Market Overview
Emerging-market equities (as measured by the MSCI Emerging Markets Index) ended the fourth quarter on a positive note. From a macro standpoint, lower commodity prices and the looming fear of the impact of rising U.S. interest rates were notable topics affecting stock prices throughout 2015, including in the fourth quarter.
In the midst of economic slowdown and ongoing reform efforts, it was not surprising that Chinese equity markets, as represented by the Shanghai Composite and the Shenzhen Composite indices, remained volatile, recovering some lost ground in the fourth quarter following significant declines in the third quarter.
Meanwhile, political and economic woes continued to pressure Brazilian equities, with the MSCI Brazil Index falling over 4% for the quarter and more than 40% for the year (in U.S. dollar terms). In December, Brazilian Congress’ lower house opened impeachment proceedings against President Dilma Rousseff, further escalating the political turmoil in the country.
For the quarter, the Brandes Emerging Markets Value Fund (Class I Share) outperformed its benchmark, the MSCI Emerging Markets Index, which returned 0.7%.
Positive Contributors
Holdings in the utility sector were positive contributors, led by India-based conglomerate Reliance Infrastructure, Brazilian water utility SABESP and APR Energy, a U.K.-domiciled supplier of temporary generators.
Reliance Infrastructure (BOM:500390, Financial) performed well after announcing a number of divestment initiatives intended to reduce debt, including the sale of a stake in its Mumbai -based power-transmission business. Additionally, the company has short- listed a number of potential buyers for its cement assets and has been in talks to monetize 11 revenue-generating road projects. These moves should allow Reliance Infrastructure to increase its focus on the defense sector.
APR (LSE:APR, Financial)’s share price increased following the company’s announcement in October that it had agreed to a buyout by a group of investment firms for approximately £175 million. The company supplies interim power plants, mainly in emerging-market countries, and has faced a difficulty in recent years after being forced to exit previously profitable markets.
Another positive contributor to returns was Adecoagro (AGRO, Financial), a Latin American agricultural company with assets in Argentina, Brazil and Uruguay. Adecoagro’s shares, which performed well throughout 2015, benefited in the fourth quarter from a December announcement by the recently elected Argentinian president, Mauricio Macri, that he would sign a decree to lower export taxes on soybeans, corn and wheat.
Additionally, a number of holdings, including Panamanian airline Copa Holdings and Indonesian telecommunication services provider XL Axiata, regained investor favor over the last three months after being some of the worst performers in the third quarter. These stock-price movements are, in our view, a great reminder that volatility is not unusual in the emerging-market asset class.
Performance Detractors
Holdings in Mexico hurt returns in the fourth quarter, notably cement company Cemex (CX, Financial). With the majority of Cemex’s debt denominated in U.S. dollars, concerns about the impact of rising U.S. interest rates have added to investor worries over intensifying competition in the company’s home market. Although leverage remains a key concern for Cemex, it is not, in our opinion, as big of a risk as it was a few years ago. We have been encouraged by the initiatives the company’s management has taken in terming out debt maturities, locking in lower interest rates, successfully negotiating with key creditors, and minimizing shareholder dilution. Moreover, while rising U.S. rates may be a near-term concern, we view Cemex primarily as a U.S.-dollar denominated business and believe the company has the ability to preserve its long-term earnings power by potentially increasing its prices to offset the impact of any foreign-currency devaluations.
In the quarter, Brazilian electric utility Companhia Paranaense de Energia and construction equipment provider Mills Estruturas E Servicos De Engenharia also detracted from performance, as did Hong Kong-based retailers Chow Tai Fook Jewellery Group, Luk Fook Holdings and Lifestyle International.
Select Activity in the Fourth Quarter
Fund activity was relatively light in the quarter. The emerging markets investment committee initiated a position in Taiwanese semiconductor company MediaTek. MediaTek (TRE:2454, Financial) is the world’s second-largest supplier of mobile phone-related semiconductors. The company has benefited significantly over the past few years due in large part to its strong relationships with smartphone vendors in China, where growth has been significant.
MediaTek competes in a difficult market environment, with relatively low barriers to entry and low customer stickiness. In addition, it is unlikely that MediaTek’s core end market (i.e. Chinese smartphones) can sustain the growth it has delivered in recent years, potentially keeping future returns from being as strong as they have been.
2015 has been a challenging period for MediaTek with its share price declining more than 45% over a nine-month period through September 30. Increased competition and various macroeconomic issues appeared to dampen the market’s prior unrealistic enthusiasm and expectations for the second half of 2015 and thereafter.
Nevertheless, we believe the market has overreacted to MediaTek’s issues and provided us with a good entry point for investment. As one of the main, longstanding players in mobile phone-related semiconductors, MediaTek is familiar with the tough competitive dynamics in the industry and has generated attractive financial returns historically nonetheless. While we expect an even more competitive environment, which may lead to margin compression, we take comfort in the company’s strong balance sheet (net cash accounted for 40% of market capitalization at year end), its attractive dividend yield (near 9%), and the fact that it traded for less than 12x earnings as of December 31.
2015 Review
The Brandes Emerging Markets Value Fund (Class I Share) underperformed the MSCI Emerging Markets Index, which declined 14.6% in 2015.
Brazilian holdings detracted the most from performance. Notable detractors included state-owned oil giant Petrobras, food retailer Companhia Brasileira de Distribuicao and telecommunication services provider TIM Participacoes.
Our underweight allocation to companies in China also hurt returns, as did allocation to Hong Kong-based companies. In both China and Hong Kong, our holdings are tilted toward Chinese consumers—an area that has been hampered by the slowing Chinese economy.
Other detractors included Mexico-based Cemex, Panamanian Copa Holdings and South Korean steel manufacturer POSCO.
There were a number of notable bright spots in 2015. Positive contributors included holdings in Russia, led by Sberbank and Surgutneftegas, which both rebounded strongly after a difficult 2014. Other Eastern European holdings also performed well, namely O2 Czech Republic and Ceska Telekomunikacni Infrastruktura, Austrian bank Erste Group and Hungary-based pharmaceutical Chemical Works of Gedeon Richter. Moreover, Latin American Adecoagro, a strong contributor in the fourth quarter, aided 2015 returns as well.
Current Positioning
Throughout 2015, we took advantage of the market turmoil in Brazil by initiating several new positions (e.g., Companhia Brasileira de Distribuicao and for-profit educator Kroton Holdings) while also adding to a number of our existing Brazilian holdings. As of December 31, our allocation to Brazilian companies continued to represent the Fund’s largest country overweight.
At year end, we remained significantly underweight China, largely due to our avoidance of financial and infrastructure-related companies, which accounted for the majority of the benchmark’s allocation. As noted, we have been finding value in businesses that are more oriented toward Chinese consumers, with allocations to companies both in mainland China as well as Hong Kong.
From a sector/industry standpoint, the Fund was significantly overweight companies in consumer discretionary, led by allocations to South Korean autos (e.g., Hyundai Motor, Kia Motors and Hyundai Mobis). On the other hand, it is probably not surprising that a value fund had an underweight to the higher-growth technology sector. This coincides with our minimal allocation to Taiwan, where technology companies account for a significant portion of the investment opportunities in the country.
As of December 31, valuations (e.g., price-to-book, price-to-earnings) for the MSCI Emerging Markets Index were at or below levels seen during prior crisis periods and at a significant discount to developed markets (as measured by the MSCI World Index and the S&P 500 Index). In our view, these valuation differences created a market environment that bodes well for emerging-market equities.
While the past year was difficult for emerging-market investors, especially value investors such as Brandes, we believe that the Brandes Emerging Markets Value Fund remains well positioned. We understand it can be hard to stay the course amid such challenging market conditions, and we appreciate your continued trust. We believe our unwavering commitment to finding potentially undervalued companies will add value for our clients over the long term.
Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the Funds may be lower or higher than the performance quoted. Performance of A shares without load does not reflect maximum sales charge of 5.75%. Performance of C shares without load does not reflect maximum sales charge of 1.00%. If reflected in both, the loads would reduce the performance quoted. All performance is historical and includes reinvestment of dividends and capital gains. Performance data current to the most recent month-end may be obtained by calling 800.395.3807.
Prior to January 31, 2011, the Fund was a private investment fund managed by the Advisor with policies, guidelines and restrictions that were, in all material respects, equivalent to those of the Fund. Class A and Class I shares commenced operations on January 31, 2011, while Class C shares commenced operations on January 31, 2013. Prior to January 31, 2013, Class A shares were known as Class S shares. (Class A shares have the same operating expenses as Class S shares.) The Class I performance information shown for periods prior to January 31, 2011 is that of the private investment fund managed by the Advisor that is the predecessor of the Fund, not adjusted for Fund expenses. Performance shown prior to January 31, 2011 for Class A shares reflects the performance of the private investment fund shares adjusted to reflect Class A expenses. Performance shown prior to the inception of Class C shares reflects the performance of the private investment fund for periods prior to January 31, 2011 and the performance of Class I shares for the period from February 1, 2011 to January 30, 2013 restated to reflect Class C expenses.
The Advisor has contractually agreed to limit the operating expenses through January 31, 2016. The Expense Caps may be terminated at any time by the Board of Trustees upon 60 days notice to the Advisor, or by the Advisor with the consent of the Board. Investment performance reflects fee waivers and/or reimbursement of expenses. In the absence of such waivers/reimbursements, total return would be reduced.
