AFC Asia Frontier Fund – 2023 Review And Outlook For 2024

2023 was an excellent year for the AFC Asia Frontier Fund and for Asian frontier markets. The AFC Asia Frontier Fund and our investment universe significantly outperformed global benchmark indexes and other peer Asian stock markets. With a year-to-date performance of +22.7% as of 30^th November 2023, the AFC Asia Frontier Fund is one of the best performing frontier funds globally this year.

In last year’s Review and Outlook, we wrote that we were cautiously optimistic as we believed that the fund and Asian frontier markets were well positioned for a re-rating in 2023. This was because, in our view, the key headwinds of higher inflation and higher interest rates had peaked out and we thought some of these headwinds had a chance to become tailwinds for Asian frontier markets in 2023.

During 2023 (especially towards the second half of the year), we saw both inflation and interest rates come down remarkably in many of our markets. Georgia, Kazakhstan, Sri Lanka, and Vietnam are some of the key markets in our universe that cut benchmark interest rates in 2023. This played an important role for the excellent fund and stock market performances. In addition to this more favourable interest rate environment, significantly discounted valuations and greater macroeconomic stability also drove overall returns, especially in Pakistan and Sri Lanka.

Looking forward to 2024, we expect the positive performance for the AFC Asia Frontier Fund and the Asian frontier stock markets to continue as we believe 2023 was only the start of a broad-based rally in Asian frontier equity markets. The key factors which will drive returns in 2024 will be:

1. Continued monetary easing in key countries like Georgia, Kazakhstan, Sri Lanka, and especially Pakistan.
2. With a more benign macroeconomic environment and lower interest rates, we expect a strong earnings recovery in Bangladesh, Pakistan, Sri Lanka, and Vietnam, while Georgia, Kazakhstan, and Uzbekistan should continue with their stable earnings growth.
3. Discounted fund valuations which still have lot of room to re-rate despite a rally in 2023. The AFC Asia Frontier Fund still trades at a very low P/E ratio of only 6.5x.

More importantly, the key global headwind which has been an overhang on global stock markets since the start of 2022, i.e. a hawkish U.S. Fed, has now abated as the Fed announced a pivot at its recent monetary policy meeting with interest rate cuts expected in the U.S. in 2024.

This change in interest rate outlook by the U.S. Fed and possibly other global central banks will be one of the key drivers of buoyant sentiment across global stock markets and will also support the positive momentum in Asian frontier markets.

2022 was the bottom for Asian frontier markets, 2023 was the year of the rebound, and in our view, 2024 will be “the” year of Asian frontier markets as all the important positive triggers fall into place – Asian frontier markets are well positioned at the right time and right place.

The AFC Asia Frontier Fund has Significantly Outperformed Global Benchmark Indexes(Year to Date Total Returns in USD)

2023 Review – The Year of Re-Rating

Asian frontier stock markets delivered a very robust performance in 2023, well ahead of most Asian emerging markets. In fact, many other major stock markets in Asia, like China, Malaysia, the Philippines, and Thailand have delivered negative returns this year. With a return of +22.7% for the AFC Asia Frontier Fund, an investor would have been better off investing in Asian frontier markets and diversifying away some sub-standard returns from other Asian markets.

Asian Frontier Markets Have Significantly Outperformed Most Asian Emerging Markets in 2023(USD returns year to date)

Though a more stable macroeconomic environment and rock-bottom valuations supported an upward re-rating in Asian frontier markets, the key positive triggers in our view were falling inflation and lower interest rates. Since central banks in our universe raised interest rates in 2022 very aggressively in light of a hawkish U.S. Fed and the war in Ukraine, they also had room to cut interest rates once the overall macro-situation concerning inflation stabilised.

Towards the second half of 2023, we witnessed interest rate reductions from central banks in Georgia, Kazakhstan, Sri Lanka, and Vietnam. This played a significant role in improving domestic investor sentiment.

Inflation has Fallen Considerably in many Asian Frontier Countries (in %)

Asian Frontier Central Banks Have Already Begun their Interest Rate Easing Cycle (Basis Points Cut in Benchmark Interest Rates in 2023)

Drivers of Performance in 2023

For the AFC Asia Frontier Fund, returns were broad-based and were generated across almost all our markets. Positive returns by contribution to performance were led by Iraq, Kazakhstan, Sri Lanka, Pakistan, Vietnam, Georgia, and Cambodia.

Iraq

In Iraq, the AFC Asia Frontier Fund gets its exposure via the AFC Iraq Fund (through a share class without management and performance fees), which has had a stupendous year with a return of +97.4%. This outstanding performance by the AFC Iraq Fund was one of the key drivers of overall performance in 2023 for the AFC Asia Frontier Fund.

Massive Outperformance by the AFC Iraq Fund in 2023 – The AFC Asia Frontier Fund is Invested in the AFC Iraq Fund

Kazakhstan

In Kazakhstan, the fund holds three positions: Kaspi, Halyk Bank, and Kazatomprom. All three positions contributed to positive performance in 2023 thanks to solid earnings growth. Kaspi and Halyk Bank are the fund’s largest and second-largest stock positions, and both have delivered impressive earnings growth in 2023 which has been reflected in positive stock price performances. The fund’s third Kazakh holding, Kazatomprom, is the largest uranium producer globally and one of the best proxies for the growing future demand for uranium since many countries shift to nuclear power generation in order to meet their climate change commitments and electricity demand.

The Fund’s Kazakh Positions did Well in 2023 – Kaspi and Halyk Bank are the Top 2 Stock Positions

Sri Lanka

Performance in Sri Lanka was driven by the two banks that the fund holds in the country, as their deeply discounted valuations rebounded positively thanks to the country’s domestic debt restructuring. This exercise did not have a negative impact on the bank’s balance sheets and in fact led to provision reversals on certain bonds. We expect the rally in Sri Lankan banks to continue in 2024 as there is more room for provision reversals, while loan growth should pick up as the economy recovers and interest rates decline further.

The other key positive contributor to fund performance in Sri Lanka was Sunshine Holdings, which is the fund’s largest position in Sri Lanka. This company’s consumer and healthcare business is outperforming the competition, leading to strong earnings growth and resulting in a very attractive 2024 P/E ratio of 5.4x.

Key Sri Lankan Holdings Outperformed the Colombo All Share Index

Pakistan

In Pakistan, the fund’s largest position is Lucky Cement, which delivered the majority of the fund’s returns in Pakistan and outperformed the benchmark KSE-100 Index by a large margin. We believe Lucky Cement is one of the best proxies for Pakistan’s economic recovery due to its diversified exposure to automobiles, cement, chemicals, and power generation.

Lucky Cement is the Fund’s Largest Position in Pakistan and Main Performance Contributor in Pakistan

Vietnam

The fund’s two largest positions in Vietnam, FPT Corp. and Gemadept, drove performance as both stocks notably outperformed the benchmark VN-Index. Furthermore, the AFC Asia Frontier Fund’s Vietnam positions have returned +11.4% in USD terms vs. +5.8% for the VN-Index. This is the second year in a row that the AFC Asia Frontier Fund’s Vietnam positions have outperformed the VN-Index in a generally tough stock market environment in Vietnam. This all boils down to superior stock selection and remaining invested in the names we are convinced in.

AFC Asia Frontier Fund Vietnam Holdings Outperformed the VN-Index led by FPT and Gemadept

Georgia

The fund holds one position in Georgia, TBC Bank Group. TBC Bank’s stock price, besides delivering good returns in 2023, has almost doubled since the fund’s initial purchase in September 2021. In addition to a strong macroeconomic environment in Georgia driving the bank’s profitability, its banking operation in Uzbekistan is now contributing 5% of total net profits, and we expect Uzbekistan to continue to be a strong growth driver for the bank in the next 3-5 years.

TBC Bank Stock Price has Done Very Well for the Fund Since our Initial Purchase in September 2021

Cambodia

In Cambodia, the fund holds the gold miner Emerald Resources which is listed in Australia. The company has already started producing gold and became highly profitable with annual net profits of USD 51 mn in 2023. In addition to this, we like the stock as a good proxy for the current bull run in gold prices.

Gold Producer Emerald Resources has been a Big Outperformer for the Fund in 2023

There are three key points to note from the stocks above that have contributed to fund performance in 2023:

1. The stocks have significantly outperformed their respective country benchmarks
2. These stocks are our top picks in our universe
3. These positions have been part of the fund over the past few years. None of the above stocks were bought as new positions in 2023. We did, however, increase some of these existing positions during the year.

2024 Outlook – Positive Triggers have Aligned for a Strong Rally in Asian Frontier Markets

2023 has been good for Asian frontier markets and fund performance, but we believe that the momentum will continue in 2024 for the following key reasons:

1. Monetary Easing by Global Central Banks

Hawkish monetary policies since the start of 2022 have been the major reason for keeping a lid on sustained stock market rallies globally. With the U.S. Fed announcing a pivot to interest rate cuts in 2024, this would be taken as a cue by other global central banks that they can go easy on their hawkish stance in 2024. This synchronized move to a dovish or less hawkish stance by global central banks will be extremely positive for equity market sentiment globally.

In Asian frontier markets, we have already seen how lower interest rates correlate to strong stock market rallies, as we witnessed in Sri Lanka earlier this year. Furthermore, despite some central banks in our universe already cutting interest rates, there is still a lot of room for them to reduce further, given that most of these central banks raised interest rates very aggressively in 2022. We believe Georgia, Kazakhstan, and Sri Lanka will continue their monetary easing in 2024 which will be positive for stock prices in these markets.

However, we expect that Pakistan will have the most significant interest rate cuts in our universe in 2024. The State Bank of Pakistan has raised interest rates by 15% since September 2021 to an all-time high of 22%. As inflation begins to decrease, we believe the State Bank of Pakistan could reduce interest rates by 600-700 basis points which will be extremely positive for the KSE-100 Index as domestic investors would rotate their fixed income and bank deposits into the equity market.

Fed Funds Futures are Pricing in Interest Rate Cuts in the U.S. in 2024 (in %)

Benchmark Interest Rates in Pakistan are at an All Time High – 2024 Could See Aggressive Interest Rate Cuts in Pakistan as Inflation Decreases

2. Earnings Recovery

Another key driver for the continued re-rating in Asian frontier markets will be the strong earnings recovery led by Bangladesh, Pakistan, Sri Lanka, and Vietnam. Earnings growth in these economies is recovering from a low base due to the headwinds they have faced in the past 12-18 months. Earnings growth will be led by both economic recovery and lower interest rates. Additionally, we expect a turnaround in net profits which will also be very positive for investor sentiment and stock prices.

Bangladesh, Pakistan, Sri Lanka and Vietnam Will Drive the Earnings Recovery in 2024 (Net Profit Growth)

3. Discounted Valuations

Valuations in Asian frontier markets are at a discount to history, especially in Pakistan. The two key factors to re-rate these valuation multiples higher should be in place in 2024: lower interest rates and a rebound in earnings growth. Taken together, we believe the twin tailwinds of lower interest rates and higher earnings will be a very positive trigger for a valuation re-rating for Asian frontier markets in general and for the performance of the AFC Asia Frontier Fund in particular.

AFC Asia Frontier Fund Trades at an All-Time Low P/E Ratio Despite a Strong 2023 Performance

Valuations at a Discount to History in Asian Frontier Markets

Our 2024 Calls

1. South Asian Frontier Markets Can Outperform in 2024

In terms of relative performance, we believe South Asian frontier markets like Bangladesh, Pakistan, and Sri Lanka will outperform in 2024 as these economies are coming out of a crisis, will see an earnings rebound, and have deeply discounted valuations.

Pakistan and Sri Lanka are well positioned for a continued stock market rally in 2024, since we forecast large interest rate cuts in Pakistan next year while lower interest rates begin to positively impact Sri Lanka. Though Bangladesh should see an earnings recovery next year, any stock market re-rating could happen in the second half of 2024 once ongoing macro adjustments peak in the first half of next year.

Furthermore, these countries are not very exposed to exports. Hence, if there is an economic slowdown in the U.S. and E.U, the impact on these economies will not be as severe as in very trade-dependent countries. Exports as a % of GDP for Bangladesh, Pakistan, and Sri Lanka are relatively low at 12%, 7%, and 17% respectively.

2. Central Asian Frontier Markets to Provide Stable Returns in 2024

Our Central Asian universe of Georgia, Kazakhstan, and Uzbekistan should continue to have positive returns in 2024 with an outlook of both consistent macroeconomic metrics and earnings growth. For these countries, exports as a percentage of GDP are not extremely high, with Georgia, Kazakhstan, and Uzbekistan at 24%, 37%, and 19% respectively. Furthermore, Uzbekistan’s exports to the U.S and E.U. are extremely low at less than 10% of the country’s total exports. Hence, we believe that if there is a marked slowdown in the economies of the U.S. and E.U. the relative impact on South Asian and Central Asian frontier markets should be lower.

Central Asian and South Asian Frontier Economies are Not Significantly Exposed to Exports (Total Exports as % of GDP)

3. Vietnam is One of the Best Long-Term Stories in Asia

With a 3-5 year view, Vietnam continues to stand out as it is the key beneficiary in Asia of the global supply chain shift, which should drive both its overall exports and economic growth higher. Vietnam should be able to return to GDP growth of 6-6.5% from 2024 onwards. For a large re-rating in Vietnam, however, we need to see earnings growth/GDP growth that is better than expectations since there is not much room left on the monetary policy side to drive a significant market rally.

The AFC Asia Frontier Fund is well positioned in all the above regions with an exposure of approximately 25% to Central Asian frontier markets, 20% to South Asian frontier markets, and 11% to Vietnam. The fund intends to increase its exposure to Pakistan and Sri Lanka in the first quarter of 2024.

Risks to Watch Out For

Though we remain broadly positive on frontier and emerging markets in general and on Asian frontier markets in particular, one key development to watch out for is the outcome of the U.S. Presidential election at the end of 2024. However, going into 2024, we expect the current positive triggers to drive strong positive global stock market sentiment, especially in the first half of 2024.

Conclusion

The AFC Asia Frontier Fund’s universe has a very good platform to see a continued rally in 2024 via lower interest rates, an earnings recovery, and discounted valuations. We would not be surprised if the NAV of the AFC Asia Frontier Fund goes back to its all-time high by the end of 2024, which reflects our confidence in the outlook for Asian frontier markets.

Some of the ways to get exposure to frontier markets in general are through ETFs such as the iShares MSCI Frontier 100 ETF (FM). However, besides giving exposure to Asian frontier markets, these ETFs would also have exposure to other frontier markets such as Kenya, Morocco, Nigeria and Romania.