing can all be incorporated into the Kaspi ecosystem. In fact, after just 18 months of operation, Kaspi have grown their Kaspi Travel business (think Trainline.com) to the largest rail and air ticketing platform in the country, annualizing $330 million in gross bookings as at 1Q22 data.

The combination of these two factors puts Kaspi into the hallowed bucket of companies that offer both a stellar growth and return profile. Kaspi delivered approximately 60% year-on-year earnings growth at an annualized 75% return on equity through 1Q22 – exceptional fundamentals compared to almost any peer globally, and even more so when we remember that they were operating through what was undoubtedly the most challenging period in the company’s history. We were emboldened by the company’s recent announcement of a share buyback of up to $100 million (~1% of market cap) and the reaffirmed guidance. We believe the strategy will be rewarded for being invested in Kaspi.Kz in the long term.

While the strategy has no direct Russian or Ukrainian exposure, a number of countries we are invested in like Egypt, Kenya, Pakistan, and the Philippines are negatively impacted by higher commodity prices. Those countries have a high proportion of energy and food in their Consumer Price Index (CPI) baskets, which results in high inflation and a worsening current account position. Taking that into account, we’ve made some adjustments in the period including exiting from our investment in Edita Food Industries, the leading snacks manufacturer and distributor in Egypt.

Edita is a fantastic business, however we have concluded it will experience lower for longer margins as a result of the pressure on the Egyptian Pound and the rising cost of raw materials. Edita has demonstrated it has pricing power over a few cycles, but we still took the decision to exit, as we think it will take them longer this time to express that pricing power. We are still close to the management team at Edita and believe there will be a time when we are once again investors in the business.

Despite our adjustments, Egypt overall still hurt the strategy and contributed to just over a quarter of the returns in the period. However, we believe that the strategy’s positioning in Egypt is appropriate for this environment and expect significant upside ahead.

We would highlight Fawry as one of the companies we continue to back in Egypt.

Fawry is transforming the payments market in Egypt where over 70% of transactions are still done in cash. In 2021, Fawry served 41 million customers through 269,000 points of sale terminals, and online through their payment gateway, as well as increasingly through the MyFawry app.

Management at Fawry is executing well on its strategy to diversify from traditional payment acceptance (the typical use case is a merchant using a Fawry point of sale terminal to take a cash payment from a customer topping up their SIM card) to higher value financial services including:

  • supplier financing and inventory management (a merchant can pre-order from PepsiCo without using cash or PepsiCo can pay a supplier using Fawry which reduces its cash management costs);
  • agent banking (using an offline network to service third party bank clients);
  • microfinance (disbursing loans to customers using technology and a rich set of proprietary data); and
  • e-commerce (from payment acceptance to buy now pay later).

Fawry’s impressive revenue growth was 34% in 2021. However, one must consider that number in the context of its traditional payments business growing 9% and contributing nearly half the revenue. This is evidence of strong execution from the management team at Fawry and has a positive impact on profit margins. Much like Kaspi, Fawry is a profitable business with EBITDA margins of around 30% that we expect will grow over time as the share of new business grows in the mix.

The strategy experienced strong positive returns from Indonesia and Vietnam in the period. From a top down perspective, both countries are relatively better positioned to weather the current climate; Indonesia is net commodity exporter and has seen improvement in its current account fundamentals, while Vietnam’s foreign direct investment (FDI) based economy means it is generally less susceptible to the ebbs and flows of short- term portfolio flows. Indonesia and Vietnam represent nearly a quarter of the strategy’s capital.

In Indonesia, the strategy is invested in Sido Muncul, an herbal medicine and beverage company that is best known for its flagship brand Tolak Angin. Sido Muncul sources most of its raw materials locally and leverages its superior manufacturing technology to extract market leading yields from those inputs. On top of that natural cost hedge, Sido has significant pricing power in the herbal medicine market given its ~75% market share and unrivalled brand equity (refer to our post on June 4, 2021 to learn more about Sido Muncul).

Sido Muncul is one of the most profitable consumer health companies in the world and is on track for a 15/15 year in 2022: 15% growth in top line and 15% growth in bottom line. Despite the strong share price performance, Sido Muncul’s fundamentals are not adequately reflected in its valuation and as such continues to be the largest investment in the strategy.

Faced with the new variables from the Russian invasion of Ukraine, our team was quick to identify companies that are relatively resilient in this environment. One such company is FPT Software in Vietnam, which we owned in a fairly small size in the past but added to during this period. FPT is part of a broader theme we are expressing in the portfolio around digital transformation and the idea that digital CAPEX spend will continue to grow and become less discretionary as organisations worldwide address the different needs of their customers, employees, suppliers, and regulators. Most of that opportunity today comes from the United States and Western Europe, and that is likely to be the case for some time. As such, the market opportunity for FPT is in fact in those markets, in addition to Japan, where FPT established a strong presence. However, the supply dynamics are very much Vietnamese; FPT counts nearly 16,000 staff, the majority of which are engineers.

Vietnam is an appealing base for IT services exporters due to its large and young population, strong emphasis on STEM in education curriculums and culture. Vietnam’s IT services industry is at a fairly early stage relative to more established Indian, Latin American, and Eastern European competition which translates to a cost advantage that FPT has used to grow and in the process win some major accounts. In fact, nearly half the order book at FPT is from Fortune 500 company clients. FPT’s main competitive advantage on the supply side (i.e.: human capital) comes from the schools and universities it owns and operates in Vietnam, which count for nearly 70,000 students and act as a hiring funnel for aspiring graduates. We see FPT as the ideal play on Vietnam’s human capital development and the global IT CAPEX spend theme. The power of the theme is evident in the numbers: FPT’s global order book was up nearly 20% in 2021, and the quality of the book shows continuous improvement based on contract size (19 contracts above $5 million), scope of work, client profile, and contract duration.

While the performance environment has been challenging in the quarter and the outlook is mired with uncertainties around inflation and interest rates, we think there are a few factors that can help the strategy perform well in 2022:

  • The country mix of the strategy is diverse. While over 80% of the strategy is invested in Asia and Africa, no one country exceeds 20%.
  • As highlighted above, the country mix means factor sensitivities to rates and commodities is somewhat managed. The strategy is, on net, exposed to commodity importers but still benefits from owning businesses in countries with a strong agricultural economy (Kenya and Morocco for example) and countries that have healthy balance of payments (Indonesia on a cyclical basis, Vietnam and Morocco on a more structural basis).
  • Within those countries, the sector mix is deliberately designed to focus on long term themes around the digital economy, financial inclusion, consumer health, and retail. These themes are driven by the formalisation of the economies we invest in and are underpinned by changes in demographics, consumer behaviour, improved regulations, entrepreneurship, and technological advancements.
  • Within those sectors, we own companies that are financially under-levered, have a healthy degree of pricing power and cost variability, and are either owner-operated or multinational-majority owned/operated.
  • The portfolio’s valuation today is attractive. This presents significant return potential for long term investors

The team is committed to our collective goal of delivering differentiated and strong returns to our partners. We have confidence in our investment process and our culture, and believe that will lead to positive long term outcomes for our partners and for us at Vergent.

Vergent Asset Management LLP


DISCLOSURES

  1. Unless otherwise stated, all data is at March 31, 2022 and stated in US dollars (US$). Source: Connor, Clark & Lunn Financial Group, Thomson Reuters Datastream.
  2. Performance history for the Vergent Emerging Opportunities Strategy is that of the Vergent Emerging Opportunities Composite. The Composite has an inception and creation date of August 2018.
  3. Net performance figures are stated after management fees, estimated performance fees, trading expenses and before operating expenses. Operating expenses include items such as custodial fees for pooled vehicles and would also include charges for valuation, audit, tax and legal expenses. Such additional operating expenses would reduce the actual returns experienced by investors. Past performance of the strategy is no guarantee of future performance; Future returns are not guaranteed and a loss of capital may occur. For illustrative purposes, performance fee of 20% on added value over the hurdle rate of 6% plus the management fee of 1.25% have been assumed. Actual management fees charged to a particular account may vary.
  4. There is no benchmark for the Vergent Emerging Opportunities Strategy because it has an absolute return objective
  5. Standard Deviation measures the dispersion of monthly returns since the inception of the strategy.

Benchmarks and financial indices are shown for illustrative purposes only, are not available for direct investment, are unmanaged, assume reinvestment of income, do not reflect the impact of any management or incentive fees and have limitations when used for comparison or other purposes because they may have different volatility or other material characteristics (such as number and types of instruments) than the Strategy. The Strategy’s investments are not restricted to the instruments comprising any one index and do not in all cases correspond to the investments reflected in such indices.

These materials (“Presentation”) are furnished by Vergent Asset Management (“Vergent”) on a confidential basis for informational and illustration purposes only. This Presentation is intended for the use of the recipient only and may not be reproduced or distributed to any other person, in whole or in part, without the prior written consent of Vergent. Certain information contained in this Presentation is based on information obtained from third-party sources that Vergent considers to be reliable. However, Vergent makes no representation as to, and accepts no responsibility for, the accuracy, fairness or completeness of the information contained herein. The information is as of the date indicated and reflects present intention only. This information may be subject to change at any time, and Vergent is under no obligation to provide you with any updates or amendments to this Presentation. This Presentation is not an offer to buy or sell, nor a solicitation of an offer to buy or sell any security or other financial instrument advised by Vergent. This Presentation does not contain certain material information about the strategy, including important risk disclosures. An investment in the strategy is not suitable for all investors, and before making an investment in the strategy, you should consult with your professional advisor(s) to determine whether an investment in the strategy is suitable for you in light of your investment objectives and financial situation. Vergent does not purport to be an advisor as to legal, taxation, accounting, financial or regulatory matters in any jurisdiction, and the recipient should independently evaluate and judge the matters referred to in this Presentation. Vergent Asset Management LLP is registered in England and Wales with its registered office address at 8th Floor, 1 Knightsbridge Green, London SW1X 7QA, United Kingdom (Companies House number OC418829) and is authorized and is an Exempt Reporting Adviser in the USA. It is regulated by the Financial Conduct Authority (FRN: 791909).

THIRD-PARTY DATA PROVIDERS

This report may contain information obtained from third parties including: Merrill Lynch, Pierce, Fenner & Smith Incorporated (BofAML), S&P Global Ratings, and MSCI. Source: Merrill Lynch, Pierce, Fenner & Smith Incorporated (BofAML), used with permission. BofAML permits use of the BofAML indices related data on an “As Is” basis, makes no warranties regarding same, does not guarantee the suitability, quality, accuracy, timeliness, and/or completeness of the BofAML indices or any data included in, related to, or derived therefrom, assumes no liability in connection with the use of the foregoing, and does not sponsor, endorse, or recommend CC&L Canada, or any of its products. This may contain information obtained from third parties, including ratings from credit ratings agencies such as S&P Global Ratings. Reproduction and distribution of third party content in any form is prohibited except with the prior written permission of the related third party. Third party content providers do not guarantee the accuracy, completeness, timeliness or availability of any information, including ratings, and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such content. THIRD PARTY CONTENT PROVIDERS GIVE NO EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE. THIRD PARTY CONTENT PROVIDERS SHALL NOT BE LIABLE FOR ANY DIRECT, INDIRECT, INCIDENTAL, EXEMPLARY, COMPENSATORY, PUNITIVE, SPECIAL OR CONSEQUENTIAL DAMAGES, COSTS, EXPENSES, LEGAL FEES, OR LOSSES (INCLUDING LOST INCOME OR PROFITS AND OPPORTUNITY COSTS OR LOSSES CAUSED BY NEGLIGENCE) IN CONNECTION WITH ANY USE OF THEIR CONTENT, INCLUDING RATINGS. Credit ratings are statements of opinions and are not statements of fact or recommendations to purchase, hold or sell securities. They do not address the suitability of securities or the suitability of securities for investment purposes, and should not be relied on as investment advice.

Source: MSCI. The MSCI information may only be used for your internal use, may not be reproduced or re-disseminated in any form and may not be used as a basis for or a component of any financial instruments or products or indices. MSCI makes no express or implied warranties or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data obtained herein. This report is not approved, reviewed or produced by MSCI.

Emerging markets were weak in Q1 2022 initially on higher inflation as the Federal Reserve turned more hawkish then in response to the Russian invasion of Ukraine.  Markets hit a closing low on 15th March and recovered a little into the quarter end.  The EM index fell 6.06% in local currency terms and 6.92% in USD. The best performing sector was financials (+5.64%) with energy the weakest (-20.75%) in large part due to Russian exposure being written off and removed from the benchmark by MSCI.

The extraordinary bravery of the Ukrainian forces matched by a poorly performing Russian military has denied Putin a swift victory and a longer conflict has ensued.  NATO leaders have avoided an escalation involving member nations so far. A negotiated peace settlement, however distasteful that process is, will be the solution but Putin will only come to the table seriously when he believes he has enough gains to sell his actions to the Russian people as a victory.  Given his autocracy’s complete control of the media that may come sooner than expected.

While the invasion has united Western leaders in condemnation of President Putin’s regime and the world’s liberal democracies have responded with sanctions and military aid to Ukraine, the response in emerging markets has been much more restrained.  A number of major EM economies such as China, India, Brazil and South Africa have adopted a “neutral” stance on the conflict.  China in particular has been subject to criticism and scrutiny over its failure to condemn the invasion, which occurred less than a month after Presidents Xi and Putin issued a bilateral statement ahead of the Winter Olympics in Beijing, declaring a shared ambition to push back against a Western-led world order.  Russia’s attempt to brutally re-establish its Soviet sphere of influence, attracting such a fierce response from the West, is unlikely to be what Xi had in mind.  

There are some signs that China did not anticipate the full scope of Russia’s incursion in Ukraine (invasion vs. a special operation in the east), signalled by its shifting messaging and failing to evacuate Chinese citizens early in response to Russian moves leading up to the invasion.   While China has made complaints about Western sanctions on Russia, it has largely complied.  This reflects the economic reality that ties between China and the US/Europe as well as their allies in Asia are far greater than those with Russia.  While Russia is an important source of oil and gas for China, nearly half of over $3 trillion in Chinese exports in 2021 went to the US, Europe and treaty allies in Asia.  Only 2% of China exports were to Russia. China’s tech industry also relies heavily on equipment and know-how from the West.

The conflict exacerbates the deterioration in global economic growth expectations, which have been revised down as consumer confidence has fallen and real wages are squeezed by higher inflation.  Monetary authorities have been behind the curve and are responding too late, instead probably making policy mistakes tightening policy as the global economy slows sharply.

China does not face the same problems with inflation as other major economies, in part due to it not relying on the same level of fiscal and monetary stimulus as developed nations through the nadir of the pandemic.   Consumer confidence is nevertheless weak following several recent Covid-19 outbreaks across China coupled with Beijing’s insistence on pursuing a zero-Covid strategy.  Added to this is regulatory overhang from crackdowns in the tech, education and real estate sectors last year which culminated in a sharp sell-off through mid-March.  In an attempt to calm markets, Vice Premier Liu He made a series of announcements in March indicating that Beijing will pivot to more regulatory predictability and stability, and engage with Washington on financial disclosure rules for US-listed Chinese companies.  

The war in Ukraine has also made clear the importance of energy security and supply chain resilience.   Western states are looking to undermine Russia’s position as a major supplier of oil, gas, precious metals and agricultural commodities by sourcing these commodities from other suppliers.  While this will drive inflation higher and dent global growth, there are a number of commodity sensitive countries such as Indonesia and Brazil which stand to benefit from rising prices.

Our liquidity indicators continue to give a negative signal for the global economy and risk assets.  The rise in inflation is probably peaking but tighter monetary policy implemented belatedly by central banks will continue to suppress real money growth. The negative excess liquidity signal usually coincides with relative underperformance by tech and other cyclical sectors while energy and other defensive sectors outperform.  Normally high yield and quality outperform while momentum suffers.  Higher bond yields due to stronger commodity prices have prevented the usual outperformance by quality which often trades at valuation premiums.  The drag from the stock building cycle should ease the upward pressure on commodities allowing bond yields to fall and quality stocks to reassert their usual pattern of outperformance in slow growth environments.

Transactions over the quarter reduced the underweight in China, added to India and Indonesia, while trimming Taiwan, Korea and Greece.  At the sector level we have added to energy moving towards neutral, reduced the underweight to materials and moved overweight financials.  IT exposure has been reduced largely through trimming cyclical tech exposure in Korea and Taiwan.  The focus has been to add to defensive stocks while reducing cyclical exposure.  Security selection was the biggest detractor from relative performance in Q1, particularly in China, with sector selection negative and country selection positive. Negative sector selection was a result of the fund’s overweight in IT and an underweight in materials.  Underweights in South Africa and Saudi Arabia, rich in commodities and oil respectively, were a relative drag for the fund.

The Composite fell 10.63% (10.55% Net) versus a 6.97% fall for the benchmark. 

Monetary indicators continue to give a cautionary signal for global economic and equity market prospects. EM equities could show relative resilience based on Chinese policy easing, pre-emptive policy tightening elsewhere, an absence of major imbalances and favourable valuations.

Underperformance of the MSCI EM Index relative to MSCI World in Q1 was entirely due to Russian stocks being repriced to zero – the rest of EM slightly outperformed. Commodity producers were winners from the interruption of Russian / Ukrainian supply, with China lagging again on economic / policy concerns and Taiwan / Korea hit by tech underperformance.

Global six-month real narrow money growth – our key leading indicator – fell to a low level during 2021 and weakened slightly further in early 2022, suggesting a significant economic slowdown through late 2022 at least. Our two measures of global “excess” money, meanwhile, are both negative, a condition historically associated with global equities underperforming cash.

While cautionary for absolute returns, a “double negative” excess money signal has not historically been associated with EM equities underperforming DM. There are grounds for expecting relative resilience now.

Chinese monetary policy remains key. A recovery in six-month real narrow money growth in H2 2021 was, as expected, reflected in better economic data for January / February. The hope here had been that monetary recovery would accelerate during Q1; real money growth did rise further but remains modest – see chart 1. Covid outbreaks, meanwhile, have delivered another negative shock to the economy.

Chart 1

Chart showing China GDP and Real Narrow Money

Policy-makers have promised increased support for the economy and further PBoC easing measures could be announced soon. As before, we await a clearer signal from monetary trends to turn positive.

Most EM central banks are still on a tightening tack but local rates may be at or close to a peak – policy adjustment is much further advanced than in DM. High inflation is mostly due to commodity prices and does not reflect DM-style irresponsible polices and monetary excess in 2020-21. E7 annual broad money growth returned to its pre-pandemic pace in mid-2021; G7 growth, by contrast, is still elevated – chart 2.

Chart 2

Chart showing G7 and E7 Broad Money

Relative valuation is a further supportive factor for EM equities. A forward PE discount on the MSCI EM index of 35% relative to MSCI World is the largest since 2005. The dividend yield premium recently reached over 40%, the largest since 2001. (Within DM, high yield outperformed as a style on average historically when the excess money indicators were negative).

The view that the global economy is heading for a harder landing than the consensus expects suggests downside risk for commodity prices despite the Russia / Ukraine supply shock. Commodity price momentum is strongly correlated with the global stockbuilding cycle, which may be beginning a 12-18 month downswing (the next low is scheduled for H2 2023 based on the cycle’s average length) – chart 3

Chart 3

Chart showing G7 Stockbuilding as percent of GDP and Industrial Commodity Prices

The economic / monetary backdrop argues for underweighting cyclical markets and sectors. Historically, consumer staples and health care were the strongest EM sectors under double negative excess money signals and could benefit as recently outperforming cyclical sectors – financials, materials and industrials – lose momentum. The cyclical consumer discretionary sector has already underperformed significantly along with tech.

Six-month real narrow money growth is holding up better in most of the larger EMs than in major DMs (the US and Eurozone / UK are now in contraction) – chart 4. Brazil is an exception, suggesting very weak domestic economic prospects. The Brazilian index has outperformed partly because of its high weightings in materials and energy but these may now become a drag.

Chart 4

Chart showing Real Narrow Money for Brazil, China, Korea and Taiwan

India, like Brazil, is classified as a cyclical market – its relative performance has been positively correlated with the OECD’s G7 leading indicator historically. Monetary policy has been supportive but the RBI recently signalled a hawkish shift. Six-month real narrow money growth has fallen back and a cross-over with China – where policy is easing – would argue for a reallocation between the two markets following substantial Indian outperformance.

The strategy generated a net return of 8.4% in the year ending December 2021. The strategy’s performance in the year was shaped by a continuation of some of the themes that underpinned returns in 2020 and others which had a less favourable impact on historical returns but now appear to be turning the corner. In the former, portfolio companies that offer digital services (payments and software), healthcare, and consumer staples have been big winners in the pandemic with many likely to experience a step change in their long-term cash flow generation capacity. With digital services companies, we’ve maintained our focus on profitable companies that are delivering valuable solutions to their consumer and business clients through the deployment of technology that is scaleable and adapted to local market dynamics. In health and consumer staples, we gained more confidence in companies we owned prior to the pandemic as management excellence, market leadership, distribution prowess, and brand equity all played nicely into consumer habit changes that were brought about by the pandemic.

In the latter, the late reopening of economies in many Asian and African markets we invest in has meant that earnings have remained below potential for longer (compared to similar companies in more developed countries). As a result, those companies trade at deeply discounted valuations, presenting an opportunity to own them as they recover back to pre-pandemic levels of earnings. Naturally, those are businesses that sell products and services in an offline environment and typically require a high degree of mobility (alcoholic beverages, education, retail, and snacking are good examples). Management teams at these companies did not rest on their laurels and have adapted their businesses to be more agile, more digital and more available to their customers. We expect these initiatives to be generously rewarded as economies begin to reopen.

This mix of businesses complements the geographically diverse nature of our concentrated portfolio and mitigates the impact that a change in the market environment can have on returns. For example, as we enter a higher interest rate environment globally, valuations of our digital services companies might be capped but we expect that to be compensated by higher margins (i.e.: earnings growth) from our financial services companies. The portfolio’s investment in a wide range of market capitalisations and exposure to different ownership structures (owner-operator or multinational) adds to factor diversification and sensitivity to the ebbs and flows of liquidity. Within the portfolio, our job then is to ensure that capital is allocated to probabilistically optimise these factors, with the objective of producing a net positive outcome that is consistent with our and our investors’ return expectations. A less observable benefit of this approach is it allows us to see through periods of volatility which extends our holding period advantage in the market.

Outside the portfolio, our research is focused on identifying companies that can provide a superior risk-reward profile to existing investments or the excess cash position we might be holding at any one time. Our team’s knowledge of the markets and companies we invest in continues to compound and the opportunity set is getting deeper and more interesting for public market investors.

This year’s performance divergence between the strategy and emerging markets (a positive swing of ~13% versus the MSCI EM which was down ~5% in 2021) adds credence to the argument us and others have been making about looking beyond index-driven emerging market classifications when allocating capital outside core developed markets. We’ve put our money behind this thesis with a signification proportion of our Managing Partners’ capital invested in the strategy. We believe that a concentrated, geographically diverse, and benchmark agnostic approach is appropriate for investors looking to capture the growth in the next generation of emerging markets (i.e.: beyond the now “emerged” markets of China, Korea and Taiwan).

As the strategy wraps up its third year, we want to thank our clients, partners, and colleagues for their support and wish all a prosperous 2022.

Vergent Asset Management LLP


DISCLOSURES

  1. Unless otherwise stated, all data is at December 30, 2021 and stated in US dollars (US$). Source: Connor, Clark & Lunn Financial Group, Thomson Reuters Datastream.
  2. Performance history for the Vergent Emerging Opportunities Strategy is that of the Vergent Emerging Opportunities Composite. The Composite has an inception and creation date of August 2018.
  3. Net performance figures are stated after management fees, estimated performance fees, trading expenses and before operating expenses. Operating expenses include items such as custodial fees for pooled vehicles and would also include charges for valuation, audit, tax and legal expenses. Such additional operating expenses would reduce the actual returns experienced by investors. Past performance of the strategy is no guarantee of future performance; Future returns are not guaranteed and a loss of capital may occur. For illustrative purposes, performance fee of 20% on added value over the hurdle rate of 6% plus the management fee of 1.25% have been assumed. Actual management fees charged to a particular account may vary.
  4. There is no benchmark for the Vergent Emerging Opportunities Strategy because it has an absolute return objective
  5. Standard Deviation measures the dispersion of monthly returns since the inception of the strategy.

Benchmarks and financial indices are shown for illustrative purposes only, are not available for direct investment, are unmanaged, assume reinvestment of income, do not reflect the impact of any management or incentive fees and have limitations when used for comparison or other purposes because they may have different volatility or other material characteristics (such as number and types of instruments) than the Strategy. The Strategy’s investments are not restricted to the instruments comprising any one index and do not in all cases correspond to the investments reflected in such indices.

These materials (“Presentation”) are furnished by Vergent Asset Management (“Vergent”) on a confidential basis for informational and illustration purposes only. This Presentation is intended for the use of the recipient only and may not be reproduced or distributed to any other person, in whole or in part, without the prior written consent of Vergent. Certain information contained in this Presentation is based on information obtained from third-party sources that Vergent considers to be reliable. However, Vergent makes no representation as to, and accepts no responsibility for, the accuracy, fairness or completeness of the information contained herein. The information is as of the date indicated and reflects present intention only. This information may be subject to change at any time, and Vergent is under no obligation to provide you with any updates or amendments to this Presentation. This Presentation is not an offer to buy or sell, nor a solicitation of an offer to buy or sell any security or other financial instrument advised by Vergent. This Presentation does not contain certain material information about the strategy, including important risk disclosures. An investment in the strategy is not suitable for all investors, and before making an investment in the strategy, you should consult with your professional advisor(s) to determine whether an investment in the strategy is suitable for you in light of your investment objectives and financial situation. Vergent does not purport to be an advisor as to legal, taxation, accounting, financial or regulatory matters in any jurisdiction, and the recipient should independently evaluate and judge the matters referred to in this Presentation. Vergent Asset Management LLP is registered in England and Wales with its registered office address at 8th Floor, 1 Knightsbridge Green, London SW1X 7QA, United Kingdom (Companies House number OC418829) and is authorized and is an Exempt Reporting Adviser in the USA. It is regulated by the Financial Conduct Authority (FRN: 791909).

THIRD-PARTY DATA PROVIDERS

This report may contain information obtained from third parties including: Merrill Lynch, Pierce, Fenner & Smith Incorporated (BofAML), S&P Global Ratings, and MSCI. Source: Merrill Lynch, Pierce, Fenner & Smith Incorporated (BofAML), used with permission. BofAML permits use of the BofAML indices related data on an “As Is” basis, makes no warranties regarding same, does not guarantee the suitability, quality, accuracy, timeliness, and/or completeness of the BofAML indices or any data included in, related to, or derived therefrom, assumes no liability in connection with the use of the foregoing, and does not sponsor, endorse, or recommend CC&L Canada, or any of its products. This may contain information obtained from third parties, including ratings from credit ratings agencies such as S&P Global Ratings. Reproduction and distribution of third party content in any form is prohibited except with the prior written permission of the related third party. Third party content providers do not guarantee the accuracy, completeness, timeliness or availability of any information, including ratings, and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such content. THIRD PARTY CONTENT PROVIDERS GIVE NO EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE. THIRD PARTY CONTENT PROVIDERS SHALL NOT BE LIABLE FOR ANY DIRECT, INDIRECT, INCIDENTAL, EXEMPLARY, COMPENSATORY, PUNITIVE, SPECIAL OR CONSEQUENTIAL DAMAGES, COSTS, EXPENSES, LEGAL FEES, OR LOSSES (INCLUDING LOST INCOME OR PROFITS AND OPPORTUNITY COSTS OR LOSSES CAUSED BY NEGLIGENCE) IN CONNECTION WITH ANY USE OF THEIR CONTENT, INCLUDING RATINGS. Credit ratings are statements of opinions and are not statements of fact or recommendations to purchase, hold or sell securities. They do not address the suitability of securities or the suitability of securities for investment purposes, and should not be relied on as investment advice.

Source: MSCI. The MSCI information may only be used for your internal use, may not be reproduced or re-disseminated in any form and may not be used as a basis for or a component of any financial instruments or products or indices. MSCI makes no express or implied warranties or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data obtained herein. This report is not approved, reviewed or produced by MSCI.

Since the global COVID-19 pandemic began 17 months ago, we have seen a dizzying parade of investment themes (and memes) that have caught the imagination of investors big and small. From Electric Vehicles (EVs) to the latest canine-inspired crypto currency, and now NFTs (Non-Fungible Tokens) and the metaverse, where one can escape the harsh inflationary realities of post-pandemic life. At Global Alpha, we are not thematic investors, but we do rely on themes to offer tailwinds to companies that have been carefully vetted around our investment process.

Themes themselves can be broad-based and structural, or narrow and niche, fueled by the latest fad or trend. We tend to favour the former, which tends to last longer and influence a broad swath of the economy, cutting across sectors. Within emerging markets (EM) for example, a broad structural theme that is currently playing out is the increasing formalization of their economies. As per the International Monetary Fund (IMF), over 60% of the world’s adult labour force participates in the informal economy and accounts for around 35% of the GDP of emerging economies.

Also, informality is not evenly spread across the EM world; Latin America and Africa have higher levels of informality in comparison to East Asia. Emerging markets with large informal sectors tend to underperform and punch much below their weight. Several countries within our EM universe have been actively trying to remedy the situation in order to increase their overall economic productivity, increase the size of their tax base, and lift the living standards of their populations. One country that has really stood out in its push towards greater formalization of its economy has been India.

In the last five years, India has enacted three key measures to push its economy towards greater formalization. Firstly, demonetization of Rs 1,000 and Rs 500 notes in 2016 forced many informal workers to join the formal work force. Secondly, the implementation of Goods and Sales Tax (GST) forced unregistered firms operating in the cash economy to get registered and enter the formal economy. Finally, the first two measures acted as a tailwind for the rapid adoption of digital payments via the Unified Payments Interface (UPI) platform rolled out by the government. The net result, as per a recent report by the State Bank of India (SBI), is that the informal economy has now shrunk to 15-20% of GDP in 2020-2021, versus 52% of GDP in 2017-2018.

This recent shift towards formalization is a generational change and is impacting every sector of the economy. For the discerning investor, it offers an opportunity to identify winners and losers of this massive shakeout that is leading to consolidation and an increase in market power of a select few companies. A great example of this consolidation is the luggage industry in India, which is estimated to be worth around US$3 billion, of which only 25% is organized. The Indian luggage industry is projected to grow in the high teens, and this growth outlook is propelled by four interesting underlying trends.[3]

  1. Indians are travelling more and are making on average three trips every year as air traffic grew in double digits up to 2018.
  2. There is a rise in brand consciousness and luggage is now seen as a fashion statement rather than a mere utilitarian product.
  3. There is a higher spending on Indian weddings, where luggage is now included as part of the wedding trousseau.
  4. Replacement cycles have been reduced, with Indians replacing their luggage in four to five years (vs 10 years earlier) and their backpacks in two years (vs three to four years earlier).[5]

VIP Industries (VIP IN)

For us, a clear beneficiary of this trend has been VIP Industries (a portfolio holding), which, along with Safari Industries (SII IN; not a portfolio holding) and Samsonite (1910 HK; a portfolio holding), control more than 90% of the organized luggage space. VIP, however, is the clear market leader with a 52% market share, having been the number one brand in India for the last 50 years. VIP started in the 1970s, making briefcases for office goers, and the name VIP was meant to give its customers an aspirational tag. The company now makes hard and soft luggage, backpacks, and handbags.

With the entry of Samsonite in India, VIP was forced to rebrand and reinvent itself to cater to a younger and trendier demographic. The company decided to mimic Samsonite’s own successful international turnaround by focusing on clearly segmenting their brands, expanding distribution, cutting costs, and spending heavily on branding. In addition to this, the company decided to switch from a promoter-led entity to hiring professional management.

The combination of these company-specific changes and macro tailwinds, coming from the shift to the organized sector, has led to remarkable results for VIP. If one were to look at their financial performance from 2016, which marked the acceleration of the shift towards formalization, up to the end of 2019, before the pandemic, we see that the company’s EBITDA and net income has more than doubled. With zero debt, their return on invested capital (ROIC) grew from 19.5% in 2016 to 25% in 2019, as VIP decided to rely less on imports from China, and invest in their own manufacturing units in India and low-cost Bangladesh.

While the pandemic disrupted travel and led to a sharp drop in business at VIP, our discussions with management indicate that demand has rebounded sharply with pent up demand for travel and discretionary spending, such as weddings, leading to higher volumes. VIP intends to take advantage of the dislocations in Chinese manufacturing resulting from power outages by leveraging its new manufacturing capacities while launching new SKUs to capture the market share across segments. As the market and the Indian consumer slowly moves away from the unorganized market, we see VIP further consolidating its position as a market leader.

At Global Alpha, we remain committed to separating themes from memes and identifying winners who can clearly benefit from these once-in-a-lifetime shifts in emerging economies.

Have a nice day.

The Global Alpha team


[3] Ambit Capital Research

[5] Ambit Capital Research

Real Estate in Emerging Markets: Unlocking sustainable growth opportunities.

Emerging markets have had difficult times during COVID-19, however, we have seen that in several cases, the recovery has been faster than expected. Not only is this recovery due to higher vaccination rates, but also because of secular trends, especially in the emerging lower middle class where growth opportunities are just beginning. In our universe, one of the sectors where we see a great growth opportunity is in real estate. The main variables that drive tailwinds for the sector are:

  • Sustainable growth of the country, which implies that the emerging lower middle class can climb the ladder;  
  • Low interest rates, inflation, and unemployment; and
  • A consolidated industry with players who have good balance sheets and are focused on profitably.

In this environment, our largest overweight in the real estate sector is in India and Indonesia. One could argue that interest rates and inflation are currently on the rise in many countries, which is true. However, the rate hike process in Asian countries has been much slower, and structural growth remains intact. For example, in the case of India, current mortgage rates are at record low levels of under 7%, compared to more than 10% a decade ago. Indonesia rates are also likely to maintain low, which continues to favour growth in the real estate sector.

India’s last real estate cycle ended in 2013 and has not been able to recover since, due to several disruptions, such as demonetization in 2016, the roll-out of the Real Estate Regulatory Act in 2017, and the Non-Banking Financial Companies (NBFC) crisis of 2018. Likewise, India hasn’t experienced real price increases since 2013. Prices have increased 3-4% on average, below inflation each year and also below growth in income levels of around 8% per capita. So, what would make this cycle effectively sustainable from 2021 onwards? Some of the reasons were explained above. Moreover, In India, the real estate sector has experienced an industry consolidation that has driven inventory reduction (around 20%). With rising demand (also boosted by additional space required driven by the work-from-home scenario) and shrinking supply, price increases are most likely to occur for the following years; a phenomenon we haven’t seen in India for the last decade. Some factors that have contributed to the real estate sector’s boom include low interest rates, rising salaries, and explosive hiring’s (i.e., Infosys has hired close to 350,000 employees this year and salary hikes have been close to 120%). With government support to housing such as stamp duty cuts by the government of Maharastra, or Gujarat government measures in December 2020 such as the possibility of agricultural land being acquired for affordable housing, this support has changed sentiment and boosted demand.

In relation to housing affordability, mortgage installments in relation to monthly income have also been improving, changing the sentiments with all the other more favourable conditions. For example, in Mumbai, this index has improved from 93% in 2010 to 61% in 2020. In cities such as Ahmedabad, the index has improved to 24% in 2020, from 46% in 2010. This means that in this city, an average household needs to spend 24% of its income to pay monthly installments for the respective loan. Mumbai remains the most expensive market, but levels are improving.[2]

Another relevant variable to monitor are launches and inventory. Companies need to increase launches overall in order to capture increasing demand in a sustainable way. In 2015 and 2016, launches were approximately between 475 and 501 million square feet, decreasing to 135 million square feet in 2021.[3] Launches decreased progressively during these years, essentially due to inventory levels being too high. Inventory months hovered around 40-45 days between fiscal year (FY) 2016 and FY2020, and lowered 40 days in FY2021. In noting this, companies reinforced their efforts to liquidate their inventory first, with prices barely increasing at a 1% compound annual growth rate (CAGR) over 2015-2021, far beyond inflation. Inventory levels have lowered to 916,195 units in FY2021, to the lowest levels in 7 years.[4] Moreover, as FY2021 was a COVID-19 impacted year, the decline in new launches was steeper than normal, as H1FY2021 was virtually a wash-out and H2FY2021 was all about monetizing existing unsold inventory.

Moving forward, we should expect launches to pick up again. We foresee that the most relevant Indian developers are well positioned to capture this window of opportunities, considering good cost of funding, low leverage (as several raised equity during 2019-2020), liquidity access, lower inventory levels, and market share gains are likely to remain consistent due to the consolidation of the industry.

The real estate sector is behaving quite well in terms of volume increases, although sustainable price increases that can also mitigate the hike in raw material prices remain as a key challenge. The real estate market in India is very important for the country’s development as it is worth USD 150-180 billion, or 6-7% of the GDP, and is expected to reach 13% of the economy by 2025. It is the second highest employment generator in the country, after agriculture.[5]

In terms of the non-residential market, in 2019, the Indian office market closed with a record high of transactions, increasing by 27% to levels of 60 million square feet during the year. In 2021, new completions surpassed transactions for the first time since 2013. During FY2021 to FY2022, in the organized market, tech-related companies accounted for around 40% of office transactions in India, with renewed massive hiring and positive business forecasts anticipate their vacancy will remain low.[6]

We still can see some work-from-home effects lowering absorption levels, nevertheless, tech and other related sectors have lowered vacancies, which we expect to maintain at reasonable levels. Their expansion plans are also likely to improve net absorption. In the first nine months of 2021, transactions increased by 13% and completions by just 6% in relation to the same period last year, showing that the levels of activity are increasing to a great extent. Likewise, projects set for completion in 2021 and 2022 are pre-leased by multinational companies. Capitalization (cap) rates in key areas such as Mumbai remain very healthy at 6-8%. Economies, such as India’s, with a young workforce and without adequate infrastructure (possess separate spaces for work from home and also lacks air conditioning) favour a hybrid model, although with less working from home than in developed markets. Considering all the aforementioned, office demands and vacancies are expected to remain at healthy levels in the medium term. Bangalore, Mumbai CBD, and Pune maintain the lower vacancy levels in the main cities, hovering around between 5 and 10%.[7]

Prestige Estates Projects (PEPL IN)

In Indian real estate, Prestige Estates Projects is one of our key holdings. Over the last decade, the Prestige Group has firmly established itself as one of the leading and most successful real estate developers in India across all asset classes. The company currently has its principal presence in South India (Bangalore) and is the main developer to boast such a widely diverse portfolio, covering the residential, commercial, retail, leisure, and hospitality segments. During 2HFY2021, Prestige signed a term sheet with Blackstone to divest its entire stake in six operational office assets (6.6 million square foot), an 85% stake in nine retail malls (3.3msf) and a 50% stake in four under-construction office assets (7.4msf), along with two hotel assets – Oakwood and Aloft. The enterprise value, as per the term sheet, was settled at Rs 92 billion, with a cap rate of 8.5%. Part of the transaction will be used to clear the debt of the company’s annuity portfolio while the remaining inflow is likely to be utilized for expanding a residential pipeline (new joint venture/joint venture development agreements) and also accelerating capex for the annuity portfolio. The yield on cost expected for the new developments is 15-20%, much higher than the cap rate of the sold portfolio. Prestige will have almost 0.2x net gearing after completing the transaction, which is much better than 1.5x before the deal, which can foster re-leveraging in new projects, giving much higher yields as recently explained.

The company is one of the few Indian real estate developers with sound geographical expansion projects, ready to capture many growth opportunities in the rising emerging low-middle class. They are characterized for their good track record in Bangalore in terms of their execution and expansion capabilities. Prestige has almost doubled its sales since 2005 and has done so every 4-6 years following, and we expect the expansion to continue with all the new projects in Mumbai. Such expansion makes the company one of the more geographically diversified developers in India and they are mainly focused in Mumbai, where opportunities are huge.

The company is setting up four office complexes in Mumbai – two in BKC: one at Mahalaxmi and one in Jijamata Nagar. They have not yet started pre-leasing any of them as they have yet to receive all approvals (construction has not yet started). All of these are prime office markets, and HDFC has been the lender in these projects prior to acquisition by Prestige, continuing to remain as the lender. These three projects are with a single local developer, DB Realty. This month, they also launched their inaugural residential project in Mumbai – Jasdan Classic, located in Byculla. Once entering the market, execution risks should be lower. Mumbai has a more “local” culture where a younger population, living in small apartments, favours a work-from-office philosophy.

Management raised FY2022 presales guidance from Rs 65 billion to Rs 70-80 billion, and targets reaching presales of Rs 100 billion in the next three years (from Rs 55 billion in FY2021) and rental income of Rs 28-30 billion per annum in the next 7-8 years (versus Rs 2.6 billion now). To achieve such growth, it is essential that the company invests in new project acquisitions and capex. In a period of five years, Prestige expects Mumbai sales to be around 25% of their consolidated revenues. Such an important figure outside its home region (Bangalore) is relevant for an Indian developer and can be the second most important diversification success case besides Godrej Properties. For the long term, their non-real estate portfolio could be transferred to a REIT.

In Indonesia, we have seen a massive rebound to robust presales and high take-up rates at launches, which implies that demand for property remains very high, whereas prices seem to have bottomed up from previous years. Launches during the year have performed well, being concentrated IDR two billion (with a tapering off of take-up rates, as prices exceed this level) and located within reasonable vicinities of large cities, fulfilling their roles as satellite suburbs serving the working population of a metropolitan area. The Government has also taken measures to boost the real estate sector. The main measure was to provide temporary rebates until December 2021, in value-added tax (VAT) for property purchases (up to 50%) if they are priced below INR 5 billion and 100% rebate if they are priced below INR 2 billion. However, developers are lobbying to extend this program into 2022.[8]

Another important issue was the relaxation on the loan-to-value (LTV) for developers. Similar to India, the last real estate cycle in Indonesia ended in 2013. Before that, leverage was not an issue for developers, as many of the properties were self-funded and banks were willing to issue mortgages for at least 80% of the value of properties. Some mortgages included some buy-back clauses from the developer, effectively protecting the bank in case of any default. After the 2013 boom cycle (which ended in 2015), one of the ways the Bank of Indonesia tightened up was by limiting LTV requirements. As a matter of fact, after 2013, for houses larger than 70 square meters, the loan-to-value was approximately 70% and 60% for first and second homes.[9] The LTV has continuously been relaxed between 2015 and in 2020, driven by a COVID-19 stimulus LTV of 100% (in practice, it is around 90%). Moreover, disbursements of funds to developers was also limited and linked to the construction progress. For example, prior to 2013, the disbursement for developers was 80% linked to the signing of the mortgage deed. In 2013, this percentage was reduced to 0%, in 2018 to 30%, and in 2021 part of the government easing measures was increasing this percentage to 100%.Such relaxations are very important for developers’ balance sheets, as construction costs hover around 50% of the selling price, helping significantly with the deleveraging of the sector.[10] 

Considering the aforementioned, we are assuming growth in presales of 45% this year, 38% of which occurred in the first nine months of 2021, and was positively impacted by the VAT exemption. We also expect 10-15% for 2022-2023, which would be the first multi-year growth after the decline between 2018 and 2020. We don’t expect price increases similar to those in the 2010-2013 cycle; nevertheless, there is a probable scenario next year for prices to start rising after seven years, if the COVID-19 pandemic ends favourably and structural demand stays intact. Despite some tough years, Indonesia’s real estate prices have been extremely resilient, avoiding any declines as developers have usually preferred to sell less volumes, while not making discounts.

In summary, we think the Indonesian real estate market is ready for another positive cycle, driven by a combination of developers’ efforts, such as better presales, capex discipline, providing housing financing through hybrid mortgages and in-house installments, together with favourable policies from regulators, such as declining debt costs, lower inventory costs and lower debt rates. Rates can hike in the medium term, but should remain low in relation to previous cycles. All of the abovementioned has helped the main developers to strengthen their balance sheets.

Another phenomenon we could start to see, especially next year, is a return from investors to the real estate markets. This situation is by far not comparable to the massive boom of the 2010-2013 cycle. In those years, yields where roughly 9-10%, and currently, they are around 5-6%, similar to a government bond yield. Nevertheless, banks’ liquidity remains very high (supported by high CASA growth), with very low LDRs, and together with strong balance sheets, most developers are good enough to continue to provide hybrid mortgages and in-house installments. This in turn will make easier roads for investors who can also expect some revaluation of their properties if the positive cycle continues.

Regarding launches, those done in August and September, post the latest mobility restrictions, were all sold out, which is a good indication of demand status. The amount of launches this year has been around 5,000 units.[11] In Indonesia’s case, we have seen a greater proportion of launches in relation to inventory cleanup in India. The main reason for this is that Indonesia’s property mix is more oriented towards landed house projects. New launches are done after most of the units are sold, and therefore, inventory is not a high concern. In order to continue growing, companies have been much more dependent on new launches, and demand has responded well.

After the cycle of 2013, the Bank of Indonesia’s double-tightening measures made developers look at external ways of financing. Hybrid mortgaging was one of the most common alternatives, being a combination of installment and mortgages, where there was an option to put a 30% down payment by instalments of up to 36 months. At the end of period, the buyer has to pay the remainder of the purchase, which can be done in cash, but this is usually done by mortgage. For the developer, as the house is under construction, these instalments are booked as liabilities as customer advances. Considering down payments are usually the hardest milestone for homebuyers, hybrid mortgages have helped their affordability. Extended down payments can also improve the buyer’s approval rates for loans because they provide more time for buyers to improve their credit profile, and also lower their LTVs. Currently, this mechanism is used in a lower extent, considering required down payments are lower (10-15% as market conditions have improved).

Regarding non-residential real estate, mall and office owners have begun reducing rental discounts, as traffic and occupancies have been recovering, and are likely to continue accelerating. Majority of shopping centres started the year with an average discount to tenants of 50%, and after the reopening in the third quarter, foot traffic recovered much more quickly than expected, so the discount has been lowered to 40%. By the second half of next year, it is most likely that we should see pre-COVID-19 rental income for malls. The office market has continued under oversupply since 2014, thus rents are not expected to rise, while also considering the work-from-home environment.

Ciputra Development (CTRA IJ)

One of the primary beneficiaries of the property market recovery in Indonesia is our holding Ciputra Development. Ciputra Development is one of Indonesia’s leading property developers, and is involved in both residential townships, as well as mixed development. Landed houses account for a major portion of Ciputra’s projects. The company also develops and operates a range of investment properties (i.e., malls, hotels, hospitals, and offices). In 50% of its projects, Ciputra employs an asset light business model, with revenue/profit share agreements with various local developers, providing the company with additional development opportunities in a balance sheet efficient manner. It currently has over 75 projects in 33 cities across the country. The company has one of the most extensive land banks in Indonesia (2,300 hectares), which implies over 15 years of assured developments and high margins in the medium term. This company fits very well in this article thesis about secular trends in emerging markets due to its huge potential in mid- and low-market segments, which are heavily underserved (total addressable market (TAM) of around 120 million people (middle-to-low income bracket), including 65 million millennials). The affordable housing business (average selling price (ASP) under Rs2 billion) has a massive potential, driven by the extensive population.

Ciputra is also tapping into geographical diversification across the major markets of the country, and has established developments in Greater Jakarta and Borneo, expanding to Semarang, Surabaya, Manado, Palembang and Makassar, currently present in 33 cities.

The urbanization trend (which has increased from 49% in 2009 to 56% in 2019) and the availability of mortgage facilities, represents strong tailwinds for the mid-long term. In relation to its residential business, even though the majority of its 55 residential projects are focused on low- to mid-income segments (65% of its 1H21 presales are priced at less than Rp 2 billion), 8 of its projects target upper income segments. In the commercial business, a Possible REIT or other method exit of portfolio of properties at good cap rates and re-allocation of capital at better yields on cost is always an alternative. Ciputra is enjoying a healthy 9M21pre-sales recovery over 33% year over year and 86% of the company’s target for the full year. For 2022 and 2023, we expect low-digit growth, with 2022 being very dependent when the VAT benefit will end.  Overall, Ciputra has superior margins, a good balance sheet, and low debt, and we expect the company to continue operating at strong levels.

In terms of recurring revenue (i.e., shopping centres, offices, and hotels), we expect it to contribute 18-19% 2021E and increase to 25-27% in FY2022-2023E. Recurring revenue brings stability to cash flows, and their normalization and acceleration in the following years is positive for the company and the stock. Ciputra expects normalization of tenant rates (to pre-COVID-19 levels) from FY2022 and its latest development, Surabaya mall, phase two, started reopening in the second quarter of 2021, where occupancy rates are expected to be around 90% by year end.

In emerging markets, it is important to be able to identify secular trends because it’s related to the fact that emerging lower-middle segments can gradually increase their purchasing power, well-being, and quality of life. However, in order to add value to our clients, we are constantly looking for the companies that can capture the best growth opportunities in this favourable environment. In this sense, we pay close attention to the quality of balance sheets, growth prospects, cash flow generation and management quality, among other things. Ciputra Development and Prestige Estates Projects are two good examples of quality companies enjoying favourable tailwinds.

Have a nice day.

The Global Alpha team


[2] Knight Frank Research

[3] ICICI securities and Liases Foras

[4] Jefferies presentation

[5] https://www.businessinsider.in/

[6] Knight Frank Research

[7] ICICI Securities and Cushman Wakerfield

[8] Just to quantify VAT Is 10% so the waiver for projects below INR 2billion is INR 200 MM, enough for buying a mid-high end car

[9] Mandiri

[10] Mandiri

[11] Citibank

Investing in Emerging Markets (EM) equities never gets boring. One of the main reasons why we love our job is that every day presents us with a dynamic set of challenges and opportunities. In our September 16 commentary, we discussed the crux of the ongoing regulatory changes in China from a local perspective, the impact on different sectors of the economy, and the steps we are taking to position our portfolio accordingly. However, China is not the only country in our investable universe where the government decided to step in and attempt to fix some areas where the free market’s invisible hand allegedly failed.

In August, we witnessed a regulatory crackdown on technology companies spread to South Korea. Many investors in that country reacted rapidly and rushed for the exits, likely spurred by their wounds sustained in China, where tech giants lost 30-50% of capitalization from their peak levels. As a result of the low tolerance of undergoing the same experience, they wiped tens of billions of United States dollars (USD) off the local tech titans’ market value.

Unlike the Chinese government ambitiously reshaping nearly every sector of their economy, the Korean regulators appear to be highly focused on addressing issues in the technology business. Leading internet platforms, both foreign and domestic, have been thoroughly scrutinized and repeatedly criticized by politicians from different parties for abusing their dominant market position and hurting competition in the pursuit of profits, aggressive expansionary business practices, personal data usage, and high commission rates, putting pressure on small and medium-sized enterprises (SME). For instance, Kakao is one of the leading Korean big tech companies, and until not so long ago was the third domestic company by market capitalization. Kakao started as a messaging platform and expanded into consumer finance, payments, gaming, and ride-hailing businesses, among others; with nearly 120 affiliates Kakao has been compared to an octopus by critics. While commenting on the topic, the leader of the ruling Democratic Party of Korea said, “Kakao must not follow the steps of the country’s other conglomerates that ignored fairness and coexistence in the sole pursuit of profit.”

Furthermore, some critics and lawmakers have advocated to adopt measures to prevent big tech companies from monopolizing online services, making it more difficult for larger platforms to acquire smaller peers. Senator Chung, from the People Power Party, suggested further enforcing the Telecommunications Business Act to restrict larger platforms’ M&A activities. He also pointed out that Korean internet is a winner-take-all market with quite grim consequences for the vanquished, likely reminiscent of the Netflix show Squid Game, as larger platforms have over 90% market share. Other lawmakers are pushing to allow smaller companies to gain access to user data accumulated by dominant platforms, creating an ecosystem where big tech companies and emerging operators can grow and innovate together and ultimately benefit consumers and the economy as a whole.

Let’s review the chronology of the main regulatory events:

One can argue that the upcoming March 9, 2022 presidential election in South Korea is the main reason why politicians are bringing up issues and bills targeting big tech companies. Coincidentally or not, five years ago, it was the family-run conglomerates (also known as “Chaebol”) that came under attack, and were accused of enriching themselves by abusing their dominance and applying unfair practices. Also, lawmakers traditionally pressured telecom companies on pricing plans as an efficient way to gain publicity.

Amid growing scrutiny and accusations from lawmakers and regulators, several big tech names pre-emptively announced action plans to appease critics by abandoning some business segments, providing support to SMEs and scrapping plans to compete with small mom-and-pop businesses. For example, Kakao announced their plans to withdraw from the hair salon, flower, snack, and salad delivery businesses. The company also created a $255 million fund for suppliers’ support in addition to other steps aimed at strengthening its corporate social responsibility.

Although the new rules announced by the government so far have limited impact on business fundamentals, the concerns of further regulatory tightening affected the market sentiment and put pressure on the technology sector. By and large, small-cap companies are less prone to the current regulatory headwinds as they usually do not exercise overwhelming market dominance, nor do they employ aggressive expansionary business practices similar to Kakao and Naver, and remain out of sight from the politicians and general public. Moreover, we believe some of our holdings are in a relatively safer position or can even come out as net beneficiaries when the dust settles.

NICE Information Service (030190 KS)

NICE Information Service is the leading credit bureau (CB) in Korea, providing consumer and corporate credit information, risk management consulting, and debt collection services. It has the largest number of members in both the financial and non-financial sectors. The company is poised to benefit from structurally higher demand for retail credit checks due to the ongoing expansion of near- and sub-prime markets, increased competition among Korean lenders (leading to higher turnover of existing loans), a greater focus on unsecured lending, deregulation (enabling more product launches), and retail customers (who are becoming increasingly careful about their credit scores).

NICE Information Service is the only CB in Korea with exposure to consumer and corporate fields, with the most robust financial big data capabilities accumulated over 30 years (database of 43 million consumers and 2.2 million corporates). It has also secured non-credit and non-financial data, such as telecommunication, rental, and social info by collaborating with numerous partners. Consumer CB and big data businesses are expected to be the primary growth drivers of the company. We believe NICE Information Service should be one of the primary beneficiaries of the lawmakers’ initiatives to allow smaller companies to gain access to user data from dominant tech platforms.

NKN KCP (060250 KS)

NHN KCP (“Korea Cyber Payment”) is the leading online Payment Gateway (PG) service provider with a 24% market share. PG is a settlement service that authorizes credit card payments for online retailers. It encrypts credit card information and sends transaction data directly to credit card companies, bypassing merchants’ systems, and thus keeping credit card information confidential. PG also withholds payment until the merchant fulfils the transaction, allowing online shoppers to avoid fraudulent sellers. NHN KCP also runs online and offline Value-Added Networks (VAN) and Online-to-Offline (O2O) businesses. Online VAN service, connects online merchants with credit card companies through secure communication networks to approve credit card transactions. Offline VAN service, connects offline merchants with credit card companies through secure communication networks to approve card transactions. The O2O business empowers SMEs and facilitates payment processing in offline channels.

NHN KCP serves over 150,000 domestic and global merchants. The company is one of the key beneficiaries of the ongoing structural growth of e-commerce and digital content consumption, credit cards’ share gains from other payment methods, and growing overseas transactions. NHN KCP provides Korean merchants with frictionless payment processing capabilities by charging highly competitive take rates (e.g., in the range of 0.10-0.12% for domestic PG). In general, the current PG take rates in South Korea are among the lowest globally and do not catch the eyes of lawmakers as being predatory. For instance, in the e-commerce business, Coupang charges its merchants take rates as high as 8-10%, which has been seen as taking advantage of mom-and-pop companies with no alternative. Also, the food delivery platforms charge take rates of 8-12% of total transaction volume. One of the main market concerns in the investment case of NHN KCP is the risk of its largest clients following the suit of eBay Korea and Naver Pay, to build their in-house PG capabilities and bypass third-party PG companies. The government push against big tech’s aggressive expansion in different verticals might cool down these potential intents and lower the risk of clients’ attrition for NHN KCP. Moreover, the company can gain extra business if one of the tech giants decides to outsource PG capabilities.

AfreecaTV (067160 KS)

AfreecaTV (“anybody can freely broadcast”) is the most prominent Korean live streaming platform, where anyone can broadcast gaming, sports, and various entertainment content free of cost. Instead of paying a subscription fee, the viewers show their appreciation by donating virtual gifts (Star Balloons) to broadcasters (Broadcast Jockeys or BJs). AfreecaTV takes 35% commission from these gifts donated to its BJs. In addition, it sells advertising products (branded content, banner ads, video ads and other solutions) to various brands. The platform has over 17,000 active BJs and hosts over 20,000 live streams per day. AfreecaTV is one of the few available options in the EM universe, providing exposure to e-sports. Gaming content drives over 60% of traffic, while around 30% of its gifting revenue and 50% of advertising revenue are derived from e-sports content.

The company enjoys a substantial supply of top BJs while supporting them financially and via collaboration in creating unique content and providing facilities for professional production and e-sports events. A BJ support department is available 24/7 and top BJs are locked in through exclusive agreements with AfreecaTV. A deep bench of highly popular broadcasters and exclusive content keeps its viewer base sticky. We expect the platform monetization to improve on the back of investments in content and BJ support. Rising content quality should drive a steady user base growth, enhance engagement, and lift the proportion of paying users and average revenue per paying user. In addition, AfreecaTV ad revenue is becoming the long-awaited second source of growth. It is poised for solid expansion, from nearly 20% of the mix to 50% in five years, primarily driven by branded content. Democratization of the data accumulated by large platforms can bring new opportunities for AfreecaTV’s ad business.

Have a great day.

The Global Alpha team

The strategy generated a net return of 2.3% in Q3 2021, bringing returns for the nine months of the year ending September 2021 to 7.2%.

Vergent Emerging OpportunitiesYTDITD
2018 (Inception Aug 1st)-3.7%-3.7%
20195.9%1.9%
20200.7%2.7%
20217.2%10.0%

The strategy’s performance in the quarter was driven by three key factors:

  1. Reopening sensitivity in the retail and financial services portfolio in Indonesia and the Philippines as those economies emerge from their respective lockdowns as a result of a ramp up in vaccinations in the key economic centers.
  2. A re-rating of our Moroccan portfolio following the results of the parliamentary elections, which saw the long-dominant Islamist party (Justice and Development Party) suffer a major defeat at the hands of pro-business parties led by the Independent National Rally party.
  3. Positive reaction to a strong results season and upgraded guidance from some of the strategy’s largest portfolio companies including Integrated Diagnostics Holdings in Egypt and Jordan and Century Pacific in the Philippines.

In our last letter, we referred to an unnamed investment in the Philippines, which we can now reveal to be Wilcon Depot Inc., the largest home improvement retailer with 70 stores nationwide. Our investment in Wilcon was undeniably triggered by the reopening of the Filipino economy, which should unlock private building and construction activity, the main demand generator for Wilcon’s tiles, building materials, electrical and lighting, and paints lines. However, our thesis is built on a long term view of the company’s ability to leverage its scale, zero debt balance sheet, and management capacity to grow the overall market for home improvement and DIY retail, and consolidate shares from smaller and unorganized competitors who have been weakened by the Philippine’s dismal handling of the COVID-19 pandemic. Wilcon’s private label and exclusive lines are also a key element of its strategy to grow like-for-like sales and increase margins with the latter experiencing a step change (+200 basis points) in the last few quarters. This has been a key driver behind consensus upgrades as management affirmed this is the new level of profitability going forward. Wilcon’s management has done a solid job of managing the business in a very difficult environment through active SKU management, supply chain control, store network expansion, and investment in online channels.

In Morocco, the strategy owns two companies in retail and payments technology, sectors that should see real gains from the positive political picture that is emerging there. Morocco has generally been a very good market for the strategy as it benefits from political stability, low inflation, a stable currency, and a large domestic institutional liquidity pool that supports equity market valuations. The country has also been relatively successful in the handling of the COVID-19 pandemic. As travel resumes, Morocco’s large tourism industry should see a strong recovery (it represented approximately one fifth of the economy in 2019). The newly elected government has the technical and political capacity to execute on reforms that will likely only add to the investment case for Morocco and as such, we continue to be bullish on the strategy’s positioning there.

We are seeing earnings upgrades across a few of the strategy’s portfolio companies, which have also been supportive of the strategy’s recent performance. We highlight Integrated Diagnostics (IDH), the leading laboratory and diagnosis chain in Egypt, Jordan, and Nigeria, which posted exceptionally strong results in the first half of this year with revenue, operating profits and operating cash flows growing 1.4x, 2.9x, and 4.8x respectively versus the same period last year. This strong growth partly reflects a low base last year, but it is also a reflection of increased demand for COVID-19 related testing and the success that management has had in scaling its home testing services (i.e., collection of samples from home and sending test results digitally), which averaged out to 3.6k visits a day in the first half of the year. IDH signed a $45 million facility with the International Finance Corporation (IFC), which it can draw to fund inorganic growth on top of the approximate $80 million of cash on its balance sheet. We also expect IDH’s management to recommend an exceptional dividend once the year concludes given the strong cash generation this year.

We believe that the strategy is entering a strong earnings growth cycle underpinned by the reopening of economies, structural adoption of digital products and services that the portfolio is over-indexed to, innovation from aligned management teams in areas of product development and distribution, and operating leverage that will kick in on the back of sustainable efficiencies that portfolio companies have realised in the last 12-18 months. The strategy remains concentrated but geographically diverse, a reflection of a portfolio construction philosophy that is focused on generating returns from company rather than country/region and that favours long-term value creation over short term returns.

Vergent Asset Management LLP


DISCLOSURES

1. Unless otherwise stated, all data is at September 30, 2021 and stated in US dollars (US$). Source: Connor, Clark & Lunn Financial Group, Thomson Reuters Datastream.
2. Performance history for the Vergent Emerging Opportunities Strategy is that of the Vergent Emerging Opportunities Composite. The Composite has an inception and creation date of August 2018.
3. Net performance figures are stated after management fees, estimated performance fees, trading expenses and before operating expenses. Operating expenses include items such as custodial fees for pooled vehicles and would also include charges for valuation, audit, tax and legal expenses. Such additional operating expenses would reduce the actual returns experienced by investors. Past performance of the strategy is no guarantee of future performance; Future returns are not guaranteed and a loss of capital may occur. For illustrative purposes, performance fee of 20% on added value over the hurdle rate of 6% plus the management fee of 1.25% have been assumed. Actual management fees charged to a particular account may vary.
4. There is no benchmark for the Vergent Emerging Opportunities Strategy because it has an absolute return objective
5. Standard Deviation measures the dispersion of monthly returns since the inception of the strategy.
Benchmarks and financial indices are shown for illustrative purposes only, are not available for direct investment, are unmanaged, assume reinvestment of income, do not reflect the impact of any management or incentive fees and have limitations when used for comparison or other purposes because they may have different volatility or other material characteristics (such as number and types of instruments) than the Strategy. The Strategy’s investments are not restricted to the instruments comprising any one index and do not in all cases correspond to the investments reflected in such indices.
These materials (“Presentation”) are furnished by Vergent Asset Management (“Vergent”) on a confidential basis for informational and illustration purposes only. This Presentation is intended for the use of the recipient only and may not be reproduced or distributed to any other person, in whole or in part, without the prior written consent of Vergent. Certain information contained in this Presentation is based on information obtained from third-party sources that Vergent considers to be reliable. However, Vergent makes no representation as to, and accepts no responsibility for, the accuracy, fairness or completeness of the information contained herein. The information is as of the date indicated and reflects present intention only. This information may be subject to change at any time, and Vergent is under no obligation to provide you with any updates or amendments to this Presentation. This Presentation is not an offer to buy or sell, nor a solicitation of an offer to buy or sell any security or other financial instrument advised by Vergent. This Presentation does not contain certain material information about the strategy, including important risk disclosures. An investment in the strategy is not suitable for all investors, and before making an investment in the strategy, you should consult with your professional advisor(s) to determine whether an investment in the strategy is suitable for you in light of your investment objectives and financial situation. Vergent does not purport to be an advisor as to legal, taxation, accounting, financial or regulatory matters in any jurisdiction, and the recipient should independently evaluate and judge the matters referred to in this Presentation. Vergent Asset Management LLP is registered in England and Wales with its registered office address at 8th Floor, 1 Knightsbridge Green, London SW1X 7QA, United Kingdom (Companies House number OC418829) and is authorized and is an Exempt Reporting Adviser in the USA. It is regulated by the Financial Conduct Authority (FRN: 791909).
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