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Portfolio Manager comment Coeli Frontier Markets Fund Q3 2019

In 3Q19 the fund returned -0.2% in USD (gross of fees), outperforming MSCI Frontier Markets TR (‘MSCI FM’) by 0.9%. This result was driven by strong results in the fund’s largest country exposure, Vietnam.

Quarterly return review

For the first time in a few quarters, it was pleasing to see the strategy deliver a positive return, albeit small (0.9%), relative to the MSCI FM benchmark. Strong returns in Vietnam and a pull-back in an otherwise red-hot Kuwait (where we have a substantial underweight) were significant contributors to this result, which was offset by weak returns in Georgia and Bangladesh. As we explore below the underlying earnings of the fund’s portfolio remain good both on an absolute basis as well as in a global context. Combined with heavily discounted valuations, the prospects for long term absolute and relative returns are good.

It was also encouraging to see yet another example of the fund’s diversifying benefits in 3Q19. Thus, the portfolio recorded significant out-performance of just about all indices in late July / early August, as trade tensions between the US and China eroded investor confidence. During this period of high tension, the fund out-performed MSCI Emerging Markets (‘MSCI EM’) by 10% and MSCI World by 7.5%, measured in USD, clearly demonstrating the fund’s benefits to a portfolio of assets.

The exceptional returns in Vietnam, which was up 20.5% (in USD) in 3Q19, taking YTD returns to 25.6%, were led by the fund’s largest holding, Mobile World, which climbed 37.9%. Mobile World has now increased 46.9% YTD and are underpinned by strong earnings, up 37% in the first eight months of 2019 compared to the same period in 2018. The earnings performance is a result of sound topline growth. Revenues are up 17% driven by growth in consumer electronics with white goods, up 35% year-on-year, as well as margin improvements from scale and improved product mix. Bach Hoa Xanh, the company’s grocery concept, has grown ahead of expectations due to the introduction of larger (300 m2 v 200 m2) store formats and improved contribution from high margin fresh produce, which has doubled YTD. Management expect that it will have 1,000 grocery stores opened by the end of the year, up from the current 725 (and 405 at December 2018) as it continues to roll out in southern provinces adjacent to Ho Chi Minh City. In 2019 returns have outpaced earnings growth, resulting in a minor re-rating. However, at 15.8 x trailing earnings it remains at a material discount to regional peers.

The fund’s holdings in Vietnam are supported by one of the strongest macro backdrops of anywhere in the globe. GDP was up 7.3% YTD September, driven by healthy consumption (up 11.6%), manufacturing (up 10.8%) and FDI (up 7%). At the same time inflation remains low, 2.5% at 9M19. The USChina trade dispute has accelerated an established pattern of small, low value production relocating from northern Asia to Vietnam. Thus, exports for the first nine months of the year were up 8% overall, and up 28% to the US, helping to fuel a USD 5.9 bn trade surplus.

The fund’s holdings in Romania continued their positive momentum, increasing 3.3% in USD during 3Q19, taking YTD returns to 11.6%, following a sharp decline in December 2018. GDP growth, 4.4% in 2Q19, has been driven by consumption and remains the strongest in the region. As the economy is running at potential, the government’s pro-cyclical fiscal policies, which are helping to fuel this growth, are also one of the biggest medium-term risks to the economy. However, the low levels of debt – government debt to GDP is 37% and private sector credit 50% / GDP are the lowest in the EU – provides a cushion. Meanwhile, the weakness of the current PSD lead government, which lost a vote of non-confidence subsequent to quarter end, limit their ability to enact any further populist policies before the parliamentary elections due next year, where the business-friendly center right coalition is expected to win back power.

We were in Bucharest during the quarter, visiting all our portfolio companies as well as meeting with policy makers. Operational performance of the fund’s holdings remains strong and the long-term prospects sound. Fondul, a holding company with a collection of infrastructure assets and a long term holding of the strategy, continues to impress with its capital allocation, returning 25% of the company’s market capitalization in 2018 in the form of dividends and share buy-backs. These distributions have been supported by good underlying growth in free cash flow (‘FCF’) of Fondul’s holdings, where 1H19 EBITDA was up 17%, compared to 1H18. This strong performance as well as conservative carrying book values for its holdings and a large share price discount to NAV provide significant upside potential going forward. Meanwhile Banca Transalvania, Romania’s largest bank, continues to deliver strong returns – ROE of 24% in 1H19 – on the back of decent loan growth and an improvement in asset quality. It has also been an astute buyer in the consolidation of the banking sector that has played out since the financial crisis.

During the quarter Ahli United Bank (‘AUB’), the fund’s sole holding in Bahrain, released an impressive set of first half results, with earnings per share (‘EPS’) increasing by 18.5% (in USD) in 1H19, compared to the same period in 2018. In addition, Kuwait Finance House (‘KFH’) announced that it had finalised its due diligence on AUB ahead of its proposed merger with the Bahraini bank, reaffirming the share swap ratios agreed earlier in the year. While the transaction is subject to regulatory approvals, AUB is still trading at a discount to the agreed purchase price, which provides further valuation upside. As a reminder the merged AUB / KFH entity is expected to receive over USD 1 bn in passive flows in connection with Kuwait’s move to MSCI’s EM index in 2020.

Returns in Bangladesh have been disappointing recently, falling 12.1% in Q3, taking the full year loss to 6.7%. The negative results for Q3 were amplified by BAT Bangladesh which fell 16% following the release of poor 1H19 results as a result of a 30% excise-led price increase implemented in the second half of 2018 (see further details below). More broadly the local stock market has been impacted by liquidity concerns in the banking sector, where the government is crowding out the banking market for retail deposits and heavy fines by the regulator on the telecom operator Grameenphone, one of Bangladesh’s largest listed companies. Notwithstanding these immediate concerns the long term prospects for Bangladesh, which has maintained GDP growth in excess of 7% for the last many quarters, remain sound with the middle affluent class growing by over 16 million people from 2015 to 2025, according to research from Boston Consulting Group.

After a promising start to the year the fund’s holdings in Georgia fell 18.8% during the quarter. The decline was led by a 24.6% fall in TBC Bank (‘TBC’) who’s founders were criminally charged on violating anti-money laundering laws in connection with some loans over 10 years ago, 2007, 6 years prior to its IPO. While the former Board members still own a combined 17% of the company they have not had  any operational influence for almost a decade. It is unclear whether the charges are politically motivated (Mamuka Khazaradze, one of the founders, is starting a political party), however, the National Bank of Georgia has already investigated the transactions and after issuing a small fine (USD 350,000) they noted that “TBC Bank is one of the leading financial institutions in the country and in the region and is led by a highly qualified executive management team and independent members of the Supervisory Board”. We have had several meetings with TBC’s senior management on this issue since it came to light in August 2018 and conclude that the governance issues from 2007 are difficult to recognise today – we consider TBC Bank as one of the best managed companies in our universe – and that these prior transactions have no impact on the bank’s current operations.

The poor news flow overshadowed a strong operating result in the first half of the year. TBC’s underlying profit was up 19% in (in GEL) in 1H19 v 1H18, translating in a ROE of 21.5%. The result, which was driven by 25% loan growth, is particularly impressive given the limits placed on highly profitable retail lending which have been in place since the start of 2019. The news flow related sell-off combined with strong H1 results have resulted in all-time low valuations. Thus, TBC’s trailing P/E, 4.8 x, has never been lower since listing in 2014 while the current P/B, 1 x, is two standard deviations below its historical average.

Earning’s growth remains strong

While in the short-term flows and momentum drive stock returns in the long run capital appreciation is created by companies growing their cash flows. It is therefore pleasing to report that the earnings per share (‘EPS’) for the fund’s holdings, which were 8% higher in USD in 1H19 v 1H18, remain strong on an absolute as well as a relative basis. Thus, the fund’s earnings growth was higher than MSCI FM (up 6.2%), not to mention MSCI EM (down -3.2%) or MSCI World (down -4.1%).

The good

The fund’s only holding in Kazakhstan, Halyk Savings Bank, the management for which we met during the quarter, continued its impressive performance increasing EPS (excluding one-off costs in 2018) by 53.9% in USD equating to an annualized ROE of 29.8%. Net interest income was 15.8% higher due to loan book growth (up 8.8%) and margin expansion. At 1H19 normalised operating costs fell by over 7%, equating to a cost-to-income ratio of 23%, on the back of realized synergies from the purchase of KKB. Asset quality continues to improve and ongoing recoveries – both from legacy loans as well as credits acquired from KKB – have helped maintain the cost of risk at an annualised rate of 0.5%. Halyk remains highly liquid (loan-to-deposit ratio of 55%) and (overly) highly capitalized with Tier 1 capital of 18.3%, which gives it ample room to increase its dividend, the yield for which is already close to 9%. Despite these impressive earnings, returns and capital characteristics Halyk trades at a lowly 1.1 x P/B and under 5 x earnings.

As noted above, the fund’s retail holdings in Vietnam continue to generate volume-based, top line driven earnings growth with Mobile World and FPT Retail increasing EPS by 31% and 29% in USD, respectively. Both companies are benefiting from strong consumer demand as well as the commercialization of traditional retail formats to modern chain stores.

Earnings at Humansoft, who operates the largest private university in Kuwait, were up 18.5% in the 1H19 v 1H18. The result reflects decent volumes – revenue was 7% higher on a 5% increase in students – as well as continued operational leverage from improved scale with the company’s EBITDA% increasing by 5 percentage points (‘ppts’) to 56.6%. The results translate to an ROE of 50.9% and ROIC of 40%, giving the company ample room to increase its cash deployment to shareholders in excess of the current payout ratio of 70%, in light of limited capex requirements. Despite continued strong results, Humansoft’s stock price continues to under- perform the Kuwaiti market and the stock trades at a lowly 11 x 2019 earnings. We have been actively engaging with management and other owners to improve the company’s capital allocation policies, including the use of buy backs, and enhance its investor relations.

The bad

BAT Bangladesh’s earnings fell by 35% in the first half of 2019, compared to the same period in 2018 as a result of softer volumes following increases in excise duties which effectively increased the retail prices of its affordable categories – Derby and Pilot – by 30%. While the most recent excise increases were larger than previous rounds – 30% v 15% in the last two increase cycles – history suggests that volumes are adversely impacted for 2 – 3 quarters before returning to their prior levels. While we expect volumes to return in time it is critical that the government: 1) controls the illicit trade to ensure that volume is not lost to the illegal non- tax paying segment; and 2) is more moderate with future excise increases.

First half earnings in Hatton National Bank (’HNB’) were 51% lower in USD as a result of elevated risk costs (provisions up 86%) and operating costs (up 19%, mainly due to the timing difference on when costs have been recognized in 2019 v 2018), despite a 17% increase in net interest income on better margins. The deterioration in asset quality was most pronounced at the start of the year (i.e. before the Easter bombings) and was broad based (including construction, trade and agriculture) in the SME sector. Some improvements were noted in the second quarter and while government disbursements and a good 2019 harvest should help in future periods, we continue to monitor the situation closely. With HNB trading at 0.6 x book value investors are adequately compensated for this spike in provisions.

Earnings of BRAC Bank, Bangladesh’s leading financial institution, fell by 12% in 1H19 v 1H18. The result reflects a substantial decrease in profits from bKash, the country’s leading payments platform. Following the USD 90 m investment by Ant Financial in November 2018, bKash has consciously increased marketing spending, essentially re- investing all operating profits to drive growth and develop the ecosystem. BRAC’s banking business delivered a 16% increase in profit before tax on 16% loan growth as an improvement in costs off-set a normalisation in risk charges (there were significant writebacks in 1H18). In a lot of ways BRAC is currently benefiting from the poor state of the Bangladeshi banking sector, which is suffering from tight liquidity, capital constraints and poor corporate governance, as depositors and borrowers engage with the country’s only high-quality financial institution.

Headline earnings in Fan Milk Ghana fell 46% in 1H19 v 1H18. However, excluding one-off gains from asset sales in 1H18 profit before tax was actually 47% higher. Together with other minority investors, we have been working closely  with local and regional  (at  Danone’s  HQ)  management  to improve reporting, communication and transparency, standards for which fell under the prior CEO.   The fruits    of this engagement have included a new IR portal, regular shareholder calls, improved disclosure and better segment data. The company’s new management team have restored the company to growth, led by the flagship Fan Yogo brand, having invested heavily in marketing and route to market. There is a long way to go to restore the company’s profitability to levels seen before Danone’s takeover but the early signs from the new management team are good.

Portfolio changes

During the quarter we disposed of Sphera Franchise, who runs the KFC  and  Pizza  Hutt  franchises,  among  others, in Romania.   We  first invested in the company at its IPO  in late 2017. In many ways it was a case study in why we  are uncomfortable investing in these initial offerings: management’s aggressive forecasts were missed in the first few reporting quarters (not least because of undisclosed IPO-related bonuses to senior executives) and there was almost no liquidity in the stock, post listing. Operationally the company has been adversely impacted by a tight local labor market, which has put pressure on its cost base while the proliferation of online aggregators has squeezed margins in the pizza business. In addition, the poor liquidity of the company meant that it was impossible for us to build a 1% position in the fund; our minimum targeted size.

The continued weakness in Nigeria, MSCI Nigeria is down 16% YTD, opened up an opportunity to invest in one of our favorite companies in the Frontier Universe, Nestle Nigeria. The fund sold its long term holding back in 2015 just before the capital account closed, making the repatriation of USD impossible. Subsequent devaluations of the Naira mean that measured in USD our (re-)entry price is some 12% below where we sold in 2015, despite USD earnings being 10% higher (excluding any time value of money gains). Thus, current valuations are 1 standard deviation below its historical average.

It is hard to understate the quality of Nestle Nigeria, the CEO and CFO of which we met with in December in Lagos. It has managed to compound earnings by 6.9% p.a. in the last 10 years, in USD, despite the currency losing 2/3rds of its value, generating a triple digit return on invested capital (‘ROIC’) in the process.

Since 1961 Nestle have been selling first generation products – Maggi, Milo and Golden Morn – to Africa’s largest and fastest growing consuming class (population growing from 200 to 400 million by 2050). The growth runway for a company with Nestle’s second (Nescafé, water, nutrition) and third (including ready-to-drink beverages, Nespresso) generation product portfolio is enormous. Being able to collect shares at trough valuations is very exciting and reflective of the opportunities being thrown up by the lack of interest in FM.

Changes to the investment universe

The goal of the fund has always been to provide: 1) exposure to early stage (poor) economies where the base is low and growth and return prospects are high; and 2) a diversified return – i.e. the portfolio benefits of low correlations to other EM assets.

Historically we have felt that the best way  to do this was by defining our investment universe to include companies operating in countries defined as Frontier Markets by MSCI or country’s that are not included in any index by MSCI. However, over time the arbitrary transition of countries from FM to EM by MSCI, a cycle which has been well documented in previous versions of this letter, have challenged the logic of this approach as it has resulted in a lot of poor (i.e. Frontier) countries having an insignificant weight in the MSCI EM, which investors are not getting exposure to.

Thus, we believe it makes sense to broaden the sub-set of countries we consider investible by including countries in MSCI EM that meet both of the following criteria:

  1. have a GDP per capita under USD 10,000; and
  2. a weight of less than 1% in MSCI

The advantages of this approach include:

-giving investors access to the poorest and fastest growing economies that lager GEM and regional funds do not provide;

-being able to maintain a diversified return profile to boarder EM assets;

-there being less turnover in the fund’s investment universe; and

-while it will likely still make sense to dispose of stocks into any future MSCI upgrades, we will now be able to take advantage of the inevitable fall in asset prices after the transition to EM. As an example, Pakistan is 65% lower (in USD), compared to when it left the MSCI FM index and we existed in May

There are currently only four countries in the MSIC EM index that meet these criteria: Colombia, Egypt; Pakistan; and Peru. Of these we have vast experience in both Egypt and Pakistan, having invested heavily in them in previous years. Furthermore, both countries have had a very low correlation to the MSCI EM index. Since inclusion in the MSCI EM index, MSCI Pakistan has had a correlation of 0.38 (in USD, based on monthly observations) while MSCI Egypt has had a correlation of 0.29 over the last five years. Thus, going forward, and especially after we sell down our Kuwaiti exposure, investors can expect to find a few high-quality franchises from these countries in the portfolio.

Still outrageously cheap

At the risk of repeating ourselves, it is clear the current market is not rewarding quality returns or fundamental earnings growth. Thus, having de-rated significantly over the last 18 months, the fund is trading at a substantial discount to both MSCI FM, which is 9% higher on a trailing P/E basis, as well as MSCI EM, which is over 20% higher.

This relative de-rating fully explains the fund’s under- performance verses the two aforementioned indices. It is, of course, impossible to say when this aberration will correct itself, however, patient investors will be rewarded.

Long term capital appreciation will continue be driven by high quality companies

Despite the pleasing relative performance in 3Q19, YTD  the performance of the fund, compared to MSCI FM remains poor with the fund trailing 8.9% in USD. As we have documented in detail in prior notes, over 70% of the negative relative under-performance relates to the fund’s underweight in Kuwait, which has benefited from hot- money flows in anticipation of its transition from FM to EM by MSCI.

As highly active investors periods of poor relative performance can be expected. However, pleasingly, it has been the exception rather than the rule over the last 9 and a half years; where the strategy has delivered an additional 5.6% every year (p.a.), compared to the MSCI FM and 5.8% p.a. v MSCI EM.

Thus, while the current period of poor relative performance is frustrating, we continue to believe that the interests of our fellow long term unit holders, is best served by remaining focused on what has worked over time; investing in high quality franchises. Companies that generate high returns on invested capital produce more cash with which to internally finance the capital required to take advantage of the long- term opportunities presented by unpenetrated industries in FM. As a result, we remain committed to a fundamental investment approach in high quality companies and will not chase short term momentum trades.


At the conclusion of the third quarter of 2019 we can summerise our thoughts as follows:

-relative performance Q3 was positive after several quarters of under-performance where momentum has trumped fundamentals;

-the performance of the fund’s companies continues to be strong with 1H19 earnings increasing 8% v 1H18, which was superior to all comparable indices;

-the fund continues to trade at a meaningful discount to comparable indices; MSCI FM is 9% more expensive, MSCI EM 21% and MSCI World 69%, despite superior operating performance;

-despite the recent period of under-performance, we remain committed being long term holders of high quality business in early stage markets, which has proven long term alpha generation; and

-we will expand our investment universe with four poor countries with low correlation to MSCI EM going

Kind regards,

Hans-Henrik and James

Hans-Henrik Skov

Portfolio Manager Coeli Frontier Markets Fund

James Bannan

Portfolio Manager Coeli Frontier Markets Fund

Inception Date 2014-02-28
Investment Management fee 1,75 %
Risk category 5 of 7
Benchmark MSCI FM

DISCLAIMER. The information provided here does not constitute professional financial advice. Past performance is not a guarantee of future returns. The price of the investment may go up or down and an investor may not get back the amount originally invested. The key investor information document (KIID) and prospectus are available at

VIKTIG INFORMATION. Detta material utgör inte investeringsrådgivning. En fonds historiska avkastning är ingen garanti för framtida avkastning. Värdet på fondandelarna kan både öka och minska och det är inte säkert att du får tillbaka hela det insatta kapitalet. Fondens faktablad och informationsbroschyr finns på och kan även erhållas direkt från Coeli.