Baron Emerging Markets Fund (BEXIX)

Portfolio Management

MichaelKass
Michael Kass

Fund Manager since 2010

View All Commentary by Michael

Fund Description

Baron Emerging Markets Fund invests primarily in growth companies in developing countries.

   

Portfolio Commentary

Institutional Performance

Review and Outlook (for quarter ended 9/30/2016)

The third quarter of 2016, "post-Brexit" rally suggests there are few signs of political change or contagion strong enough to disrupt the market equilibrium in place for many years. Sovereign bond markets initially moved aggressively to discount likely global policy support, a stimulative catalyst, particularly for the emerging markets. From our vantage point, while we may question the fundamental underpinnings, we must respect that such a significant decline in cost of capital is likely to spark an earnings recovery, particularly in the developing world where previous pressures suggest pent-up demand and trough corporate profit margins. As such, we remain confident that EM equities can maintain a leadership position for the time being.

A key question in the past year has been whether imbalances and strong credit growth in China will ultimately lead to a credit contraction and/or a marked RMB devaluation. While we have previously noted cause for concern, financial and economic conditions now appear to be stable and improving, with economic growth, consumption, and commodity prices holding up well in the face of moderating stimulus measures and increased scrutiny over non-traditional bank lending. We view this as a sign that structural reforms, improved policy coordination and communication, and progress on capital market liberalization, financial reform, and bank non-performing loan recognition, seem to be achieving desired goals. As an important contributor to global demand, we believe stability in China is a key variable in the outlook for global growth and corporate earnings, and are encouraged by recent progress.

Looking forward, we remain optimistic, though as always, we are monitoring several key variables. We believe EM economies and equities have reached a favorable inflection point, where the cyclical earnings recovery seems to be coalescing with longer-term structural reforms across many EM countries, driving outperformance and potentially a sustainable bull market. Such reforms are in direct response to deteriorating economic and financial conditions suffered over the past several years, and often take time to take effect. In particular, we note China, India, Indonesia, Mexico, Brazil, and Argentina as countries where we have invested in companies likely to benefit from economic, financial or labor reforms, or significant political change.  More recently, our enthusiasm is balanced by early signs that we may be passing through an important secular bottom in sovereign bond yields.  Developing political realities, likely fiscal expansion, signs of rising wage and rent inflation, and comments by the U.S. Federal Reserve and Bank of Japan suggest the central bankers appear to be encouraging inflation expectations to rise, and perhaps “run hot” for the time being. This important shift is occurring after an historic decline in global yields that leaves investor sentiment and positioning vulnerable to “inflation sightings.” We suspect bond market volatility is likely to rise, although it remains an open question as to whether this would be favorable or unfavorable for equities, and we suspect we will have more to report on this at year end.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 9/30/2016)
  • Shares of Alibaba Group Holding Limited, the largest e-commerce company in China, performed well in Q3 following strong quarterly results. Enhanced financial disclosure helped investors to understand better the profitability of the core commerce business and thereby attribute a higher value to it. We expect that mobile monetization will continue to improve through 2016 and beyond as the company invests in new areas such as online grocery and cloud computing.

  • Copa Holdings, S.A. is a leading Latin American airline with a hub in Panama City’s Tocumen airport, a strategic location with reach to major destinations across the Americas and superior infrastructure to neighboring airports. Shares have been under pressure in 2015 due to economic and currency weakness in Latin America. With the industry rationalizing capacity and prioritizing yield, we have seen a strong return to profitability for Copa, and the third quarter continued the year-to-date recovery in share price.

  • NAVER Corporation is the leading search company in Korea. It also owns Line, the leading messaging application in Japan, Taiwan, and Thailand and the second largest global messaging application after WhatsApp. Shares of NAVER were up in Q3 as investors ascribed greater value to the company as a result of Line's recent initial public offering.

Detractors (for quarter ended 9/30/2016)
  • Mr Price Group Limited is a South African fast fashion brand and retailer. It has performed remarkably well, growing same store sales at 10% CAGR for years despite a challenging economy. However, exogenous factors appear to be finally catching up. Mr Price is experiencing the impact of low spending in a country with 27% unemployment, increasing regulation on credit, and growing price competition. While the company itself remains interesting, we have trimmed our position given negative forces that are larger and more protracted than we expected.

  • LG Household & Health Care Ltd. is a South Korean company in the cosmetics, home & personal care and beverage categories. In recent years, it has been riding on the success of its cosmetics division through exports into mainland China and duty free sales to Chinese tourists. Despite the company’s strong fundamentals year to date, geopolitical worries surrounding North Korea and the Thaad missile deployment pressured the share price in Q3. We believe the correction is a buying opportunity.

  • Shares of Grupo Lala, SAB de C.V., Mexico’s leading dairy conglomerate, fell in Q3. The stock was pressured by a slowdown in consumer spending in Mexico along with currency weakness, which negatively impacts profitability. The company recently announced a U.S. acquisition from a related party, which investors viewed unfavorably. We believe Grupo Lala is well positioned to sustain double-digit earnings growth over the next two to three years given strong brand loyalty, nationwide supply and distribution network, and improving operational efficiencies.

Quarterly Attribution Analysis (for quarter ended 9/30/2016)

When reviewing performance attribution on our portfolio, please be aware that we construct the portfolio from the bottom up, one stock at a time. Each stock is included in the portfolio if it meets our rigorous investment criteria. To help manage risk, we are aware of our sector and security weights, but we do not include a holding to achieve a target sector allocation or to approximate an index. Our exposure to any given sector is purely a result of our stock selection process.

Baron Emerging Markets Fund gained 7.33% in the third quarter, yet trailed the MSCI EM IMI Growth Index by 203 basis points due to a combination of stock selection, relative sector weights, and average cash exposure of 8.8% in an up market.

On a country basis, outperformance of investments in India, Panama, and Korea and lack of exposure to poor performing Malaysian and Turkish equities added the most value. These positive effects were overshadowed by underperformance of investments in South Africa, Taiwan, China, Hong Kong, and Indonesia. Lower exposure to outperforming Chinese equities, which rose 17.4% as a group within the index, and larger exposure to lagging equities in Mexico also hampered relative results.

On a sector level, Industrials investments added the most value, mainly due to the outperformance of Panamanian airline Copa Holdings, S.A. and South African conglomerate Bidvest Group Ltd. Copa was the second largest contributor to absolute results, while shares of Bidvest rose after the company successfully spun off its food services division. In addition, Bidvest continued to grow earnings despite a challenging macro environment in South Africa.

Significantly lower exposure to the top performing Information Technology (IT) sector, which rose nearly 18% in the index, and underperformance of investments in Financials and Materials detracted the most from relative results. Within IT, lower exposure to sizeable positions in the index that were up sharply in the quarter, including Tencent Holdings Ltd., Alibaba Group Holding Ltd., and Samsung Electronics Co., Ltd., weighed the most on relative performance. Weakness in Financials was mostly attributable to the underperformance of diversified banks, led by Grupo Financiero Banorte, S.A.B. de C.V. of Mexico and BDO Unibank, Inc. of the Philippines. Shares of Grupo Financiero Banorte declined after the company reported a slight increase in delinquencies within certain consumer portfolios, suggesting potentially higher credit costs ahead, while BDO’s shares underperformed after the company announced an impending equity rights issuance to fund future growth. Brazilian financial exchange operators BM&FBOVESPA SA and Cetip SA also hampered relative performance after performing well early in the year following their announced merger. Uncertainty around the timing of regulatory approval of the deal and a recently launched antitrust investigation by a competitor weighed on these stocks. Within Materials, larger exposure to poor performing gold stocks through investments in AngloGold Ashanti Limited of South Africa and Zhaojin Mining Industry Company Limited of China detracted the most from relative results.

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The prospective performance of the companies discussed herein is based on our internal analysis and reflect our opinions only. We cannot promise future returns and our opinions are a reflection of our best judgement at the time of publication. Our views are not intended as recommendations or investment advice to any person and are subject to change at any time based on market and other conditions and Baron has no obligation to update them. Investing in the stock market is always risky. Current and future portfolio holdings in the Fund are subject to risk.

Source: FactSet PA.