Wednesday, September 21

The Moby Offshore Fund: End of August Update

Welcome back to the exciting world of Emerging Markets!

It's only been about a month since we updated this portfolio but it feels like a year given everything that's happened in the month of August.

Interest rates are at the centerfold of the news this summer as inflation drives up the price of everything around us. So what does this mean for investors in the emerging markets?

Well as inflation rises, central banks "tighten monetary policy" -- aka raise interest rates. This makes borrowing money more expensive which is not so great for those companies and countries that borrowed/borrow money.

However, higher rates also have the effect of attracting foreign investment.

With two identical countries, you typically want to invest in a country with a higher interest rate because you can get a higher rate of return for the same level of risk.

A knock-on effect is that the demand for the currency of the country with higher interest rates increases, raising the value of that currency relative to the currency of the country with a lower interest rate. So higher interest rates lead to higher valued currency.

So if you were wondering why the US dollar is up so much while inflation is high, there's your answer. Whew, that is a complex and very inexact system but hopefully, you get the picture.

  • So why do we care?

Well as the United States increases interest rates in response to inflation, the demand for USD increases. This is great for people who are paid in USD as now your money is worth more when buying assets priced in foreign currencies but not so great for everyone else.

  • Here's why this is important:

A lot of foreign debt is priced in USD and those companies and governments that issue that debt are exposed to these adverse movements in exchange rates. This is generally referred to as Currency Risk.

  • Here's an example:

A German company does all of its operations and transactions in EUR. Then they issue a floating rate bond internationally a year ago and promise to pay interest on the bond in USD (everyone's favorite currency).

But now EUR is not worth as much as it was (relative to USD) when they first issued the bond, and interest rates have risen. Now the amount of money required to pay the interest on the bond has risen from both the change in the exchange rate and rising interest rates.

This cuts into the company's profits, and ultimately make the stock less attractive. There are ways to hedge these risks with financial instruments like futures and swaps, but we'll save that for another day.

Unfortunately, this isn't an exact science so as the world reaches a new equilibrium, there will be some tumultuous repricing of assets from both companies and governments, especially in foreign markets, and even more so in Emerging Foreign Markets.

  • So why are we telling you this?

Well no matter who's investing in foreign stocks, there's a virtual certainty that their portfolio is down. And we're not immune to the same volatility that everyone else is too.


Performance Review:

That's why performance over the last month has been less than stellar.

However, our strategy is built around quality earnings growth and attractive valuations so we're still very confident with the positioning of this portfolio.

We just need to find companies that are insulated from these risks and have strong outlooks.

 The outlook of these companies below remain attractive and we see this drawdown as a STRONG overreaction by the market.

Luckily our allocations to VALE & SNAP overshadowed the tough month of performance by BABA.


New Portfolio:


Old Portfolio:



The strategy is largely unchanged, however, we've subbed out some of the smaller names in the portfolio. Let's discuss a few of the changes:

  • Changes

    • While BABA is down significantly this year, this drop in price is helping the stock screen better from a valuation perspective. BABA is cheaper than its peers on a P/E & P/S basis. We're therefore adding to our position and driving our cost basis down.

    • Gerdau S.A. (GGB) has had an envious run-up in price lately, however, in the last month it's slowed down while outperforming the index. However, like last month, it's still trading below book value! On top of this, GGB has had incredible revenue and net profit growth over the last few years, making it a great long-term buy.

    • A familiar face, Daqo New Energy (DQ) has been a great contributor to our strategy in the past, and we welcome them back gladly. Similar to GGB, DQ has enjoyed an unbelievable year of revenue and net income growth.

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