AEC Commentary (Q3 2025)
October 2025
Emerging markets continued their positive trajectory through Q3, holding onto S&P-beating performance. The fund returned 3.00% in Q3 and, though a positive result, trailed the EM Small Cap ETF’s (EEMS US) 4.73% return. The EM universe as a whole continues to demonstrate higher economic growth rates, superior debt metrics, and cheaper valuations versus the developed markets, giving us conviction that this outperformance can be sustained.
While our returns YTD (12.25% gross) are nothing to apologize for, we have left some near-term performance on the table as a result of our geographic allocation. Underexposure to China and Taiwan had a -2.35% impact on Q3 alone. Taiwan (at 19% of the benchmark) returned 15%, and China+Hong Kong (at a combined 9% weighting) returned 25%. The fund is currently at 7% Taiwan and 3% China, respectively. As bottom-up GARP (Growth at a Reasonably Price) investors, staying disciplined to our investment philosophy has kept us underweight these two markets for a few years now, as extremely dynamic macro and thematic winds dictate the course of each.
The chart below displays our track record over short- and long-term periods:
| Periods ended 9/30/2025 | AEC | MSCI EM Small Cap
ETF (EEMS) |
|---|---|---|
| Quarter | 3.00% | 4.73% | 1 Year | 10.47% | 17.60% | 3 Years Annualized | 14.66% | 17.02% | 5 Years Annualized | 10.60% | 11.83% | ITD Annualized | 9.81% | 5.70% |
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.
Long-time clients know that China has always been a challenge for our style of investing. Last year, China fell into the left-for-dead valuation category as a weaker domestic economy and macro posturing out of the US weighed on the market. With the exodus of both domestic and foreign capital, valuations reached extremes. We responded to the opportunity with multiple screens and meeting requests, yet were predominantly met with no response. Unfortunately, as the tariff and tech economic war has escalated, limited access to management has become the norm. To illustrate, we have been unable to procure a single call with a Chinese tech company for over three years, but have had hundreds of calls with managers in other regions. Our strategy relies on direct communication with the companies we own, so this lack of transparency triggers cautionary alarms. And though the rally has been strong, by all accounts it has been very low quality in nature, with the rising tide lifting all boats, especially in the technology sector where we tend to allocate most of our capital. The conclusion is clear: China remains a poor fit for our fundamental investment approach in which growth, return on capital, valuation, and management quality are all major factors. We will not and cannot ignore China, yet neither will we overhaul our style to fit their market. Unless things significantly change, it’s unlikely that China will become substantial in our fund.
That said, Essex Bio (1061 HK) is the exception to the rule. Essex is a Chinese pharmaceutical company that we have owned since inception of the fund, and we now believe it is time to scale it to a top position. Direct access to and trust in management offer us this confidence. There are three tailwinds poised to hit Essex over the coming year: first, large price cuts incurred over the past two years (as volume-based pricing replaced direct sales) have ended, which means volumes and revenues should match going forward; second, the company is launching a new delivery method for their core basic fibroblast growth factor product in tier 1 cities (~70% of revenue), which comes with double the average selling price; lastly, in August their new drug was approved, which has the same efficacy as the dominant player, yet is lower cost. If they achieve 5% market share for their new product, it would double their existing sales. The stock trades below a 9x trailing P/E ratio, while we expect earnings to compound at 20%+ over the coming three years.
As for Taiwan, AI ripples stemming from Mag 7 capital expenditures have had the biggest impact on the Taiwanese market. We broke down the MSCI Taiwan Small Cap Index constituents, and it’s evident that the strength of the market has been driven by a select group of companies. As of 10/3/25, the index returned 10.5% over the trailing twelve months – notably, the average return in the tech sector was 14.5% vs -4.5% for all other sectors. When looking at median results, the tech return falls to -1.2% with all other sector returns dropping to -13.7%, respectively. The data shows that a few companies drive the entire market (sound familiar?). The obvious question is: why don’t we own these market-propelling companies? The response: as GARP investors we rely on earnings for valuation support, we are disciplined in what we’re willing to pay for a stock, and we are not momentum or thematically driven in our style. The AI rally has driven some valuations to dangerous levels, leading to narrow leadership within the market. Taking out extreme outliers, the median PE of Taiwan tech currently sits at a level 42% above the five-year average. If we roll the clock back three years, there was undeniably a big opportunity for us, but as we studied the market and individual stocks that fit our style, the trade was very challenging – with AI leaders moving exponentially higher a year in advance of any visible positive earnings impact from coming investment. Valuations were far out of our wheelhouse long before earnings were present. Our belief (and one of the reasons our long-term performance has been so consistent) is that while near-term stock gains may feel good at the moment, history provides many examples where investing in stocks with extreme valuations is a dangerous game for long-term investors.
We have not ignored AI, but instead of playing a momentum game, we turned our view to Korea, which shares a very similar tech dynamic to Taiwan. Without diving too deep, the tech bellwethers of Taiwan and Korea (TSMC and Samsung) split paths about a decade ago, with TSMC focusing more on logic IC’s (integrated circuits), and Samsung on memory IC’s. With AI still in a developmental stage, the logic piece is paramount, but as AI becomes a scaled tool, the memory will be equally essential. The memory-side of this investment is where we’ve put our energy, and today three of our top ten positions fall directly into this bucket: S&S Tech Corp (101490 KS), FNS Tech (083500 KS), and Pemtron (168360 KS).
S&S Tech (101490 KS) is ramping production of EUV mask blanks which are directly tied to processing of advanced nodes. Despite moving 100% higher YTD, the stock trades at 28x earnings and below 20x 2026 P/E with the 50% EPS growth we anticipate in the coming year. What we love about S&S, is that their product is recurring/volume-based rather than capital equipment. FNS Tech (083500 KS) has a legacy in capital equipment which led to extreme earnings cycles in the past. But what has our attention, is that under the covers, FNS is evolving into a high-margin consumables supplier through their CMP pads business – approved with Samsung for their newest HBM4 (high bandwidth memory) lines. With the recent acquisition of Asahi Lamps (Taiwan), we also believe there is ample cross-selling opportunity for their products to penetrate Taiwan as well. We expect the consumables business to achieve 50% of company sales in ’26 and to continue growing at a 20% clip for the subsequent three years. With the stock trading at 10x trailing earnings and 7x 2026 EPS, the stability and growth of future earnings appears totally undiscovered. Pemtron (168360 KS) seems to be an exception to our investment style when looking at current earnings losses, but as noted, capital equipment lends to extreme cyclicality. Their new semiconductor inspection line (focused on HBM inspection and next-gen memory module testing) is not yet reflected, and should meaningfully reposition the company over the coming year. We believe our 140% sales growth estimate for 2026 is just the beginning of a major adoption cycle and, per our expectations, the stock trades at 13x 2026 EPS. Each of these three companies represents a different way to participate in the AI memory cycle, and all have earnings trajectories that imply PEG ratios well under 1.0 over the next several years. Although Korea as a market returned 2.4% in Q3, our holdings returned nearly 12%, and we believe there’s a lot of room to run given the reasonable valuations. Our style is bearing fruit in Korea, where we’ve found companies with exposure to AI’s memory buildout without abandoning our valuation discipline.
Just like last quarter, our largest two positions were our biggest detractors. 3B BlackBio (3BBLACKB IN) and Bliss Pharma (BLIS IN) returned -8.5% and -6.5%, respectively. Within our benchmark, India declined 7% in Q3 which was only trailed by the Philippines at an 11% decline. Even with India out of favor near term, we are surprised that both positions retreated this past quarter given positive newsflow. At a combined 11% weighting, we remain highly confident in the investment opportunity of both positions. 3B announced a large acquisition in July that should drive revenues ~50% higher this year and at least 25% higher next year. Though the business they purchased is currently operating near break even, we anticipate significant cross-selling of their India-produced products and substantial savings (given the likelihood of offshoring the Belgium manufacturing). Using extremely conservative estimates, we see EPS growing at 20% for the coming three years, and that doesn’t include expected future acquisitions which would accelerate the earnings pace. Bliss Pharma, the leading pessary and suppository manufacturer in India, has become a high-conviction holding despite lackluster stock performance since our purchase in December 2024. Full capacity has curbed growth over the past few years, but with a $40 million investment into the tripling of production now beginning to hit, we believe the financial inflection point has arrived. The company grew EBIT 20% the most recent quarter, despite the fact that they were still only offering trial batches of their new lines. Bliss operates in a niche corner of the pharma market which has allowed the multinational corporation to retain their leadership while keeping competition and investment limited. With their scale and low costs of production, we expect them to take significant global market share over the coming years. At 15x trailing earnings and with visibility on sustained volume growth, we expect the company to compound earnings at a 40% CAGR over the next three years.
Looking forward, conviction remains high in our style and discipline. The fund continues to exhibit our core strategic attribute of compounding earnings predictably rather than sporadically. Equally important, we are not seeing any need to stretch our valuation tolerance in order to capture earnings growth. As of the end of Q3, the fund’s median P/E sits at 19x ttm and 14.7x forward for an expected 20% earnings growth over the coming year. The EEMS ETF stands at 20.5x median P/E and a 17.5x forward P/E. The fund historically has traded stocks with valuations similar to the stocks in the index, but the stocks the fund has traded have better growth, profitability, and balance sheets. We see recent positive flows into emerging markets and strong YTD performance from the indices, indicating investors are beginning to look beyond the US and into EMs for returns. Having invested in emerging markets for 15 years, we know the value of discernment over the long run – not all companies and investment opportunities are created equal. The rising tide can be effective short term, but ultimately capital will find the most attractive returns. As the world begins to pay attention to our neck of the woods, we expect our portfolio to be discovered and appreciated. But if the world determines to ignore our asset class, we are happy to lean on earnings growth to drive performance.
Sincerely,
Spencer Stewart,
Portfolio Manager
DEFINITIONS
EPS: Earnings per share
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
P/E: Price-to-earnings is a relative valuation multiple that is calculated by taking the current stock price and dividing it by the earnings-per-share.
PEG: Price/Earnings-to-Growth ratio, is a stock valuation metric that compares a company's P/E ratio to its expected earnings growth rate
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.
All investing involves risk. Investments in securities of foreign companies involve additional risks, including less liquidity, currency-rate fluctuations, political and economic instability, and differences in financial reporting standards and securities market regulation. Investing in small and micro-cap funds will be more volatile and loss of principal could be greater than investing in large cap or more diversified funds.