AEC Commentary (Q4 2025)
January 2026
2025 was a strong year for emerging markets. For the twelve months ended December 31, the MSCI Emerging Markets Small Cap ETF (EEMS) returned 19.79%. The fund gained 10.40% net of fees for the full year, finishing the fourth quarter flat versus the EEMS 1.9% return. Although we are proud of our absolute results over our eight years of operation, benchmark-beating performance has proven challenging over the past three. The market has favored a style that differs from our philosophy of investing in high-quality reasonably-valued growth companies. While we have certainly made mistakes, we believe we have largely succeeded in delivering on our approach, as reflected in our portfolio’s fundamentals. Over the last three years, earnings of our portfolio companies have compounded at more than an 18% CAGR, and the portfolio ended 2025 with a weighted-average return on equity (ROE) above 20%. These results have been produced by owning companies with P/E valuation in the 18-20x range. As previously stated, lately the market has not rewarded our style. We view this trend as transitory, and are staying true to our investment philosophy which has produced favorable results over the long term.
Consider the MSCI Emerging Market Quality Index (MXEFQU), an index aiming to capture the performance of quality growth stocks. It identifies stocks based on three main fundamental variables: high ROE, stable year-over-year earnings growth, and low financial leverage. The Quality index underperformed the MSCI Emerging Markets Index (M1EFSC) by nearly 20% in 2025. In eight of the thirteen years prior to 2025, the Quality index outperformed. In the five years it underperformed over that period, the average shortfall was less than 4%, putting into historical perspective the truly dramatic 20% underperformance in 2025. In fact, the strongest-performing group in 2025 within the EEMS was, counterintuitively, companies with negative ROE. This bucket delivered an average return of nearly 31% — the highest in the last decade and more than 50% above the ETF’s overall return. Clearly 2025 rewarded lower-quality, lower-visibility profiles. If history is any guide, this is not a sustainable trend.
The theme driving this market anomaly is AI, which has concentrated stock performance towards the most direct AI capex beneficiaries and higher market cap names. The benchmark’s 2025 outperformance versus ours was driven by an unusual concentration in a small number of companies within the largest country allocation sleeves. Of the 317 Taiwanese companies in our benchmark (nearly 20% of the index and the second-largest country weight at the end of 2025), the top fifteen contributors accounted for nearly 68% of Taiwan’s return. Those same fifteen companies began the year with an average market cap of roughly $3.1 billion and an average trailing P/E of about 31x (excluding three of the fifteen who were, and are still, without earnings). India told a similar story. Strip out the top fifteen contributors, and the remaining 468 stocks would have returned negative 3.75% last year. The top fifteen began the year with a $3.6 billion market cap and traded at over 90x trailing earnings. In other words, a small handful of large, expensive stocks disproportionately impacted index returns.
These numbers sit within a broader backdrop that still favors our asset class. International and emerging markets outpaced the S&P 500 in 2025, with non-US indices delivering high-teens to low-thirty percent returns, compared with 17.72% from the S&P ETF (SPY) and 12.66% from the Russell 2000 ETF (IWM). Emerging markets, in particular, continue to offer faster economic growth, cleaner balance sheets, and lower valuations than developed markets. Within that world, small caps remain a deeply inefficient corner where incremental research and boots on the ground can still move the needle. That niche is precisely where we spend our time, and it also explains why our relative results can be heavily influenced by where the benchmark’s leadership is concentrated in any given year.
The chart below displays our track record over short- and long-term periods:
| Periods ended 12/31/2025 | AEC | MSCI EM Small Cap
ETF (EEMS) |
|---|---|---|
| Quarter | -0.01% | 1.88% | 1 Year | 10.40% | 19.79% | 3 Years Annualized | 12.19% | 15.01% | 5 Years Annualized | 7.65% | 7.77% | ITD Annualized (1/1/2018) | 9.48% | 5.76% |
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.
The fourth quarter was heavy on travel: Korea in October, Taiwan in November, and India in December. Our Korea visit was intentionally focused on AI and memory beneficiaries. The largest addition following our meetings was S&S Tech (101490 KS). S&S is expected to begin EUV mask blank production for Samsung in Q2 2026. The company remains a top idea for us and, as of December, traded at 24x trailing earnings and 17x FY26 EPS. Our second largest addition was FNS Tech (083500 KS), a business transitioning from a purely capital equipment producer to a high-margin consumables supplier through its CMP pad business and the recent acquisition of Asahi Lamps Taiwan. At the end of 2025, FNS traded at 10x trailing earnings and less than 7x FY26.
We embarked on our Taiwan tour with high hopes, but overall found the trip disappointing given a clear bifurcation of business outlook between the AI exposed and the rest. There are a select few companies explicitly benefiting from the AI capex cycle, most of which have moved into the mid-cap range and carry very high multiples. The median tech stock had no change to earnings in 2025 (zero growth), while the median non-tech stock had an earnings decline of 9%. The lack of earnings growth for the majority, in tandem with extreme valuations of a handful of companies, has driven the Taiwanese market P/E to 40x TTM EPS, versus the seventeen-year average of <25x. Given this context, we view the investment options as sparse — the bulk of the companies are slogging through a generally weak consumption cycle with intense competition out of China, and a limited few are trading at feverish valuations.
While in Taiwan, we did find a few core growth stocks trading at reasonable valuations. Sunonwealth (2421 TT) is an electric fan maker with broad end markets exposure. It is showing strong growth from the server cooling market, which is becoming a significant driver of growth. The stock is trading on 14x 2026 P/E with expectation for 30% earnings growth. Another recent addition is Sinbon Electronics (3023 TT), a niche electrical connector manufacturer trading at 14x 2026 P/E – a huge discount to its peers Bizlink (3665 TT), which trades at 22x 2026 P/E, and Amphenol (APH), which trades at 35x 2026 P/E. While Sinbon went through some challenges related to weakness in the renewable energy end market, they have improved end market diversification and are expected to accelerate revenue growth this year. We will continue to look for opportunities in Taiwan, especially given the reasonable valuations we are seeing in the non-AI sections of the market.
India was, unfortunately, a meaningful detractor in 2025, and the irony is that it did not feel like a “bad year” on the ground. If anything, the mood in India remained confident, entrepreneurial, and busy, as management teams continued investing aggressively. What changed was the market’s ability to absorb that enthusiasm. After several years of strong performance, valuations entered 2025 with little room for error. As the year progressed, foreign investors became net sellers, and the marginal bid shifted toward domestic institutions. The result was a more mixed tape than the headlines indicated. Many of the best businesses continued to compound fundamentals, but share prices were far less reactive, particularly in areas of the market that had benefitted most from momentum and multiple expansion. Our Indian holdings delivered solid operating results: for the trailing twelve months ended September 2025, our exposure generated a weighted average revenue growth exceeding 20% year-over-year, with EBIT growth above 19%. Despite this growth, there was little stock appreciation, as valuation multiples compressed.
We remain constructive on India’s long term growth, and we left the country with higher conviction in several existing holdings and a short list of what we believe are genuine gems. One of those gems is Kwality Pharmaceuticals (KWPL IN), a specialty generics company with registrations across 70+ countries. Supported by a menu of over 3,000 formulations and a favorable loss-of-exclusivity cycle across our core LATAM markets, we believe Kwality will be able to convert off-patent openings in hospital tenders into share gains, thereby sustaining 30%+ sales and earnings CAGR over the next five years. At the close of the year, Kwality traded at 23x trailing earnings and less than 12x FY26 earnings. In our view, periods like 2025 are not a reason to step away from India. They are when the market begins to offer the kind of inefficiencies that disciplined bottom-up investors can profit from.
Another region deserving a discussion is Poland, which has delivered some of the most durable contributions in our portfolio despite the global conversation fixating on mega-cap tech. We have often written about our conviction in Poland since its local small caps combine European institutional stability with lean cost structures and ambitious management teams. That conviction rewarded us in 2025, as Poland was our largest contributor, returning 83%. The single biggest stock contributor was Digital Network (DIG PW), up 162% since our first purchase in February 2025. In the fourth quarter, the company announced and began to integrate a transformational acquisition of Braughman Group Media Outdoor, one of the most recognized out-of-home platform (OOH) advertisers in Poland, which owns large format premium billboards and digital screens in top city centers, class A offices, and key transport hubs. The deal essentially bolts a high-quality more-traditional OOH footprint onto Digital Network’s existing digital infrastructure. The opportunity, as we see it, is straightforward: migrate these legacy assets toward richer digital formats, monetize more impressions per location, and leverage shared sales and technology across a larger network. The market seems to agree. Even after a 70%+ fourth-quarter rally that made it the fund’s largest contributor, Digital Network still trades at 13x FY26 earnings. That move owes something to a still-underappreciated structural trend, namely the digitization of outdoor advertising in Poland, where advertisers are steadily shifting budgets toward interactive and data-rich campaigns.
Emerging markets remain under-owned – a pond full of fish with far fewer boats on the water than in developed markets. US investors typically allocate only ~3-5% to emerging market equities, versus ~10%+ in global benchmarks. This underweight has persisted even as emerging economies make up the majority of global GDP (PPP). The fact that India just posted back-to-back record IPO years while foreign ownership sits near a fifteen-year low is emblematic of the kind of inefficiency we seek to harvest.
We would, of course, prefer to beat the benchmark every quarter and every year. That is not realistic for a more-concentrated fundamentally-driven strategy operating in volatile markets. There will always be years when flows, politics, or momentum temporarily swamp bottom-up fundamentals. 2025 was one of those years.
Our commitment to you is to stay consistent in how we respond. We will keep doing the unglamorous work of visiting companies, challenging our own assumptions, and searching for high-quality earnings streams that the market is temporarily mispricing. We will remain fully invested in emerging markets small caps, not because they are easy or fashionable, but because decades of experience have taught us that they are inefficient enough to reward that diligence.
Thank you, as always, for your trust and partnership.
Sincerely,
Spencer Stewart,
Portfolio Manager,Ark Global Emerging Companies, LP
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
PPP: Purchasing power parity is a measure of the price of specific goods in different countries and is used to compare the absolute purchasing power of the countries' currencies.
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.