AEC Commentary (Q4 2024)
January 2025
The AEC fund closed out the fourth quarter outperforming our EM small-cap benchmark (M1EFSC) by 350 basis points. We are pleased with the resilience of our portfolio through a period of headwinds in which the benchmark declined 7.2% versus a 3.6% pullback for the fund.
The past three months have been newsworthy in both the developed and the emerging world. In the EM world, Korea saw momentary martial law that ultimately led to the impeachment of a standing president. Brazil surprised markets as the central bank rapidly swung from interest rate cuts to sharp increases within a six-month span in an effort to cool the still-hot economy. And the Chinese stimulus announced in September has, thus far, underwhelmed. While these country-specific events added localized pressure, the noise from within the US has had the most significant impact on our asset class.
At present, this noise is partially fact and partially fiction. Fact: glimmers of returning inflation in a still-strong US economy triggered a sharp dollar move following Chairman Powell’s dashing of meaningful interest rate cut expectations. The market's recognition of this reality has driven yields (and the dollar) sharply higher since the end of September. Currency (US dollar strength) has been the biggest detractor from performance. The dollar index, which averages exchange rates between major world currencies, moved 8.5% higher through the fourth quarter. In layman's terms, after being converted into US dollars, foreign currency-denominated securities on average ended the quarter worth 8.5% less than they began the quarter. The fund fared better than the average, but was not immune to the impact, with foreign exchange hitting performance by approximately -4.5%.
The fiction component of the US headwinds can be attributed to tariff proclamations by incoming President Trump. Although nothing has been enacted, the initial language specifically called out Mexico and China in the EM world as potential targets. Possibly of greater import, the approach suggests a protectionist regime that may put pressure on trading partners that want to do business with the US. While the exact impact from the announcement cannot be quantified, we believe that the repercussions have already been meaningful. On the flipside, we have a pro-business administration at the helm, and if this leads to stability and continuing success of the US economy, the rest of the world will benefit.
Yet one quarter does not make a trend, nor do a few headlines suddenly create a static market that lacks opportunity. We won’t belabor the attractive valuations that exist in Korea, Brazil, China, and EM small-cap markets on the whole. Nor will we expound on what we view to be lopsided global markets, with the US weighting appearing bloated compared to the rest of the world. Change is the expectation, and it’s what we work with every day. With dollar moves and market declines discounting our asset class further, we find it ever more attractive given the long-term outlook of the businesses we own.
As opposed to staring at a tough tape, we spent the fourth quarter on the road, with team members traveling to India and Taiwan – our top two exposures at 34% and 10% respectively. Prior to heading off to India, my own fear was that I’d like the already-hot market too much. Matt and I met with 55 companies over a two-week period and, as always, were blown away with the quality, growth, and headroom opportunities of the emerging companies in India. My “fear” was confirmed, as we both felt the exuberance of opportunity. It’s obvious that the growth potential for Indian businesses remains enormous on both domestic and export fronts. What has changed, on the other hand, is the ability to raise capital at strong valuations. This is great for companies coming to the market, and has led to India capturing pole position for new IPO listings last year (327). The challenge is to discern which of the companies we met have the business model, discipline, and prowess to become a billion dollar company, rather than simply taking advantage of nearer-term opportunities in a “hot” market with easy access to capital. The trip was extremely productive, and as a result, we purchased small stakes in five new positions and exited three holdings. We have yet to shift our portfolio meaningfully, as we continue to make follow up calls to ensure our T’s are crossed and our I’s dotted, and wait to confirm that messaging and fundamentals are tracking.
Directly on the heels of India, Matt headed to Taiwan to meet up with Andrey. The trip was vital, but didn’t produce the same exuberance that India did. What we did return with, is renewed confidence in, and purchases of, several companies we had previously owned but dismissed due to noisy sales numbers or challenging valuations. We like owning companies that we already have a history with. The most important result of the visit is that we have higher conviction in a number of our existing holdings, and have found the assurance needed to put more wood behind the arrow.
The chart below displays our track record over short- and long-term periods:
| Periods ended 12/31/2024 | AEC | MSCI Emerging Markets
Small Cap Index |
|---|---|---|
| Quarter | -3.75% | -7.20% | 1 Year | 0.78% | 4.80% | 3 Years Annualized | -0.31% | 2.11% | 5 Years Annualized | 12.84% | 8.56% | ITD Annualized | 9.35% | 4.59% |
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.
PERFORMANCE
Once again stock selection and exposure to India drove our outperformance. On the whole, our India return was +10.5% – a significant contrast to the benchmark return of -5.8%. The majority of our India positions beat the benchmark, but our Materials and Healthcare positions really carried the day. 3B Blackbio (3BBLACKB IN) was our largest portfolio position heading into the fourth quarter, and Time Technoplast (TIME IN) was our second largest holding. 3B Blackbio returned 43% in the fourth quarter, with Time Techno jumping 23%.
3B is a Healthcare company that is miscategorized in the Materials sector. The Materials miscategorization only added to the appeal when we first came across the company in 2020, after their COVID reagent showed phenomenal adoption. Prior to the COVID-driven success, the company was running at ~50/50 agro chemicals and diagnostics. But with notoriety captured through COVID, the legacy chemicals business, while stable, has dropped and remained below a 20% per annum contribution. What’s most impressive is that COVID reagents no longer contribute anything to revenue, and it’s their niche oncology reagents that are taking share at home and abroad. Today 85% of revenue is derived from molecular diagnostics reagents that are used for healthcare testing. The company has ~15% market share of a domestic oncology reagent market that’s growing near 20%. They’ve captured this share from multinationals, like Qiagen (QGEN US) and Thermo Fisher (TMO US), by pricing items 50% below competitors while retaining the same quality. We believe that they can capture more market share from multinationals around the globe. Four years ago, exports were 1% of company sales. This year we expect exports to be near 20%. In three more years, we believe they can be a 45% contribution. There are additional reasons behind the sharp move over the last quarter. First, the Healthcare versus Materials nature of the company is being discovered, and the stock valued more appropriately for the stability and headroom that the diagnostics business offers. Second, their results have been phenomenal (83% EPS growth last quarter). And third, their export business is gaining traction, with sales up 112% year over year through the first half of 2024. 3B has been listed for well over a decade. The diagnostics story has been apparent since 2020, yet as recently as 18 months ago, the stock was trading at 11x earnings. Opportunities and inefficiencies such as these are why we focus on emerging markets.
Time Techno (TIME IN) is a Materials company that we have covered in numerous past commentaries, so we’ll keep this brief. The company leads the globe in niche plastic packaging solutions, and also has a rapidly growing composite pressurized gas cylinder business with enormous headroom, if adopted en masse. The value-add business (composites) continues to grow over 30% and drive margins higher as a result. The company began the quarter trading around 20x earnings and reported 40% EPS growth, and the stock obediently marched higher.
Inversely, we saw significant pressure in Korea and Brazil, the two worst-performing markets through Q4, down 16% and 24% respectively. We are slightly overweight Brazil but underweight Korea, which led to roughly on-par performance versus the bench. Two of our worst three performing stocks were Brazilian, and the third was Korean: Oncoclinicas (ONCO3 BZ) and Mills Locacao (MILS3 BZ) out of Brazil, and FNS Tech (083500 KS) in Korea.
Both markets are very compelling as a result of their corrections. The political chaos in Korea is now all but resolved, and the market remains very inexpensive. With TSMC and Taiwan capturing most of the AI benefit thus far, Korea appears all but forgotten. We do not believe that Korea will miss the AI train altogether, and are placing our positions accordingly (specifically FNS (083500 KS)). Brazil has been a challenging market for over a decade as a result of poor fiscal restraint and a weaker commodity cycle. At the same time, it’s a land of resources and size with well-managed businesses trading at all-time low valuations. While we are not willing to dive deeper into this uncertain policy cycle, we like our Brazilian positions and are eager to add to them once the chop settles.
Through the quarter, our most notable new additions were Kri-Kri Milk (KRI GA) and Andes Tech (6533 TT). Kri-Kri is a leading private-label Greek yogurt supplier that distributes to Western European countries. They are the largest yogurt exporter out of Greece and have strong relationships with top European supermarket chains such as Tesco and Lidl. Their market share is already strong in the UK and Italy, and with added capacity and dominant distribution partners in place, we are confident in their ability to expand throughout the rest of Europe. Kri-Kri sits at the intersection of two significant trends: a shift in consumption towards private-label goods due to stagnant incomes in Western Europe, and increased consumption of Greek yogurt given the health benefits of its higher protein content. The company anticipates double-digit revenue growth and margin expansion as they branch out through Western Europe and add new products. We purchased the stock at an 11x price to earnings ratio, which we believe to be a bargain for a secular-growing defensive business.
Andes Tech (6533 TT) is a leading IP provider for RISC-V CPU instructions architecture. RISC-V is an open-source design architecture used for assigning semiconductor instructions. The advantages of RISC-V are greater customization, decreased time to market/development cycles, improved efficiency, and as an open-source resource… it’s free! Their headroom and competition is essentially defined by looking at their “proprietary” architecture competitor Arm Holdings (ARM, US $147B market cap). ARM owns their library, thus anyone that uses the instructions they’ve designed pays licensing fees. Andes isn’t that different, in that they also have a library of internal designs that they sell to RISC-V users, yet their market is growing rapidly because of the aforementioned advantages of speed and price versus Arm. Not only that, but Andes is particularly strong in faster-growing end markets such as AI, consumer, storage, and IoT. Over the past four years, the company has almost quadrupled their engineering team – punishing to profits, but appropriate for this stage of adoption. Additionally, they have added ~25% of the team in the US, where salaries are nearly double Taiwan. With hiring now stabilized and a host of new product launches about to hit the market, expenses will grow at ~10% versus revenues at around ~30%, thus we anticipate significant margin expansion.
OUTLOOK
We view our business as a combination of both art and science. The science is grounded in analysis of data that’s available to all. While there are any number of metrics and calculations used to identify expected returns on investment, results rarely follow science alone. The art is the ability to successfully select companies where the science is sound, unappreciated, yet will become accepted. In a recent screen of Korea, we came across numerous companies that have a negative enterprise value (EV). EV is often used as a simplistic formula to estimate the cost of buying a company. A negative EV generally exhibits no scientific logic. Unfortunately, the art is not as simple as just buying stocks that defy logic. Without delving into the weeds, we see little appreciation of art or science as we look at global market dynamics today. We see crowding, consensus, and frankly, fear-driven allocations. As seekers of inefficiency, we are okay with this distortion because it perpetually produces abundant opportunities. The foundation of our strategy is hinged on making logical investments (sound science) in companies whose value is underappreciated by the markets (innovative art). Thus, we are adding to Mexican holdings, we have a calendar of calls with Koreans and Brazilans, and Indian companies are always part of our daily discussions. We do not see our asset class losing relevance. In fact, we see just the opposite from the ground up. Our pond is jammed with fish, and fewer and fewer people are fishing.
Sincerely,
Spencer Stewart, Portfolio Manager
The MSCI Emerging Markets Small Cap Index includes small cap representation across 24 emerging markets countries. With 2,014 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. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown.
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