STRATEGY
• In which stocks/sectors/countries was exposure reduced and in which was it increased? Why?
In the Czech Republic, where the fund is underweight, the market fell during the quarter. Contributing factors included the anticipated interest rate hike by the Central Bank and tariff reductions by the national power generator.
Meanwhile, in Poland, the Central Bank's reductions in the interbank rate helped to quell concerns about a global recession; however, the Polish market is suffering from an economic lag, still very high real interest rates, and political uncertainty regarding the results of the general elections.
In Hungary, where the fund has slightly increased its weighting, the events in the US had a significant impact on the market. However, defensive stocks such as Gedeon Richter (Healthcare, Overweight) and OTP (Financial, Overweight) have performed well this quarter.
Meanwhile, Moody's upgraded Russia's rating (to overweight) from stable to positive. Concerns about the poor market conditions in Argentina and Turkey lessened during the quarter. However, oil prices remain volatile following the US attacks. As a result, the fund reduced its holdings in less cost-competitive oil producers and focused more on domestic sectors such as mobile telephony.
The last quarter in Turkey has been very turbulent. The currency continues to depreciate, and industrial production has plummeted. A lack of progress on agreed banking reforms has delayed the disbursement of IMF loans, and heightened political tensions stemming from the economic difficulties have left Turkey aggressively underweight.
PERFORMANCE
• Which stocks/sectors/countries performed relatively better than the benchmark or reference index, and which performed worse? Why?
The fund's relative performance was particularly strong in September (5.5% above its benchmark), leading to a total return of 2.6% for the quarter. The main drivers were the overweighting of funds in Russia and the aggressive underweighting of Turkey. The stock selection in Poland (overweighting in banks) also contributed positively.
PROSPECTS
• What are the key factors that will drive the market in the coming weeks/months? How are you positioned to benefit from what is expected to happen?
We believe Russia remains the key positive pick within our investment universe, driven by its improving current account balance. However, due to increasing uncertainty surrounding oil prices, we have reduced our position in Russian oil. On the other hand, we maintain a positive outlook on stocks such as Gazprom (the national gas monopoly) and UES (national utilities), as well as shares of companies with strong domestic demand, such as mobile phone providers.
In Hungary we remain on the defensive and will therefore invest in sectors geared towards domestic consumption whose growth is undervalued; such as banks, refineries, and integrated telecommunications.
Meanwhile, in Poland, we remain focused on the banking sector, as it is one of the sectors that has benefited most from the initial interest rate cuts following the general elections. Although the election results were somewhat disappointing (the Socialist Party did not win an absolute majority), we believe the future government will receive external support for its program of tax reforms and privatizations.
Finally, in Turkey, the fund has reduced its aggressive underweight position due to extremely low stock prices and the increasingly real possibility of additional financial assistance from the IMF and the World Bank, given Turkey's growing geopolitical importance following the tragic events in the US. However, Turkey still faces a financing gap of nearly US$10 billion, which it could only address through external aid.
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