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The year ended on a high note across the board for equity markets. The MSCI EM Index gained close to 8% in USD in the quarter, resulting in a full-year return of nearly 10%. Despite the robust gain for the asset class, emerging market (‘EM’) equities continued to underperform developed markets.
The dominant feature in the period was a growing expectation that central banks would start cutting interest rates sooner and faster than expected, resulting in nearly all (with the notable exception of commodities) risk assets rallying significantly.
Latin American markets drove the index gains, with Mexico and Brazil each gaining around 18%. Furthermore, investor sentiment was boosted by optimism around the future trajectory of U.S. interest rates. At the same time, macroeconomic factors continued to point positively where, in Brazil, the current account is close to a surplus, which would be the first time since the commodity boom of the 2000s.
In Asia, China was again the laggard, with a loss of 4%. While concerns persisted around the health of the consumer and leverage in the property sector, the big story in the quarter came late in December when the National Press and Publication Administration published new online game administration rules, which were harsher than expected. Stricter restrictions on in game spending were mentioned, while gaming approval licenses will now only be valid for one year, among other restrictive measures.
Portfolio Performance & Attribution
Over the fourth quarter of 2023, the Polen Global Emerging Markets Growth Composite Portfolio (PGEIX, the “Portfolio”) returned – 6.64% gross and 6.45% net of fees, respectively, underperforming the Index, which returned 7.86%.
At a country level, security selection supported relative performance in China and Hungary, while positioning in Poland also contributed positively. The leading detractors from relative performance included a lack of exposure to South Korea, a relative underweight position in Taiwan (which was again among the best performing markets in the quarter), and security selection in Vietnam. On a sector basis, relative losses were concentrated in the Consumer Discretionary, Information Technology, and Financial sectors. On the positive front, positioning in Consumer Staples, Industrials, and Communication Services sectors helped relative performance.
On a stock level, Dlocal (DLO, Uruguay payments), NetEase (NTES, China gaming), and Mobile World (Vietnam retailer) were the largest detractors from relative performance. Mobile World, NetEase, and Yum China (YUMC) were the top detractors from absolute returns.
Dlocal lost around 8% in the period. The stock appeared to drift lower after a solid run-up in Q3 on the back of some positive news relating to the appointment of the highly respected Pedro Arnt as the new co-CEO. The company continues to perform operationally well, and we expect that it will further consolidate its market position in 2024. Dlocal is a digital payment processing company focusing on online payments for multinationals in multiple countries (35 and growing) across about 700 payment methods in most currencies.
NetEase (a leading PC and mobile game developer in China) was down around 11% in the period. They are known for developing MMORPG (large multiplayer online role-playing games), where the user is entirely immersed in a virtual world, forming emotional attachments to characters and storylines. According to our research, this type of game results in stickier users and a more enduring revenue stream than casual games. There has been significant volatility in video gaming companies in China towards the year’s end after news broke of material rule changes aimed at curbing in-game spending and reducing the amount of time gamers (particularly younger users) spend playing. While it is not new for the Chinese regulator to impose such rules, the market was surprised at the scale and communication around these changes. Subsequently, there has been some clarification (the curbs not being as severe as first thought) while an official at the regulator’s office has also been removed, indicating that Chinese officials were not happy with how the situation was handled.
Mobile World corrected 18% in Q4. The company is one of the largest retailers in Vietnam, with over 4,500 stores nationwide. It operates three retail concepts: mobile phones, consumer electronics, and grocery retail. There has been a general slowing in consumer spending in 2023, which has been more protracted than expected. This resulted in Mobile World having to engage in more extensive use of promotions to gain market share. While improvement in the grocery operation has continued to be positive, and headline earnings have not been strong, underlying cash flow generation has been positive. On what we expect to be a more normalized earnings environment in 2024, current valuations look attractive for a well-managed business in a fast growing economy.
Tencent Music (TME, China consumer), Dino Polska (OTCPK:DNOPY, Polish retailer) and Wizz Air (OTCPK:WZZAF, Eastern European airliner) were the largest contributors to relative performance. Tencent Music, Dino Polska and Taiwan Semiconductor (TSM) were the top contributors to absolute performance.
Tencent Music’s Q4 results were received positively by the market, with the stock price gaining 40%. The company’s music business continued to perform well in a robust pricing environment, recording its highest-ever quarterly average revenue per paying user (ARPPU). Yet, it was not all positive, given that its social entertainment business suffered from regulatory and business model changes (resulting in fewer users and ARPPU). Online music revenues grew 33% to 69% of consolidated sales (from 58% last quarter), and social entertainment revenues fell from 49% to 31%. The company now has over 100 million paying music subscribers, equivalent to north of 17% of its user base. This revenue mix shift and higher ARPPU led to the company’s highest quarterly gross margin in five years.
Dino Polska was up 44%. The company is a Polish supermarket chain operating highly standardized stores in the discount proximity format. The stock price has been volatile in 2023, ending the Q with a gain of over 40% (noting that this rebound came after a nearly 30% drop in Q3). Polish equities were generally strong in the period (MSCI Poland was up 35%), likely on the back of what was seen as a market-friendly outcome to elections, where the ruling PiS party did notwin enough seats to secure power, allowing the more centrist party, Civic Coalition, led by former Prime Minster and European Council President Donald Tusk, to form a government.
Wizz Air gained 20% in the quarter after significant losses in the prior period. It appeared that the market started to recognize the consistent operating results from Wizz Air when the company delivered robust growth in 2023 in sales and profit. As noted in last month’s commentary, the airline industry is recovering from the Covid-19 pandemic. Wizz Air is no exception, with load factors per plane returning close to pre-pandemic levels. We expect Wizz to continue to gain market share, and despite some concerns over their use of debt financing, we believe that Wizz remains an attractively valued asset in the Portfolio.
Portfolio Activity
No material activity.
Outlook
In our view, external factors have been the main headwinds in the past number of months for emerging markets rather than any significant structural internal risks. This is likely to be the case in the year ahead as the market continues to grapple with factors such as high global interest rates, the developed markets’ banking stresses, and stubborn inflation across developed markets (‘DM’). EM growth should continue to be stronger than DM. In our view, valuations of what we believe to be high-quality growth companies within EM remain highly attractive and at a material discount to history and the broader EM universe.
We continue to stay focused on the long-term value propositions, competitive advantages, growth opportunities, and potential earnings power of our Portfolio companies. This allows us to think and act like owners. The markets continue to have a lot of uncertainty and be influenced by macroeconomic issues. Still, we believe that quality companies can weather the uncertainty and come out the other side firmer.
As investors, we focus our attention on the long-term fundamentals of the companies we own. Our conviction in our investment’s competitive advantages, sustainability, and durability remains high, and we believe the Portfolio is well- positioned to navigate the future.
Looking ahead, we remain dedicated to finding companies with competitive advantages that we believe can compound earnings and cash flows over the long term independent of commodity swings or economic cycles.
Given the power of compounding over time, we think that once we invest in great businesses, the best path forward is to maintain a long-term approach.
Thank you for your interest in Polen Capital and the Global Emerging Markets Growth strategy. Please feel free to contact us with any questions.
Sincerely,
Rishikesh Patel, Damian Bird and Dafydd Lewis
