East Capital Global Emerging Markets Sustainable

Q3 2024 was a spectacular quarter for emerging markets, which returned 8.7%. For the second consecutive quarter, this was above developed markets, which returned 6.5%. While the FED’s jumbo interest rate cut should not be ignored, China stole the show late in the period, with the MSCI China (Hong Kong and US listed names) being the main driver of absolute performance, returning 23.6% in the quarter. It was also an exceptional quarter for the fund, which returned 11.5%, 2.7% above the benchmark. This was driven by strong stock picking in many countries, particularly India, China and Brazil. Year-to-date, the fund has outperformed the benchmark by 5.2%.  

All eyes were on China when, somewhat unexpectedly, the government announced a broad and coordinated policy response to the country's well-documented economic problems. This marked a significant and unexpected shift from the previous approach of drip-feeding small policy changes on a piecemeal basis. It all started on 24 September, when the heads of all the financial regulators held a joint press conference and announced a series of positive measures. These included reserve and interest rate cuts, which should release USD 142 billion into the economy, changes to down payment rules, and two new tools to boost capital markets. The first is a USD 71 billion programme to allow funds, insurers and brokers to pledge shares (as long as they return the money to the stock market) and the second provides up to USD 43 billion in cheap loans to commercial banks to help them finance share purchases and buybacks by other companies. Two days later, the Politburo’s meeting issued a strongly worded set of policy directives. Key among these were calls for increased government spending through borrowing, “forceful rate cuts” and “stopping the decline of the housing market”. Press reports on the same day suggested the government was considering borrowing some USD 140 billion or more in loans to boost consumption and the same amount to recapitalise local banks. This is the kind of cash injection that economists have long been calling for to really start to turn the economy around.  

Much of the performance was driven by aggressive short covering as the sentiment towards China was extremely poor ahead of this, and also by a wave of optimism from Chinese retail investors looking to invest ahead of the Golden Week holiday. Brokers had to stay open 24 hours a day to cope with the influx of new investors and onshore trading volumes (Shanghai and Shenzhen) hit an all-time high of USD 370 billion traded on 30th September. 

The question, of course, is whether this rally can continue. We remain cautiously optimistic as we believe the government can and will follow through on the fiscal/demand-side stimulus – probably in the next few weeks. We note that this isn't something China is completely averse to - we recall the 2008-09 stimulus package, which drove GDP growth to 10%. We also note that the market is still below the peaks of even 2023 and still 41% below the peaks of 2021, with valuations still well below historical averages. However, we do believe that the market will need to see concrete evidence of this fiscal package before making another significant move higher. 

Thanks to our approach of trying to remain broadly country neutral (instead preferring to let our stock picking create the alpha), we were already fairly well positioned, although we did make some minor trades to increase beta. One such trade was to double our position in Ping An Insurance, which will be a key beneficiary of the updated repo rule, as well as a high-quality exposure to the broader economy. At the time of writing (3 October), the stock is currently up 42% compared to our 24 September purchase price, demonstrating the benefit of acting quickly and at scale to reflect our changing convictions, a cornerstone of our investment process.

The broader question regarding China is how this will affect the rest of emerging markets. Unequivocally the sentiment is positive, not least because it increases the chances of a “soft landing” globally. However, in order to see a more fundamental impact, we need to see the government succeed in turning the economy around, which is a mammoth task. We have already seen some small moves in key commodities such as iron ore, but there is clearly more to come as construction activity starts to pick up in a more meaningful way.

India also had a solid quarter, briefly overtaking China as the largest market in the MSCI Emerging Markets Index in early September, with both countries at around 22%. This is a big change from 2020, when India accounted for just 8% of the index, compared with 40% for China. While flows from domestic investors have been strong over the past two years, international investors have recently joined the fray - domestic flows year to date are close to USD 30 billion, and foreign inflows were over USD 10 billion in Q3 alone. Unlike in the US, many of these flows are active, so finding the "future investor darlings", which is our approach in India, can be a very fruitful approach. This was borne out in Q3 as our Indian holdings returned 24.8%, compared with 7.3% for the benchmark. Our alpha generation from India was therefore 3.5%.

The main alpha contributor was recycling company Gravita, which returned 65.3% over the period. The stock came onto investors' radars on the back of several major initiations by local brokers, as well as several regulatory developments that will significantly accelerate the shift from informal to formal lead recycling, which is the company's main product. Currently, 65% of recycling is done by the informal sector, but this is expected to fall to 25% by 2028; as the largest player in the industry, Gravita will be a key beneficiary. We expect earnings to grow at a CAGR of more than 30% over the next three years.  

Trading activity remained high as usual. One of the main trades was to increase the beta of our Chinese names as discussed, for example adding to Alibaba in late August, partly because it was about to be added to the Stock Connect programme, which means that local Chinese investors will be able to invest in the stock for the first time. 

On the sustainability side, we published our H1 2024 Impact Report, which we are happy to discuss in detail with interested investors. It is pleasing to see that many of the key sustainability metrics we focus on are trending in the right direction. For example, due to the small and mid-cap tilt of our portfolio, we previously lagged behind the index in terms of board gender diversity which was at 14% in H2 2023.. Following the AGM season, our portfolio has now jumped to 19%, which is actually above the benchmark at 18%. 

Going forward, falling rates and an improving China provide a very positive backdrop for emerging market equities, at least in theory. A key point we highlight is that it is not just the US (and China) that are cutting rates. The FED's jumbo cut has allowed many EM countries to start cutting as well, with the Philippines and Indonesia being the first to do so in September, which will be positive for growth and companies in these countries. However, we can't ignore the US presidential election, which is still very much on investors' minds. Although it is still far too close to call, a Harris victory would likely be positive for emerging markets, bringing a more predictable foreign policy and likely a weaker US dollar. However, this is by no means a given, so we're focusing on what we've been doing all along - building high-quality, robust portfolios that we believe can outperform in a range of scenarios. 

Our portfolio currently trades at 12.1x P/E for 2025, in line with the MSCI Emerging Markets benchmark, although our earnings growth is superior at 18.2% versus 14.5% for the benchmark.   
 

Performance in USD net of fees.

This publication is not directed at you if we are prohibited by any law in any jurisdiction from making this information available to you and is not intended for any use that would be contrary to local laws or regulations. Every effort has been made to ensure the accuracy of the information in this document, but it may be based on unaudited or unverified figures or sources. The information in this document should not be used as the sole basis for an investment. Please read the Prospectus and the KID, which are available on the fund page.

East Capital Global Emerging Markets Sustainable is an Article 9 fund under the EU Sustainable Finance Disclosure Regulation (SFDR) which means that we are explicitly looking to invest in companies that have a positive impact on the world around them in addition to outperforming the market.

The key proprietary tool developed to assess this has been highlighted on various occasions by the PRI - UN Principles for Responsible Investment. The implications of this approach are that the fund:

• Doesn’t invest in fossil fuel companies and most mining companies
• Has a strong quality bias
• Aims to identify the future “ESG darlings” of the market before the ratings agencies and international banks 

Key documents explaining the sustainability process and outcomes are listed under Sustainability - Documents.