Carmignac Portfolio Emergents: Letter from the Fund Managers

Carmignac Portfolio Emergents¹ lost 0.97% in the second quarter of 2023, against a 0.48% gain in its reference indicator². This brings the Fund’s year-to-date return to 3.95%, versus 2.61% for its reference indicator. In Q2, emerging markets once again sharply underperformed their peers in the developed world, owing mainly to a drop in Chinese stocks.

Chinese equities experienced another quarter of steep losses, primarily on the back of disappointing economic data – especially in the real-estate sector. Investors had been hoping for a strong economic recovery in China after Beijing reversed course on its public health policy in November, shelving its radical zero-Covid policy and instead letting the virus run its course so that the population could reach herd immunity. This was obviously a boon to the country’s economy, and especially its services sector. But so far the rebound has fallen short of expectations. A number of factors are at play, starting with weakness in the country’s real-estate sector. Small and mid-sized cities have a huge backlog of unsold apartments, leaving little scope for a healthy, lasting recovery. In addition, consumer confidence is low, unemployment is unusually high, and manufacturing output contracted in Q2 as a result of the global economic slowdown. Economists have lowered their full-year GDP growth forecasts for the country. All this prompted us to scale back our exposure to China. We sold our stake in ENN Energy, a utility that supplies households and businesses with natural gas in order to reduce the share of coal in China’s energy mix. ENN Energy has been in our portfolio for 11 years, but is now trading at multiples we believe are too high for the company’s growth prospects, which have been pared back in light of the company’s higher market penetration and China’s demographics. On the other hand, we built up our stake in EHang, China’s leading supplier of “flying taxis,” or electric passenger-grade drones. EHang has obtained the very first permit to operate in China and stands to benefit from this newly opened market.

Also in Asia, we increased our stake in Taiwan Semiconductor (TSMC) to just under 10%, the maximum allowable allocation for our Fund. We believe the artificial-intelligence (AI) revolution that drove up the stock prices of US companies like Nvidia and Microsoft isn’t yet reflected in TSMC’s price, even though the firm sits at the head of a near-monopoly on silicon-wafer production for semiconductors and supplies all of Nvidia’s chips. Samsung Electronics (8.4% of the Fund’s assets) has been another big winner of the AI revolution; AI technology requires a lot of memory, including the advanced types – such as high-bandwidth memory – for which Samsung has unique expertise and a dominant market share³.

We shored up our Indian holdings (9.0% of the Fund’s assets⁹) in Q2 by purchasing additional stock in Kotak Mahindra Bank (2.5% of the Fund’s assets⁹). Indian equities are some of the priciest in the world, but the country’s banking sector has never been healthier thanks to the excellent work done by its central bank. We intend to invest further in this sector at the next market correction.

We added a new Mexican company to our portfolio – Inmobiliaria Vesta – bringing our country allocation to 6.6% of the Fund’s assets (and our total Latin American allocation to 17.6%⁹). Vesta operates in the highly lucrative market of industrial real estate. While Mexico’s commercial and office property markets are facing headwinds from online retail and remote working, respectively, industrial real estate is getting a structural boost from nearshoring. US multinationals in particular are increasing their production capacity in Mexico in order to diversify away from China and take advantage of close proximity to the US, cheap natural gas from Texas, and labour costs that are more competitive than those in China. Vesta owns real estate mainly in manufacturing but also in warehousing – with Mercado Libre and Amazon among its customers – meaning it’s also poised to gain from the boom in online retail. What’s more, Vesta has the best corporate governance and capital allocation policy in its sector.

Today our Fund is the most conviction-driven it’s ever been. We now have only 35 positions, and the 10 biggest account for 52.0% of the Fund’s assets. This reflects our desire to focus on those companies we feel the strongest about in this extremely uncertain market climate. Our highly active approach to asset management, coupled with the strength of our portfolio companies’ balance sheets, should enable us to outperform at a time when rate hikes by the main central banks are making things difficult for investors. Seven of our ten biggest holdings are in companies with a positive net debt position, and the only bank on the list – Grupo Banorte (Mexico) – has a 22.9% capital adequacy ratio⁴.

Since its inception in 1997, Carmignac Emergents has combined what we consider our emerging-market DNA since 1989 with our commitment to strengthening our credentials in socially responsible investment (SRI). In welding together those two areas of expertise, we aim to add value for our investors while having a positive impact on society and the environment.

Classified as an Article 9 fund under the Sustainable Finance Disclosure Regulation (SFDR)⁶ and was awarded France’s SRI label in 2019 and Belgium’s Towards Sustainability label in 2020⁷.

As an Article 9 Strategy under the SFDR, the Fund will invest mainly in shares of emerging companies that have a positive outcome on environment or society and derive the majority of their revenues or CAPEX from goods and services related to business activities which align positively with UN Sustainable Development Goals (SDGs)⁸. This sustainable objective will be measured and monitored by the percentage of revenues aligned with the SDGs.

Our portfolio is currently structured around 4 major SRI⁵ themes that are central to our process:

As a reminder, our socially responsibility approach is based on three pillars:

• Invest selectively and with conviction, giving priority to sustainable growth themes in underpenetrated sectors and countries with sound macroeconomic fundamentals.

• Invest for positive impact, favouring companies that deliver solutions to environmental and social challenges in emerging markets and reducing our carbon intensity by at least 50% relative to the MSCI Emerging Markets Index. Our sustainable objective is: >80% Fund’s AUM invested in companies with >50% revenue or CAPEX derived from goods and services positively aligned with at least 1 of 9 targeted United Nations Sustainable Development Goals.

• Invest sustainably by consistently incorporating environmental, social and governance (ESG) criteria into our analyses and investment decision.