Q1 was a strong quarter for emerging markets, returning 2.7%, significantly outperforming the S&P 500, which declined by 4%, marking the worst quarter for US markets relative to the rest of the world since 2002. However, after the quarter ended we saw Trump’s “Liberation Day” tariff announcements, with the S&P 500 falling 11% in the two days that followed, and Hong Kong’s Hang Seng Index having its worst day since the 1997 Asian crisis on Monday 7 April, closing down 13.2%.
Focusing on Q1, China was the standout performer in Q1, returning 15%. This was catalysed by the release of DeepSeek in January, followed by further AI models from listed Chinese companies such as Alibaba. The latest DeepSeek and Alibaba models are, respectively, ranked first and third globally among all well-known large language models (LLMs) in the Hugging Face LLM rankings, which assess LLM reasoning abilities using various benchmarks. Much attention has been given to the cost of these models; while actual costs may be slightly higher than reported, it is clear that they are significantly cheaper than the AI models developed in the US. We rotated our portfolio into the tech sector and increased our position in names like Alibaba, subsequently returning 57%.
Meanwhile, BYD launched its ‘God’s Eye’ self-driving technology, which is available on a range of vehicles, including the USD 10,000 Seagull model. Tesla charges USD 8,000 for its self-driving feature alone, and with significantly higher vehicle prices. The stock, which was one of our largest alpha generators in the period, returned 47% as investors appreciated the strength of the company’s offering. It’s important to mention that BYD doesn’t sell cars to the US, and therefore, the direct impact of the tariffs is limited.
For China’s market rally to broaden, economic conditions remain crucial. After spending the past few weeks meeting companies in Hong Kong, we found a degree of cautious optimism, with companies showing signs of improvement in Q1. Key indicators, such as housing prices, appear to be stabilising rather than declining month on month. We therefore continue to see significant value in China, provided the government continues its gradual stimulus measures, as we expect. Towards the end of the quarter, we took some profits from the tech holdings and rotated into high-quality non-tech companies with strong growth but trading at attractive valuations.
Elsewhere in emerging markets, performance was more muted, with two other large markets, Taiwan and India, returning -13% and -3%, respectively. We visited Taiwan, including TSMC’s headquarters during the quarter. Our view remains that the AI hype was largely priced in by late 2024 and recent negative sentiment from the emergence of DeepSeek and a broader Nasdaq sell-off has impacted Taiwan. That said, we see significant value beyond tech hardware (e.g. auto parts), and have generated 37bps of alpha in Taiwan from these non-tech stock picks.
India had a volatile quarter, with the MSCI India down -11% at one point before recovering to 3%. The key driver of the sell-off was strong outflows from international investors rotating into China, compounded by concerns about a cyclical slowdown and weak earnings. Since November of last year, we have been significantly reducing our exposure to mid and small caps (by 7% of the fund). However, the exposures that we had sold off aggressively, which drove approximately 1.9% of negative alpha, down from over 5% of positive alpha in 2024. We now have very little exposure to mid and small caps and are selectively adding high-quality names with strong earnings visibility at attractive prices as the market appears to be bottoming out.
It has been a busy period for travel, with our team visiting the Philippines, Sri Lanka, Taiwan, India, China and Hong Kong. These trips provide not only opportunities to meet promising companies but also valuable insights from other market participants and stakeholders, helping us understand broader market drivers beyond company fundamentals.
On the sustainability front, we published our H2 Impact Report for the fund. A key highlight is that 85% of our portfolio companies now report Scope 1 and 2 emissions, a significant improvement from 35% in 2020. We think numbers like these go a long way to addressing the many questions we receive about the availability of sustainability data in emerging markets. This progress reflects both investor engagement from managers like us and regulatory changes, such as India’s mandate requiring all companies to disclose emissions.
Trump's "Liberation Day" announcement, which came after the quarter end, was in many ways the worst-case scenario. The US imposed a baseline tariff of 10% on all countries (excluding certain goods such as semiconductors and certain countries such as Mexico) and much higher tariffs on certain key trading partners. The market has been in a bit of a freefall since then, especially after China announced its willingness to retaliate by increasing tariffs on US goods and opening up investigations into US companies operating in China.
The big question going forward is the extent to which Trump is willing to negotiate. As is often the case with his administration, the messaging has been mixed, and he has occasionally indicated that there would be room to reduce tariffs, for example with China if they would agree to the sale of a majority stake in US TikTok to a consortium of US investors.
We are keeping a level head, trimming certain positions where we feel the risk-reward no longer looks appealing, while of course being on the lookout for stocks that we believe have sold off excessively.
In contrast to the US, investor positioning in emerging and frontier markets remains light, particularly among US investors, who control the majority of global AUM. Moreover, not all markets are hit evenly – for example Goldman Sachs estimates that India’s GDP would be reduced by just 30bps, but this would be offset by lower oil prices (10bps) and lower interest rates (10bps).
If the tariff situation takes a positive turn, it wouldn’t be unreasonable to expect that emerging and frontier markets could continue their outperformance. The tit-for-tat taking place between the US and China at the time we are writing this commentary is indeed worrying and we, along with the rest of the world, will be watching closely.
Our portfolio trades at 10.0x PE 2025 compared with 11.5x for the benchmark, whilst offering superior earnings growth of 19.7% versus 11.6% for the benchmark.
Performance in USD net of fees.
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