Liontrust Emerging Markets Fund

• Emerging markets outperformed developed markets for the second consecutive quarter, with falling US interest rates creating a favourable macroeconomic backdrop and a Chinese stimulus package providing a significant boost.
• South-East Asian and Chinese equities performed best, while South Korea and Taiwan suffered due to an investor rotation out of the wider tech sector.
• The sell-off in the Korean technology sector hit the Fund’s holdings in pure-play memory producer SK Hynix and Samsung Electronics. However, the Fund’s exposure to South Africa, Indonesia and India all made positive contributions.

The Liontrust Emerging Markets Fund returned -1.4% over the quarter, compared with the 2.5% return from the MSCI Emerging Markets Index comparator benchmark and the 1.4% average return from the IA Global Emerging Markets sector, also a comparator benchmark*.

The third quarter saw emerging market equities continue their steady progress higher, having bottomed approximately two years ago in October 2022. While emerging markets have generally lagged the wider global equity rally over this period − weighed down notably by China's poor performance − this was the second quarter in a row where emerging markets have outperformed developed markets, supported by a conducive macroeconomic backdrop.

This year has seen a general easing in global monetary conditions, with bond yields starting to fall back thanks to moderating inflation, which had spiked aggressively in the aftermath of Covid lockdowns and various global policy responses. In the US, core inflation continued to ease, allowing the Federal Reserve to begin cutting interest rates with a 50-basis point reduction from 5.5% to 5.0% in September − the largest since 2008 (excepting the Covid response). With the US 10-year bond yield falling, this created a favourable backdrop for emerging markets, which often match their monetary policies to the Federal Reserve. In general, emerging market central banks have behaved proactively and responsibly in order to get ahead of the interest rate hiking curve in the past several years, leaving policy tight and with space to reduce interest rates. While some central banks, such as in the Philippines and Indonesia, have already begun loosening interest rates, many others now have the leeway required to ease in turn.

While emerging markets have benefited from this improved macro backdrop, the underperformance of China has remained a huge headwind for the asset class over the past several years. However, the quarter saw a dramatic intervention from the Chinese authorities aimed at stemming the ongoing decline in the property market, which has weighed on the broader economy, especially consumer sentiment. In late September, a co-ordinated policy response took shape, combining monetary policy (including lower interest rates) with an about-turn in fiscal policy, which saw the Chinese markets rally in stunning fashion, rising nearly 40% from recent lows by the first week of October. For the quarter, MSCI China rose 16.4%, well ahead of both developed (+0.2%) and emerging markets (+2.5%) and is now up 23% for the year, also well ahead of both developed markets and emerging on a year-to-date basis.

The initial catalyst was the coordinated stimulus measures announced by the People's Bank of China (PBoC), China Securities Regulatory Commission (CSRC) and China Banking and Insurance Regulatory Commission (CBIRC) on  September 24th, just days after the Fed had kicked off its easing cycle with a 50 basis point cut. Measures included lower interest rates and reserve requirements, lower mortgage rates and downpayments for second homes, and lending facilities for stock purchases and buy backs. This was reinforced by a Politburo meeting on the 26th calling for stronger housing and fiscal stimulus, including capital injections for major banks and cash distributions for low-income groups. This represented a broad shift in policy stance and additional details on fiscal support for both the property market and consumers are expected in the coming weeks. Initial estimates are for RMB 2-3tn ($300-400bn) of support which could rise to RMB 10tn ($1.4tn) through 2025.

Given the falling rate environment, the best performing markets were those in South-East Asia and China, while the major laggards were the North Asian tech-heavy indices of South Korea and Taiwan, which suffered due to rotation out of the wider tech sector due to valuation concerns as well as a weakening of the outlook for component pricing, especially in the memory sector. India performed well, albeit slightly underperforming the average.

The heavy rotation in the market worked against the Fund this quarter, which has otherwise enjoyed strong performance this year. On a year-to-date basis the Fund is approximately in-line with the benchmark index, though well ahead of the average fund. The most significant driver of performance in the third quarter was the aggressive sell-off in the Korean technology sector, where holdings in pure-play memory producer SK Hynix as well as Samsung Electronics hurt fund performance. The sharp and un-foreseen rally in China also weighed on performance to a lesser extent. On the positive side, South Africa, Indonesia and India all made positive contributions to performance, especially in the financial sector, where banks rallied on the improving economic prospects from lower interest rates.

Changes to the portfolio mainly involved responding to the Chinese policy interventions, which we believe are more credible than those we have seen in the past. This largely involved increasing exposure to existing positions in the consumer discretionary sector such as Alibaba and Meituan. The weighting to South Africa was increased early in the quarter with the addition of Nedbank and Outsurance Group in the financial sector as well as retailer Shoprite. These positions were funded by profit taking in both South Korea and Taiwan.

We believe that emerging markets are well set up for a period of outperformance against developed markets, spurred on initially by lower interest rates and therefore yields and US dollar, but now also supported by a real chance of economic stabilisation in China. The spread of emerging market growth over developed at an economic level has been rising and, with it, a relative improvement in corporate earnings. When paired with low valuations and ownership in the asset class, this offers a clear window for a much welcome return to form for emerging markets.

Discrete years' performance (%) to previous quarter-end:

*Source: FE Analytics, as at 30.09.24, primary share class, total return, net of fees and income reinvested.

KEY RISKS

Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested.

The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.

Overseas investments may carry a higher currency risk. They are valued by reference to their local currency which may move up or down when compared to the currency of the Fund. This Fund may have a concentrated portfolio, i.e. hold a limited number of investments. If one of these investments falls in value this can have a greater impact on the Fund's value than if it held a larger number of investments. The Fund may encounter liquidity constraints from time to time. The spread between the price you buy and sell shares will reflect the less liquid nature of the underlying holdings. Investments in emerging markets may involve a higher element of risk due to less well-regulated markets and political and economic instability. This may result in higher volatility and larger drops in the value of the fund over the short term. Outside of normal conditions, the Fund may hold higher levels of cash which may be deposited with several credit counterparties (e.g. international banks). A credit risk arises should one or more of these counterparties be unable to return the deposited cash. Counterparty Risk: any derivative contract, including FX hedging, may be at risk if the counterparty fails.

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