AEC Commentary (Q1 2025)
April 2025
For the clarity-loving markets, 2025 has offered very little to grasp onto. A new US administration has been jockeying on a global scale and the markets have responded with distaste to the pace and unpredictability of the messaging. International allies and opponents have their hackles up after being thrust into an “Art of the Deal” tariff gambit that pits trade with the US in an us versus them standoff.
We don’t want to understate the magnitude of the paradigm shift in the US playbook, but theorizing the next move isn’t a valuable use of time. The broad and indiscriminate market corrections are presenting abundant opportunities and, despite the volatility carrying the fund down 9% in Q1, we are relishing the discord. We realize the difficulty shareholders may have with swallowing that pill, and won’t argue that up is up and down is down. But as we watch the current market status quo show cracks, optimism is the outlook emerging from the team. Be it Mag 7, AI, or US exceptionalism (valuation), the shakeup is forcing allocators to reassess their positioning and look beyond the “consensus US” trade. Our belief is that the uncertainty will ultimately restore health to what we view as distorted global markets. We’re halfway through April, and the MSCI Emerging Market Small-Cap ETF (EEMS US) has outperformed the S&P by 7% YTD. The discounted valuation and superior earnings profile generated by emerging markets leaves a lot of room for a continuation of this trend. In house, we view the EM resilience as extremely telling, and supportive of a normalization of common sense diversification and appropriate asset allocation that has been all but abandoned over the past decade.
The distortion is clear to us when we look at our own fund. The ROE and ROA of the fund are 22% and 12%, respectively, for a portfolio with anticipated earnings growth of over 20% for the current and future years. The S&P metrics for ROE and ROA are respectively 17.5% and slightly below 4%, for a projected earnings growth of 8% in the year ahead. The distortion lies in the fact that our portfolio trades at a 20% price to earnings (P/E) discount to the S&P. As a refresher: according to the IMF, emerging markets comprise over 85% of the global population and ~50% of global output (PPP-adjusted), and both of these numbers are poised to continue growing as a percentage. The disparity between the economic contribution of EM’s and their representation in global equity portfolios remains askew, with an 11% allocation in the MSCI ACWI Index as of 2024. From our direct correspondence with potential investors, we believe that the majority of allocators sit far below the index level. This underrepresentation creates a powerful structural case for long-term investors, which only becomes stronger as we approach the argument in relation to the fund from the bottom up. If we were to frame our fund metrics and the S&P as single companies, picking the superior company is easy. If we were to layer on the fact that the superior metrics of our fund come at a 20% discount to the inferior metrics of the S&P, the decision would be a no brainer.
The chart below displays our track record over short- and long-term periods:
| Periods ended 3/31/2025 | AEC | MSCI EM Small Cap
ETF (EEMS) |
|---|---|---|
| Quarter | -9.16% | -4.35% | 1 Year | -0.39% | -3.09% | 3 Years Annualized | -0.17% | 1.25% | 5 Years Annualized | 16.42% | 14.37% | ITD Annualized | 7.58% | 3.12% |
Source: Bloomberg
Data shows past, net of fees performance. Past performance is not indicative of future performance and current performance may be lower or higher than the data quoted.
In Q1, India and Indonesia were pain points, though in both cases we continue to believe that attractive opportunities exist. In the first quarter, our India exposure was down 19%. Yet, with the exception of Time Technoplast (TIME IN), we do not attribute the performance to poor company fundamentals or tariffs. On the heels of phenomenal results and hype around en masse government adoption of their composite products, TIME capped off 2024 with a +25% move higher over the final six weeks of the year. We believe in the long-term success of the company and anticipate product adoption over the long run, but at the beginning of this year, as valuation extrapolated flawless execution and an unrealistic pace of product adoption, we began selling down our 5% position. We completed our exit following results in mid-February that showed a notable earnings deceleration. As for the rest of our India investments, after a strong 2024, the fundamentals remain intact and we have been adding weight to India on the market pullback. While we agree that some valuations in India were getting ahead of themselves, we view our portfolio valuations as extremely attractive for the long-term fundamentals of the businesses we own. Although India wasn’t excluded from the US tariff list, we view the country as a trade beneficiary and key partner to the US. As costs escalate around the globe, the India proposition becomes much more attractive — a trend that, as bottom up investors, we have observed accelerating over the last 10 years.
Our Indonesian pressure, on the other hand, was driven by two large positions that corrected after reporting subpar results. In both cases we believe the fundamental story is very much intact, and we remain enthusiastic investors in the stocks. Medikaloka Hermina (HEAL IJ) underperformed after reporting lighter revenue growth and increased expenses related to three rapid hospital openings. In addition to the weaker results, the government is in the midst of updating the public health system, which is unnerving to some investors. After speaking with the management from HEAL as well as the number two player in the private space, we are confident that HEAL will emerge as a beneficiary from the new scheme. We have owned HEAL for seven years and believe that it’s a 20+ year investment given the size of the headroom. Mediakaloka dominates the private hospital industry with 52 locations, and we assume that they will be the consolidator of choice in a country with over 3000 hospitals. The second notable detractor was PT Midi Utama (MIDI IJ), a market share-gaining mini-supermarket chain. MIDI dropped in the first quarter after missing Q4 earnings expectations due to a one-time restructuring charge related to the closure of all their loss-making Lawson stores. Lawson is a non-core convenience store concept that MIDI unsuccessfully attempted to grow, and only contributes 4% to MIDI’s total revenue. Exiting Lawson had been telegraphed, but doing it in one quarter was unexpected, and the resulting write-off pressured earnings. MIDI’s core business remains very healthy, with 9% same-store sales and 15% net income growth in the 4th quarter. With the loss-making Lawson stores out of the system, we expect strong earnings growth for the coming year.
Poland and Mexico both picked up significant weight in the portfolio during Q1. We initiated two new starter positions in Poland: Sygnity (SGN PW) and Digitanet (DIG PW). We repurchased Vesta SAB (VESTA* MM) in Mexico after a year-long correction in the stock.
We think Sygnity is a diamond in the rough. The stock came through our screening with a very high score despite results that optically appear choppy. After reading through the annual report, we discovered that Constellation Software (CSU CN) — arguably the best software rollup/integration company in the world — became the largest Sygnity shareholder in late 2023 via their Dutch-based Topicus arm, transitioning what was essentially a sleepy yet strong cash-flowing IT services business into a vertical-specific software powerhouse. Digitanet is the dominant player in Poland’s digital ad space. With over 20,000 screens and nearly 50% market share, its integrated platform and national scale offer a clear advantage to customers in an industry that’s growing double digits organically. The stock trades at 12x earnings and yields 8% for a business that we believe can easily compound earnings at 15%.
Vesta (VESTA MM) is Mexico’s premier industrial real estate operator with a 25-year track record and over a decade of history as a public company. As Mexico benefits from accelerating nearshoring trends, Vesta stands out as a best-in-class operator with long-standing tenant relationships, US-dollar-denominated recurring revenue, and a deep new construction pipeline to drive long-term growth. We have known this company for a long time and have owned it in the past, but exited the position due to high valuation. The recent market volatility has given us an opportunity to buy the stock back at a significant discount, as tariff concerns caused a steep sell-off in the stock with Vesta’s valuation falling from 1.05x net asset value to 0.7x. We view nearshoring concerns as temporary since economics continue to favor Mexico as the premier manufacturing destination for the US market.
A final note addressing recent changes to the structure of our organization. Last month, we sold the global and international mutual funds. Exiting the mutual funds allows us to focus exclusively on the asset class we find most compelling. As the founding product of Seven Canyons, Ark Global Emerging Markets, LP (AEC) sits among the top 1% of EM funds since inception. The AEC fund plays in the largest and most inefficient markets on the planet, which means that there is always money to be made. Our portfolio is built upon phenomenal businesses that are unappreciated and yet to be recognized. Over the last year the portfolio grew earnings at 2.5x the pace of the benchmark for a set of companies that have ROE’s and ROA’s that are nearly double, and margins that are 50% higher. And our portfolio trades at the same trailing P/E as the benchmark. We are proud of delivering industry-leading performance since our inception seven years ago, and we believe we have the right people, approach, and experience to deliver for our clients going forward. To this end, we have added to our capabilities with the return to Seven Canyons of one of the founders. The original tenet of the firm was to create an environment where excellence in performance sits at the center of our purpose. These recent internal moves help assure that our founding vision remains firmly in place. And, as we said earlier, we believe the current volatility will cause people to finally focus on the abundant opportunities in other areas of the globe — areas where Seven Canyons has proven its ability to excel.
Sincerely,
Spencer Stewart,
Portfolio Manager
DEFINITIONS
*MSCI EM Small Cap ETF (EEMS): iShares MSCI Emerging Markets Small Cap ETF The fund generally will invest at least 80% of its assets in the component securities of the underlying index and in investments that have economic characteristics that are substantially identical to the component securities of the underlying index. The index is designed to measure the performance of equity securities of small-capitalization companies in emerging market countries.
Trailing P/E: Trailing price-to-earnings is a relative valuation multiple that is calculated by taking the current stock price and dividing it by the trailing earnings-per-share for the past 12 months.
ROA: Return on assets is a ratio used in financial analysis that demonstrates how efficiently a company uses its assets to generate profits
ROE: Return on equity is a measure of financial performance calculated by dividing net income by shareholders' equity.
The MSCI Emerging Markets Small Cap Index includes small cap representation across 27 Emerging Markets countries. With 1,693 constituents, the index covers approximately 14% of the free float-adjusted market capitalization in each country. The small-cap segment tends to capture more local economic and sector characteristics relative to larger Emerging Markets capitalization segments.
This report was prepared by Seven Canyons Advisors, a federally registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Neither the information nor any opinion expressed it so be construed as solicitation to buy or sell a security of personalized investment, tax, or legal advice.
The mention of specific securities and sectors illustrates the application of our investment approach only and is not to be considered a recommendation. The specific securities identified and described herein do not represent all of the securities purchased or sold for the portfolio, and it should not be assumed that investment in these securities were or will be profitable. There is no assurance that the securities purchased remain in the portfolio or that securities sold have not been repurchased. For a complete list of holdings please contact your portfolio adviser.
The information herein was obtained from various sources. Seven Canyons does not guarantee the accuracy or completeness of information provided by third parties. The information in this report is given as of the date indicated and believed to be reliable. Seven Canyons assumes no obligation to update this information, or to advise on further developments relating to it.
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