Please note that the commentary is for the retail class of the fund. The Coronation Global Emerging Markets Fund returned 3.1% in ZAR during the third quarter of 2016, which was 1.4% ahead of the index’s return. Year-to-date the fund has now appreciated by 7.3% in ZAR, which is 4.4% ahead of the index’s return of 3.0%, and over the past one-year period the fund has returned 29.8% in ZAR (+30.8% in USD), which is 13.9% ahead of the 15.9% return from the index. Over the past year, five of the top 10 contributors were Brazilian stocks, collectively contributing 9.2% of the fund’s 13.9% outperformance. All five (Kroton, Estácio, Itaúsa, Hering and BB Seguridade) are up by over 50% in USD over the past year, with the education company Kroton being the standout, having appreciated by 143% in USD and contributing around 4% to outperformance. Other notable contributors over the past year have been the owner of Jaguar Land Rover, Tata Motors (+78%), the Indian private bank Yes Bank (+70%) and the Russian food retailer X5 Retail (+66%).

There were a few notable developments on the political front during the quarter, however none had a material impact on the fund’s performance. The final impeachment and removal of former president Dilma Rousseff in Brazil was highly anticipated and therefore did not really have an impact when it happened, as the big upward moves in Brazilian equities and currency had already happened in the first half of the year. We did continue to reduce the fund’s Brazilian exposure by slowly reducing a few of the bigger positions, with the result that the total Brazilian exposure is now 16.3% of fund compared to 21.5% at the end of June. The fund’s biggest Brazilian exposure is still in the education companies. In this regard Kroton and Estácio’s shareholders approved the proposed merger at an increased offer price to that initially proposed by Kroton, and the deal is now awaiting regulatory approval by the country’s anti-trust authorities. We remain very positive on the long-term prospects for the Brazilian education industry, and in particular the prospects of a combined Kroton/Estácio (which are respectively the number one and two tertiary private education companies in Brazil). We think both assets are actually still very attractive on a standalone basis, and even more attractive as a combined entity due to the scale, nationwide footprint, synergies and the fact that the best management team in the industry will be running the combined entity. As such, 6.9% of the fund is still invested in Brazilian education, made up of 4.0% in Kroton and 2.9% in Estácio.

The attempted coup in Turkey in early July and its aftermath has severely dented investor confidence in that country. The fund held only two Turkish stocks prior to the coup attempt - small positions in Garanti Bank and in BIM, a hard discount food retailer. We sold out of the position in Garanti Bank - as a bank it was simply too exposed to a big downturn in the Turkish economy and therefore the risk/reward tradeoff did not, in our view, warrant retaining the position, despite what appeared to be reasonable upside in the share. In contrast, we believe BIM is one of the best food retail operators in emerging markets and should not be materially impacted by post-coup developments, so we have marginally increased the fund’s exposure to BIM as it has declined (along with the Turkish lira). It still remains a sub-1% position and we would require more upside before increasing the position size materially further.

In terms of portfolio activity over the quarter, on the sales side a notable reduction in position size was that of the Indian banks. In our view, India remains one of the most attractive emerging markets on a ten-year view. Its banks offer a significantly cheaper way to get access to the Indian consumer - through very low financial services penetration that is gradually increasing, as well as through market share gains from the State banks - than the country’s more obvious names in the household and personal care space, which trade on eye-watering multiples. We had been adding to the positions in the two banks that the fund owned (Axis Bank and Yes Bank) from the fourth quarter of 2015 as their share prices declined (along with the broader market) as investors lost faith in the pace of regulatory reform in India under the Modi government. We also bought a third (HDFC, a mortgage provider that also has a stake in HDFC Bank, as well as insurance and asset management interests) for the first time in early March. From their bottom at the end of February, all three banks are up sharply - Axis Bank, the largest position, is up close to 50%; Yes Bank, the second largest position, has almost doubled; and HDFC, the smallest position, is up 35% (all returns in US dollars). Naturally we have trimmed position sizes in response to such large moves in share prices. Although all three are still reasonably attractive, their reduced upside warrants a smaller exposure. At the end of June the combined holding in the three amounted to 8.3% and by 30 September their collective exposure was down to 4.8% of fund. This in turn meant the fund’s Indian exposure decreased from 16.4% to 12.2% over the quarter.
During the quarter there were also a few new buys. LiLAC (Liberty Latin America and Caribbean), was one of the bigger new buys and is now a 1.2% position. LiLAC was initially created as a tracking stock by Liberty Global to spin out its Latin American broadband, mobile and pay-TV assets. During the spin-out process, LiLAC bought Cable & Wireless Communications (mobile telecoms in the Caribbean and Central America), which itself had just purchased Columbus (broadband and pay-TV in the same region). The single biggest market for LiLAC is Chile (25% of total operating profit), followed by Panama (19%) and Puerto Rico (12%), with various Caribbean islands making up the bulk of the rest. The share price is down by a third since late May after poor results and from an overhang of shares, with the latter having had the bigger impact in our view. Many of the shareholders of Liberty Global (who were the recipients of LiLAC shares due to the unbundling) may have little interest in holding onto their LiLAC shares given how small the business is/was in the context of the overall Liberty Global business (5%). Aside from revenue opportunities from rolling out services in countries where there is low penetration and also from market share gains, there are big cost saving opportunities due to the newfound scale of the business, as well as the ability to realise synergies. For these reasons we believe margins have scope to increase from current levels. In addition, capital expenditure is currently high and will reduce to a more normal level over the next few years. As a result of these factors, we believe the company will generate significant free cash flow looking a few years out, and LiLAC trades on only a high single-digit multiple of this free cash flow. In addition, we have high regard for the capital allocation skills (running an efficient balance sheet, undertaking significant share buy-backs, etc.) of John Malone (the Chairman and controlling shareholder of both Liberty Global and LiLAC) and his senior managers, and we believe that over time these same capital allocation skills will be applied to LiLAC to the benefit of shareholders.

Over the past few years we have spent a lot of time researching and understanding online classified businesses due to the fact that these businesses make up a large part of the valuation of the fund’s largest holding, Naspers. We like dominant online classifieds businesses - the largest player in each vertical benefits from the virtuous circle of most sellers/service providers and most buyers/users being attracted to the biggest site, and as such it is very hard to disrupt once established as the network effect creates a high barrier to entry. They are also inherently very cash generative (converting over 100% of earnings into free cash flow) and generate very high returns on capital. In this regard, the fund’s largest buy during the quarter was a 1.5% position in 58.com, the leading classifieds website operator in China. The company is very strong in a number of key classified verticals, with dominant positions in Jobs (70% market share of the blue-collar job market), Yellow Pages/online classifieds (85% market share) and property (in which they have three of the leading property sites). The company is investing significantly in these three verticals as well as others, in order to achieve dominance and the economic benefits that come with this. It is also investing heavily in its home services arm, which will allow plumbers, electricians and other service providers to offer their services online and be booked directly by the customer. Customers will be able to rate the quality of the service provider, creating a feedback mechanism and loop that will entrench customer loyalty and trust for good service providers, much like (as an example) the review system works for hotels on TripAdvisor.

This investment in the business means that current profitability is low (single-digit EBIT margins) and is well below normal in our view. The leading (those with > 50% market share) online classifieds businesses in the world (both in emerging markets and developed markets) are extremely profitable and typically generate EBIT margins in the 40% to 60% range (Avito in Russia, for example, generates 45% EBIT margins). In this context one must bear in mind that 58.com already has dominant positions in a number of verticals, and in fact currently generates gross margins of 90%. We would not expect 58.com to generate EBIT margins of 40% to 60% (its business model requires higher cost because of a large direct sales force), but we do believe that normal EBIT margins will ultimately be much higher than the current single-digit level. The online classified industry in China is still in its infancy and 58.com has many leading positions in this market. In our view, it is well placed to retain these leading positions. As a result, we believe that its revenue, profits and free cash flow will grow at a high rate over the next five years and beyond. We also like the fact that Tencent own over 20% of the business. Tencent is dominant in social media in China and captures a very high percentage of all online traffic; it also has management that we have high regard for. In addition, we like the fact that the founder and CEO of 58.com still retains a big stake (11%) in the company, resulting in an alignment with minority shareholders.

While the weighted average upside to the portfolio has come down (now just below 50%), this is still very attractive upside. At the same time a useful positive backdrop is provided by the fact that political environments appear to be getting slightly better in many emerging markets (Brazil, South Africa and India stand out in this regard) and arguably worse in a number of the main developed markets as populism takes hold (US, UK and Europe would fall into this category). This arguably increases the relative attractiveness of emerging markets. We are continuing to find a number of potentially interesting ideas - either stocks that we cover already but that are becoming more attractive due to share price declines or as a result of additional work we are doing on them, or stocks we are doing the detailed work on for the first time. Over the past quarter we went on research trips to South Korea and China and also met with management from a number of portfolio holdings and other companies in London and New York. During October we will be going to Asia and will be returning to Brazil in January, followed by India in February.

Portfolio managers Gavin Joubert and Suhail Suleman as at 30 September 2016

Please note that the commentary is for the retail class of the fund.

The fund appreciated by 1.37% during the first quarter of the year compared to the 0.24% increase in the index. In terms of positive contributors, the three largest contributors over the quarter were all Brazilian companies: Kroton up 34.9% in USD; BB Seguridade up 39.9% in USD; and Itausa up 37.5% in USD. Credicorp (the largest bank in Peru) also contributed (up 34.2% in USD) as did Yes Bank (a top 5 Indian private bank) which was up 18.9%. In terms of notable detractors over the period, JD.com (no.2 e-commerce retailer in China) declined by 17.8% and Brilliance China Automotive (BMW JV in China) declined by 17.7%.

Having launched in December 2007, the fund now has surpassed its 8-year track record and since inception has outperformed the market by 2.4% per annum.

During the quarter we reduced a number of the fund’s Brazilian holdings as a result of sharp share price appreciation, which was driven partly by increased prospects for President Rousseff’s impeachment and a resultant change in government. The fund’s overall Brazilian exposure, however, still remains high at 19.5% of fund as we believe the country still offers some of the most compelling risk-adjusted investment opportunities in emerging markets today. Given its size in the portfolio taken together with the current above-average risks, we continue to spend a large part of our time on Brazil (we have been on three trips to the country in the past four months). As a key part of this process, we continually reassess the long-term earnings streams (and hence fair values) of all the Brazilian holdings in the fund, and in this regard the weighted average upside to these holdings is just under 100% today.
We are of course well aware that Brazil is in a deep recession, and is experiencing difficult and uncertain economic and political times (this is factual, with ongoing headlines in this regard). However, in our view not all Brazilian companies are equal, asset prices are depressed, and valuations are attractive due to Brazil being loathed by investors. We make investment decisions based on what we believe a business will earn over the next several years and not based on current macro news flow or the next one year of earnings. This is simply because we believe that the true value of a business is made up of its earnings over the next several years (and indeed into perpetuity), and not just the next year of earnings. In our view, many market participants tend to value businesses on the next one year of earnings (T1 earnings x PE) and in doing so extrapolate current experience (be it good or bad) into perpetuity. In contrast, our long-term approach often gives us a totally different answer as to whether a stock may be attractive or not. In this regard, based on the long-term earnings prospects for the fund’s Brazilian holdings, there is very good value to be found in Brazil in our view. In summary, we believe the magnitude of the upside compensates one for the risks - if there was only 30% upside to the fund’s Brazilian holdings (as opposed to the c.100% upside), we would have very little invested in Brazil.

Other meaningful sells during the quarter included our continued reduction of the fund’s Russian exposure as two selected holdings (X5 Retail and Mail.ru) moved closer to our fair values for the respective businesses. As a result, the fund’s Russian exposure reduced from 6.2% of fund as at 31 December to 4.6% of fund as at the end of March.

The sharp sell-off in South African equities following the dismissal of the finance minister in December has started to open up a few selected opportunities in South Africa, and we bought new positions in two South African companies: Aspen and Old Mutual. Aspen is a globally diversified generic pharmaceutical company run by Stephen Saad, who in our view is one of the most impressive CEOs in the country, and who importantly still owns a 12% stake in the company which he founded. The business has favourable long-term positive drivers (increasing generic use), is defensive, generates high returns (ROE of c. 20%) and is very cash generative. The sharp sell-off in the share price over the past year (from R400 to R240) enabled us to buy a stake in this very good asset at around 15x forward earnings, which we believe is an attractive entry point. Old Mutual is a diversified financial services company with interests in asset management, wealth management, insurance and banking spanning South Africa, Africa, the UK and the US with around 60% of the value of the business sitting in emerging markets, primarily South Africa. We like most of the group’s underlying assets, which in our view are being undervalued by the market. In addition to fundamental undervaluation, we believe the restructuring of the business announced recently by the new CEO (whom we have met with twice recently to understand his thinking about what can be done in terms of restructuring/unbundling) will add a lot of value. The two new purchases mentioned above, and continued small buying of Discovery (South Africa’s no. 1 health insurer) resulted in the fund’s South African exposure increasing to 9.0% of fund at the end of March. Most of the South African holdings do, however, have substantial businesses outside of the country, which means that the 11.6% South African exposure is not entirely reflective of reality. In this regard, the underlying look-through South African exposure is actually less than 3% at the overall portfolio level.

We also added to the fund’s Indian banking exposure through a new position in Housing Development Finance Corporation (HDFC). We have followed HDFC for a number of years (we undertook the initial detailed research and resultant research report on the company almost three years ago). While we have always liked the asset, we have never owned it due to valuation. Over the past few years the value of the business has continued to grow at a strong pace, but recent months saw a decline in its share price, driven by concerns over slower short-term growth, which brought the share into buying range. The share price decline also coincided with our meeting with three senior executives of the company on two separate trips to India in February, which reinforced our positive view on the long-term prospects for the business and on the quality of the very experienced and conservative management team. In addition to the three senior executives we met with recently, we have also met with the CEO a number of times over the years. Collectively, the management team of HDFC is one of the most impressive we have come across in emerging markets. Average tenure of the senior management team at the company is 30 years.

HDFC’s main business is that of mortgage lending, which makes up approximately 70% of our valuation. The company was founded in 1977 as the first specialist mortgage lender (loans against predominantly residential property) in India. Today they have a 30% share of this market. In addition to the mortgage business, it also has banking interests (a 21.6% stake in HDFC Bank, which makes up 20% of our valuation) as well as life insurance and asset management interests (both JVs with Standard Life and together making up approximately 10% of our valuation). The long-term track record of HDFC is exemplary - over the past 15 years the company has produced EPS growth of 20.8% per annum, DPS growth of 19.4% per annum and average ROEs of 24.2%. Very importantly for a bank, their credit control has also been outstanding: cumulative write-offs since their founding in 1977 (i.e. total write-offs over this almost 40-year period divided by total loans granted over this same period) has been under four basis points. This bad debts experience reflects both the conservatism of management and the strength of the bank’s credit granting process.

While we believe that it will be more difficult to replicate 20% per annum earnings growth over the next 15 years (the bank is just so much bigger now and competitive intensity has increased somewhat over the years), the long-term fundamentals for the business remain excellent in our view. From a financial services point of view (including mortgage penetration, as illustrated in the graph below), India is one of the least penetrated emerging markets. It has a large young population (60% of the population are under 30 years of age and most are not home owners yet) and urbanisation is still only 30%. Under Prime Minister Modi, India is also one of the few emerging markets that is (slowly) implementing reforms to stimulate growth. The country is a net importer of commodities (including oil) and as such, unlike a number of other emerging markets, is a beneficiary of declining commodity prices. The implied valuation on HDFC’s mortgage business (stripping out our values for the stakes in HDFC Bank, the insurance and asset management businesses) is currently around 14x forward earnings, which we believe is very attractive for an asset of this quality.

China remains the fund’s largest country exposure (22.5% of fund). A large part of this exposure is invested in the Chinese internet sector where we find the long-term structural drivers very compelling. The fund has significant positions in Baidu (the no.1 search engine in China), JD.com (the no.2 e-commerce retailer in China), Ctrip (the no.1 online travel company), and the no.1 gaming/social network company Tencent (held indirectly through Naspers). We also bought a position in Netease (the no.2 gaming company) during the quarter. Besides the internet holdings, the fund’s other meaningful position in China is Brilliance China Automotive, the only BMW joint venture in China. Brazil represents the second largest country exposure at 19.4% of fund of which the main areas of exposure include private education (6.5% of fund invested in the no.1 and no.2 education companies, Kroton and Estacio) and financials (4.5% of fund in total invested in the no.1 insurer BB Seguridade and largest and best run private bank, Itau). India, now the third largest country exposure, makes up 17.8% of the fund. The three main areas of investment in India are the private banks Yes Bank, Axis Bank and HDFC (together 8.6% of fund); the IT services companies (4.6% of fund invested in Cognizant, Tata Consultancy Services and HCL); and the owner of Jaguar LandRover, Tata Motors (3.9% of fund). Other meaningful industry exposures in the fund include a 4.8% holding in the global brewers Heineken and AB InBev, both of which earn over half of their earnings from emerging markets. The fund also has a 4.0% investment in the Russian food retailers (of which the no.1 and no.2 operators Magnit and X5 Retail make up the bulk of the exposure).

During the quarter we undertook research trips to Brazil (two trips) and India (also two trips), and the next three months will see visits to China, Mexico, Russia, Turkey as well as a third trip to India where recent investor disillusionment is starting to make some stocks potentially more interesting. Overall we continue to find very good selected value in emerging markets. In this regard, the weighted average upside of the fund at the time of writing is 75%, which is far north of the 5-year average of around 50%.

Portfolio managers
Gavin Joubert, Suhail Suleman, Pieter Hundersmarck and David Cook

While the final quarter of 2015 was a good one for the fund (appreciating by 20.9% compared to the 12.6% return of the index), for the year as a whole performance was disappointing with the fund underperforming the index by 11.6%. This underperformance came almost exclusively from Brazil, in particular the currency (Brazilian real) which declined by 33% against the USD in 2015. The currency move alone accounts for around 80% of the fund’s underperformance. In terms of detractors to performance in 2015, all five of the largest detractors were Brazilian stocks, with Kroton being the single largest negative contributor. While the economic (and political) outlook in Brazil remains poor, the long-term (3 -5 year+) individual company fundamentals remain very attractive for the Brazilian companies owned by the fund. While the short to medium-term economic outlook plays a role in deciding which stocks to own, the long-term fundamentals and earnings prospects - and very importantly the current valuation - are far more important factors in how we invest. In this regard, based on our assessment of their long-term prospects and earnings streams, a number of Brazilian companies are significantly undervalued (offering over 100% upside in most cases), and as such Brazil remains a large part of the fund (20% in total). In terms of positive contributions, the Russian food retailer X5 Retail and the Chinese online retailer JD.com were the only meaningful contributors.

Having launched in December 2007, the fund now has a 8-year track record and over this period has outperformed the market by 2.3% per annum.

During the quarter we sold out of Eurocash and Coca-Cola Hellenic as theyreached our estimation of fair value. We also sold a number of small positions(all less than 0.5% of fund). We bought new positions in the Indian IT servicescompany HCL, after it declined sharply subsequent to reporting weaker thanexpected results, and in Yahoo, which the fund has owned before and whoseprimary asset is a stake in Alibaba. The most significant purchase over the pastquarter, however, was Ctrip, the leading online travel agent (OTA) in China.

The fund already held a small position in Ctrip and we increased this to a moremeaningful 2.8% of fund in recent months. The increase in the position wasdriven partly by continued research on the company (including two trips toChina) as well as by Ctrip's acquisition from Baidu of a large stake (45%) inQunar, its main competitor. This was a transformational deal, which completelychanged the competitive landscape of the online travel industry in China. Overthe past few years, the OTA space has experienced aggressive competitorbehaviour, driven by high levels of "couponing" - where OTAs rebate part oftheir commission to the user in order to attract traffic. This reached a level of20% of Ctrip's hotel commission revenue at its height. With Ctrip now effectivelycontrolling both Qunar and the no.3 player eLong (in which Ctrip alsopurchased a stake earlier in 2015), the aggressive level of competition shoulddecline, leading to an increase in operating margins going forward. Thecontinued shift of travel from offline to online channels will fuel strong revenuegrowth, with the bulk of the benefits now accruing to Ctrip/Qunar as a result ofnetwork effects (Ctrip-Qunar have over 75% online travel market share). Anotherpositive element to this deal is further collaboration with Baidu (who now own25% of Ctrip, which they received for their Qunar stake) in their search and mapbusiness, which acts as a very powerful customer acquisition tool.

Ctrip have been profitable since listing in 2001, while experiencing rapidgrowth. Interestingly, over the past 12 years Ctrip's free cash flow conversion(what percentage of earnings has been converted into free cash) has averaged120%. This is extremely impressive for any business, but even more so for a fastgrowing business. The business is also very well positioned to take advantage ofthe ever growing middle class in China, who have an increasing appetite totravel (a sector also strongly supported by government), making China the mostattractive travel market in the world; albeit still largely serviced by offlineproviders presently (90% of the market still offline). Ctrip offer a superiorcustomer experience, and have one of the largest hotel review databases. Thismakes them a valuable source of information for the prospective traveller, withthe ability to monetise this interest via the travel services they offer. Ctrip havean unrivalled inventory of hotel rooms, both in the domestic Chinese marketand the rapidly growing outbound market (the Chinese have yet to venturemuch further than Hong Kong, Macau, Taiwan and Korea in mass), aided bytheir global inventory partnerships with both Priceline (who also have aneffective 15% equity interest in Ctrip) and Expedia. Ctrip have built up hugebarriers to entry in their airline ticketing business as base commissions are now0%, with airlines only paying volume commissions. Ctrip are able to pushmassive volumes, thus earning them 3-4% commission, while making itimpossible for smaller players to survive in this market as they do not receive abase commission. Ctrip's train and bus ticketing platform is also experiencingextremely strong volume growth (150% as at Q3-15). The train ticket platform isa very cheap customer acquisition tool as it lures people onto their system,allowing an opportunity to convert them into loyal customers as it creates brandawareness. When these customers migrate to higher value travel services, theyare already accustomed to transacting via Ctrip.

China is the fund's largest country exposure (21.9% of fund) and a large part ofthis is invested in the Chinese internet sector where we find the long-termstructural drivers very compelling. Besides Ctrip, the fund has significantpositions in Baidu (the no.1 search engine in China), JD.com (the no.2 onlineretailer in China) and the no.1 gaming/social network company Tencent (heldindirectly through Naspers). Brazil makes up 20% of the fund of which the mainareas of exposure include Brazilian private education (7% of fund invested in theno.1 and no.2 education companies, Kroton and Estacio) and financials (5.6% offund in total invested in the no.1 insurer BB Seguridade and largest and bestrun private bank, Itau). India represents the third meaningful country exposure(16% of fund) of which the three main areas of investment are: the Indian privatebanks, Axis Bank and Yes Bank (7% of fund); the Indian IT services companies(4% of fund invested in Cognizant, Tata Consultancy Services and HCL); and theowner of Jaguar LandRover, Tata Motors (4% of fund). In terms of othermeaningful industry exposures, 5% of the fund is invested in Russian FoodRetailers (the no.1 and no.2 operators Magnit and X5 Retail make up the bulk ofthis) and 5% in the global brewers (Heineken and AB Inbev), both of whom earnover half of their earnings from emerging markets.

The negativity towards emerging markets has continued into 2016, with furtherdeclines since the start of the year. The same issues of rising US interest rates,concerns over China and commodity price declines are driving emergingmarket equity moves at the moment. As always, our primary focus remains onthe long-term prospects for the individual companies owned by the fund andthis is where we spend our time. In this regard, the weighted average upside inthe fund is 85%, which is far north of the 5-year average of around 50% and notfar off the all-time high of slightly above 90%.

Portfolio managers
Gavin Joubert, Suhail Suleman, Pieter Hundersmarck and David Cook