Volatility is to be expected in emerging markets. The often dramatic swings in the stock market result in large shifts that can be exploited by a seasoned investor. In a volatile market, a company's value on the stock market does not always reflect its underlying value. This is what makes emerging markets some of the most interesting hunting grounds for investors looking for good risk-adjusted returns. Because where there is risk, there are also stocks where you may discover that the risk has been mispriced by the market if you dig deeper into the company. And mispriced stocks with potential are exactly what we, as an active, value-based fund, are looking for in SKAGEN Kon-Tiki.
While we do not claim to be smarter than the rest of the market, we do things a little differently to most. In a challenging market, it pays to go against the flow and look for value in places where most people do not.
Most large emerging markets funds are weighted towards large companies and primarily orientated towards growth, while SKAGEN Kon-Tiki does the opposite. We invest in companies where, after thorough analysis, we believe that the risk is lower than the market has assessed, regardless of the company's size or popularity. Or we invest in companies where the price is favourable - even when weighed against the perceived risks.
This tactic has paid off so far this year; SKAGEN Kon-Tiki, through active and careful stock selection, has achieved a return of 6.7 percent, compared with a return of 2.4 percent for the fund's benchmark index. The same is true over a three-year period, where the fund's return has been 9.2 percent compared to 5.7 percent for the index[1].
A surprising winner
Emerging markets span several continents, and SKAGEN Kon-Tiki is currently invested in 15 countries ranging from Chile and Brazil to India and China. Given both the broad geographical spread and the general downturn in China, it may come as a surprise that three Chinese positions were the top performers in SKAGEN Kon-Tiki in the first few months of the year.
The strategy that has led to our success in China is a good reflection of SKAGEN's contrarian investment approach: SKAGEN Kon-Tiki increased its exposure to China during and after the pandemic, at a time when many others were fleeing the region. The prices subsequently rebounded, and this year we are reaping the rewards of these contrarian investments.
Chinese holdings deliver
Almost all our 13 positions in China, Taiwan and Hong Kong have performed positively this year, despite a dip in, amongst others, Chinese Alibaba in April. However, this does not mean that we are wedded to China, and this year we have sold more than we have bought in the country. This is not because we no longer believe that the Chinese economy will recover, rather we believe that other investors have gradually realised that China will get back on track.
As a result, the price of some of our positions has gradually risen more than the underlying company value justifies, which means it is time to sell. Active management is not just about buying cheaply, but also about exiting positions when the risk becomes too high relative to the potential reward. It is about remaining focused on strategy, not on news headlines or client concerns, even – perhaps especially – when the markets are at their most turbulent.
Balance is key
It is no secret that emerging markets can fluctuate rapidly. However, the risk that these movements inevitably pose can be mitigated through careful portfolio positioning. While it does not pay to put all your eggs in one big inflation-proof basket, nor is it good to blindly chase growth. We focus on distributing capital evenly between companies that perform well in a low inflation environment, those that thrive in a high inflation environment and those that perform well in different growth scenarios. The only risk you cannot really diversify out of in a portfolio is overpaying for a stock; everything else can be offset.
Positioned to face future challenges
In June last year, emerging markets underwent a dramatic downturn and SKAGEN Kon-Tiki was significantly behind its benchmark index. Now we are ahead. This is worth remembering the next time the arrow points sharply downwards; it is rarely a permanent condition.
No one can predict the outcome of the Turkish election or whether Xi Jinping will follow through on his threats against Taiwan over the next few years. However, SKAGEN Kon-Tiki's portfolio reflects what we believe in - without betting the whole fund on red or black. Since investing in emerging markets can be dramatic, it is important to focus on diversification, to maintain a conservative view of valuations, and not least, to keep a cool head.
SKAGEN Kon-Tiki has been going for twenty years, and we have weathered many crises in emerging markets during that period. We will do our best to continue to weather whatever the future may hold.
[1] All return data measured in EUR, net of fees, as of 23 May 2023