Zurich Investments Emerging Markets Eq (ZUR0614AU) Report & Performance

The Fund fell with the market in the September quarter but was ahead of the index return by 1.34% in Australian dollar terms. China/Hong Kong was the leading contributor to performance due to a combination of stock selection and an average underweight as the market declined 22.5% during the quarter. The leading detractors were all Chinese companies, including Postal Savings Bank of China, a leading retail bank in China. The bank reported positive first-half results but still underperformed given expectations for the banking industry in China to experience net interest margin compression from interest rate cuts, and rising net profit loss pressure from the extended property down cycle. India was one of the better-performing markets in the third quarter.

Three of the Fund’s top five leading contributors were Indian companies, including Colgate-Palmolive (India), India’s largest oral-care products company. Although the company reported first-quarter fiscal-year 2023 revenue growth that was below consensus estimates due to a decline in volumes emanating from continued weak rural demand, the company’s product portfolio is defensive and therefore attractive in the current market environment. Positioning and stock selection in the communication services and financials sectors resulted in positive attribution but this was partially offset by stock selection in materials and an underweight in energy. Financials stock selection was positive due in part to a position in LIC Housing Finance, the second-largest housing finance non-bank financial company in India.

The company reported in-line quarterly results including a strong year-over-year increase in net income and solid year-over-year growth in loans. LIC Housing Finance remains attractive given all asset-quality metrics have improved year-over-year and it is leveraged to growth tailwinds, including a preference for larger houses, wage inflation and strong hiring trends. Ganfeng Lithium, a leading lithium producer in China, was the leading detractor in the materials space. The company reported impressive increases in net profits and gross margins but performed poorly given market concerns of a correction in lithium prices in 2023. The supply/ demand dynamics are expected to remain tight in 2023 as new projects have been delayed primarily due to COVID-19, as well as expectations for new energy vehicle sales to grow by 2 to 3 million in China and 1 million in the rest of the world. The outlook is indeed challenging for global economies; however, there is a silver lining in emerging markets. Stronger monetary and fiscal stimulus is expected to continue in China with confirmation of Xi Jinping’s third term at the 20th Communist Party Congress in mid-October. Overall, new opportunities are being found in all emerging market regions from the bottom up. Margin pressures are expected to ease as input costs come down, and there appears to be an end in sight to tightening cycles in emerging markets compared with developed markets. Emerging market valuations are very compelling at 10x forward earnings and an approximate 45% discount to developed markets. Emerging markets should outperform developed markets through 2023 as the relative growth premium of emerging versus developed markets expands once again.

The Fund edged ahead in local currency terms and was ahead of the index return by 0.67%. Calendar year-to-date, the Fund is outperforming the index return by 3.76%. The Asian region performed in line with the broader index in May. Taiwan was excluded from the 13-member Indo-Pacific Economic Framework (IPEF) given certain members concerns of retribution from China. However, the US and Taiwan are expected to announce plans to deepen economic ties with a focus on enhancing economic cooperation and supply chain resiliency. South Korea increased its policy rate as inflation exceeded consensus expectations. On the fiscal side, the National Assembly approved a $49.5 billion supplementary budget to support businesses negatively impacted by COVID-related restrictions. The Philippines reported a faster than expected increase in gross domestic product (GDP) in the first quarter, fuelling calls for the central bank to raise its policy rate as inflation also exceeded expectations.

Sentiment in China/Hong Kong improved as the People’s Bank of China cut the 5-year loan prime rate by 15 bps. The State Council announced 33 incremental measures to stabilise the economy from a broadening of tax rebates to relaxation of automobile purchases. The COVID outbreak in Shanghai continued to improve with expectations for Beijing to follow a similar pattern. President Biden also stated that he was considering removing some tariffs on Chinese imports. Latin America was the best performing region in the index in May. Chile led the region as it completed the draft of a new constitution which left out more radical proposals including expropriation of all mining activities, although it still implies a bigger role for the state.

The draft constitution has now moved to the harmonisation stage which is expected to result in a streamlined draft before a vote in September where rejection appears increasingly likely. Colombia also outperformed as the first-round presidential election provided more clarity to the market with left wing candidate, Gustavo Petro, and independent candidate, Rodolfo Hernandez, moving to the second round. Brazil hiked its policy rate by 100 bps and the government announced a 10% reduction in taxes for 87% of imported goods to quell inflation.

The Emerging Europe, Middle East, and Africa (EMEA) region underperformed in May The UAE, Saudi Arabia, Qatar and Kuwait all declined as investors took profits on lofty valuations relative to other emerging markets as growth concerns outweighed a strong increase in brent. Hungary was the worst performing market in the index as it introduced a windfall profit tax targeting the bank and energy industries. South Africa outperformed in May following a weak April as the government extended relief on fuel prices, helping to contain inflation. Investor sentiment remains cautious on the extended war in Ukraine, the China lockdown spreading from Shanghai to Beijing, and the expedited rate hike by the US Federal Reserve (Fed). China, refusing to deviate from its zero COVID policy, will have to introduce more policies to support the economy, including further monetary easing, larger fiscal stimulus, additional tax relief. With oil prices well above $100 per barrel, countries such as Saudi Arabia, Qatar, and the UAE stand to benefit. Within the EMEA, South Africa offers alternatives to Russia for gold and palladium while Latin America enjoys distance from the epicenter of the war, and exporters also get a boost from current oil and food prices.

Higher commodity prices and aggressive rate hikes in general have been supportive of Latin American currencies. Higher oil prices will be a headwind for Asia, where the risk-off trade favors Indonesia and Malaysia over Korea, India, Thailand, and the Philippines. South and Southeast Asia are well positioned as supply chain alternatives with better reopening than North Asia. Taiwan and Korea are expected to continue to be impacted by volatility in the technology sector from rising rates and slower demand.

The Fund fell with the market in the quarter and was unable to outperform the index return. Calendar year-to-date, the Fund is ahead of the index return by 1.97%. Tencent Holdings was the leading detractor due to the Fund’s underweight position in the name.

The investment team has maintained the underweight in Tencent Holdings as they believe the internet industry is transitioning to a slower growth environment with a healthier competitive landscape. Real estate contributed positively as China Resources Land, a state-owned property developer, performed well on signs of regulatory relaxation and monetary easing. Property sales are starting to show good sequential volume growth which should benefit China Resources Land due to its sizable land bank.

Energy detracted with oil refiner, Hindustan Petroleum Corp, being the leading detractor. The company and its peers have not passed on the market-based fuel price to consumers, resulting in a continuation of losses on diesel and retail fuel. Hindustan Petroleum Corp was subsequently exited as the government and central bank’s efforts to tame inflation lower the probability of a reversal in losses. At the country level, positioning in the United Arab Emirates (UAE) and Taiwan contributed positively. Fertiglobe PLC, the largest nitrogen fertiliser producer in the Middle East and North Africa, was the leading contributor in the UAE. The company is experiencing strong demand for fertilisers, which has so far not been met by a strong supply response. The company is also well positioned with low costs and generates healthy free cash flow that is supportive to dividends and growth investments in areas such as clean hydrogen.

The investment team added to China in the quarter given expectations for the economy to recover considering supportive monetary and fiscal policy, a modest relaxation in mobility restrictions, a reduction in regulatory scrutiny on platform businesses and bottoming out of the property sector. The exposure to information technology and real estate was reduced given a slowdown in consumer electronics spending, especially amid inflationary pressure, resulting in higher interest rates in most of the emerging world, with the exception of China.

Despite challenges from inflation and higher interest rates, economic activity in emerging markets is holding up with no red flags for crises. Whilst global tensions are expected to persist and weight on growth this year, emerging market valuations are compelling. The investment team expects emerging markets to continue to outperform developed markets for the second half of the year and into 2023, as relative growth premium expands once again.

The Fund fell in the March quarter by 6.36% but outperformed the index return by 3.58%.

The Asian region underperformed the broader index in March. China/Hong Kong was the leading detractor in the region given concerns surrounding the country’s relationship with Russia. Additionally, a surge in COVID-19 cases resulted in the largest lockdowns since the onset of the pandemic in cities including Shenzhen and Shanghai. Taiwan was negatively impacted by foreign outflows as investors drew parallels between Russia’s invasion of Ukraine and the risk of Chinese military action against Taiwan. South Korea was flat in March as the country elected a new president in Yoon Suk-yeol, widely viewed as the pro-market candidate, ending uncertainties from a tight race with Lee Jae-myung. India was the best performing market in the region in March as the BJP party won four of five states in assembly elections suggesting policy continuity. Indonesia and Malaysia also recorded gains in March.

Latin America was the best performing region in March. Brazil saw its currency appreciate to a two-year high and the central bank also signalled an end to its rate hiking cycle. Mexico raised its policy rate as inflation remained stubbornly high although economic indicators, including industrial production and retail sales, were positive and reversed recent declines. Colombia, Chile, and Peru also raised rates in March. The Emerging Europe, Middle East, and Africa (EMEA) region was the worst performing region in March primarily due to MSCI’s decision to reclassify Russia from emerging markets to standalone status, at a price of effectively zero. Gulf countries including Kuwait, the UAE, Qatar, and Saudi Arabia, outperformed on the continued strength of brent oil. Turkey, the Czech Republic, Poland, and Hungary also advanced in March.

The Fund delivered a solid absolute return in August but was unable to keep pace with the strong index return. For the 12 months to 31 August 2021,

the Fund is comfortably ahead of the index return. The Asian region performed in line with the broader index in August. Thailand cut its 2021 growth outlook amid the country’s worst COVID-19 wave. However, in the second half of the month the country shifted to an endemic COVID-19 strategy, “learning to live with COVID-19,” which will focus on containing the virus such that infections don’t overwhelm public health resources rather than bring cases to zero to generate more economic activity. The Philippines eased movement restrictions to the second strictest level in the metro Manila region for the last 10 days of the month and the central bank said it was likely to maintain

its easy monetary policy until gross domestic product (GDP) growth and unemployment near pre-pandemic levels. India reported the highest GDP growth for the quarter (ended June 2021) since the government began compiling data in the mid-90s. The local market also benefitted from China’s recent clampdownsas investors looked for new opportunities in other Asian countries. China/Hong Kong underperformed as the regulatory clampdown, which initially targetedprivate education, internet companies, and real estate, spread to additional industries. The composite Purchasing Managers Index (PMI) declined for a thirdconsecutive month, the first contractionary reading since February 2020, driven by a drop in the non-manufacturing PMI as China imposed strict measures to contain the spread of the Delta variant

The Fund produced a solid return in June but was unable to keep pace with the strong index return. For the 12 months to 30 June 2021, the Fund is ahead of the impressive index return. The Asian region underperformed the broader index in June. South Korea reported another strong month of export growth in June and reiterated that the current policy rate was significantly accommodative, and that normalisation would start at an appropriate time this year, marking the clearest signal of future rate increases in Asia. China/Hong Kong also reported strong export growth providing another sign of the strengthening of the global economy. China’s producer price index rose in May due to increases in the price of oil, metals, and chemicals. The increase was the highest reading since 2008 and has the potential to add to global inflationary pressures despite intense competition among exporters, which may finally seek to pass on higher prices as opposed to accepting lowermargins.

Latin America was the best performing region in June. Brazil raised its 2021 gross domestic product (GDP) forecast, driven by an increase in demand for commodities and government spending. The central bank took up its policy rate by another 75 bps to 4.25% as consumer prices rose in May well above the target for 2021, primarily due to electricity prices. Mexico reported a slowing of inflation in May although inflation was still almost double the 3% target due to large increases in food and services. Peru was the worst performing country in the region and the broader index as Pedro Castillo appeared to have won the presidential election in Peru over Keiko Fujimori, who is challenging the results for alleged irregularities. The market underperformed given fears that Castillo, a former schoolteacher, and union organiser, would upend Peru’s economic model