Carmignac Emergents: Letter from the Fund Managers

Before the invasion, we had 5.5% of the Fund’s assets invested in Russia. This Russian exposure was based on several factors. The country had excellent economic fundamentals, very low public-debt levels (less than 20% of GDP), and high foreign-currency reserves (over 43% of GDP) thanks to a large current-account surplus (nearly 10% of GDP) and a hefty fiscal budget surplus (some 4% of GDP). We had also identified high-quality companies in Russia with attractive valuations, good growth prospects, and excellent corporate governance. But when Putin recognised the independence of the separatist regions in Donbas, and we realised that war was about to break out, it was too late to sell our Russian stocks. Financial-market intermediaries had stopped trading Russian assets when the first sanctions were announced. We therefore decided to value our Russian holdings at close to zero and book a sizable loss, to reflect the fact that it had become impossible to close out our positions.

Another development that shook financial markets in the first quarter – and what explains most of our underperformance – was the sell-off in Chinese stocks (39% of the Fund’s assets at 31 March) following the outbreak of the war in Ukraine. Many investors, particularly in the US and UK, decided to offload their Chinese stocks when Putin and Xi reaffirmed their relationship through an official statement in late January. What’s more, the SEC began naming the first ten Chinese companies that will have to delist from US exchanges by 2024, underscoring US investors’ perception of China as an “uninvestible” market. We believe this fresh slump in Chinese equities is overblown and see it as a good opportunity to build up our exposure. The MSCI China Index has fallen back to levels last seen in 1993, when China’s GDP was 40 times smaller than it is today and the country was still eight years away from entering the World Trade Organization. Several companies in our portfolio have a market capitalisation that is below their cash level – something we haven’t seen since the 2008 financial crisis. Chinese stocks are trading at prices that seem to factor in a major break in diplomatic ties with the Western world, which could occur if Beijing gives military support to Putin, for example, or if China’s army invades Taiwan. We believe both of these events are highly unlikely at this point. Rather, we think China will maintain its neutral stance on the war in Ukraine and won’t take the risk of an escalation in Taiwan, especially since Western countries have shown they are united and determined in introducing heavy political sanctions.

We took advantage of the excessive decline in Chinese stock prices to add two new companies to our portfolio. The first is Sungrow, listed locally in Shanghai. Sungrow is the world’s leading producer of electrical components for the solar power industry. It has a 25% share of the global market¹ and is ideally positioned in a sector experiencing secular growth, fuelled further by the war in Ukraine and the EU’s plans to step up its investments in renewable energy and reduce its dependence on Russia. Sungrow also operates in the power-storage industry – another market with attractive growth prospects given the need for a steady power supply throughout the day. In addition, Sungrow has particularly effective waste, water and environmental-risk management policies, which include yearly targets for cutting CO2 emissions per unit of sales, and continuously improves its processes for waste treatment and recycling – all efforts which are tailored specifically to its operations. The second company is Beike, listed in the US. Beike used to be China’s biggest real-estate agency thanks to an expansive network of offices across the country. It then developed an online platform for housing transactions and grew into the world’s third-largest online sales plateform, behind Amazon and Alibaba². Beike’s stock price fell sharply amid the broad downturn in China’s real estate market, to the point where we believe it’s trading at absurdly low levels given the quality of its management team. We sold our stake in China’s internet giant Baidu when the stock rebounded at quarter-end, booking a profit in the process, taking profit on the position.

Although the war in Ukraine forced us to lower our growth forecasts for 2022, we still think our Fund is well positioned for a significant rebound in the coming months. Our Chinese stocks could bounce back if Beijing comes to an agreement with US regulators on giving them access to the accounting data of Chinese companies. Meanwhile, our Korean stocks are also trading at depressed prices. That’s especially true for Samsung Electronics and LG Chem, even though these firms are global leaders in the fast-growing markets of semiconductor memory and EV batteries. Our holdings in Latin America (17% of the Fund’s assets) should keep doing well in light of higher commodities prices. Brazil (12% of the Fund’s assets)³ looks more attractive now that Lula, the leading presidential candidate, has formed an alliance with key centrist parties, diminishing the chances of a new government hostile to financial markets.

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