During the fourth calendar quarter of 2012, the Seafarer Overseas Growth and Income Fund gained 5.28% and 5.24% for the Investor and Institutional classes, respectively, while its benchmark, the MSCI Emerging Markets Total Return Index, rose 5.61%. By way of broader comparison, the S&P 500 Index fell -0.38%.

The Fund paid a semi-annual distribution to shareholders in December. The Fund distributed $0.06080 and $0.08710 per share for the Investor and Institutional classes, respectively. Cumulative distributions per share since the Fund’s February 15, 2012 inception are $0.11075 and $0.12194 for the Investor and Institutional classes, respectively.

[Please note: the portfolio review below encompasses only the fourth quarter of 2012, and not the entire calendar year. The Fund operates on a fiscal year that concludes April 30; as such, Seafarer offers comprehensive portfolio reviews for its annual and semi-annual periods, which are typically published on this website in May and November respectively. Previously published portfolio reviews (for the annual and semi-annual periods, as well as the calendar quarters) are available in the Archives.]

Performance

Developing markets continued to march forward during the last quarter of 2012, extending the gains of the prior quarter. However, most of the gains that occurred during the period were confined to the month of December. Stocks in the emerging markets spent October and much of November trading sideways, as market participants exhibited concern over the pace of economic growth around the world, and over fiscal policies in the U.S. Yet in December markets climbed the classic “wall of worry”: despite an absence of evidence that growth would improve, or that the U.S. would resolve its problems, markets began a steady ascent, scaling the hypothetical “wall” of fears and frustrations. (For the record, the U.S. Congress ultimately settled on a temporary solution to avoid a fiscal impasse; yet markets rose well before this event was a certainty.)

As the emerging markets rose, the Fund lagged a bit behind its benchmark index, by about four-tenths of a percent. We were relatively pleased that the Fund kept rough pace with the index during a period of compressed, rapid gains. Seafarer’s investment strategy seeks to provide a relatively stable means of participating in growth, while providing some downside protection; we don’t expect that the Fund will necessarily keep pace with markets on the upside, especially when they rise quickly.

Most positions contributed positively to the Fund’s performance during the period; over three-quarters of the positions produced gains during the quarter. Top amongst those contributors was the Fund’s holding in a small company located in Hong Kong called CITIC Telecom. Historically this company has provided a diverse set of communication services to a broad range of clientele – to individual consumers, to commercial enterprises, even to other telecom carriers in China. During the quarter, CITIC caught the market’s attention with news that its ownership structure would shift from one parent company to another. The shares rallied sharply when CITIC announced it would make a bid to control Macau Telecom, a company that is a private holding of a global telecommunications conglomerate called Cable and Wireless. Since the close of the quarter, news releases announced CITIC had secured funding for its purchase, suggesting the deal is likely to proceed. Apparently the market is fascinated by the company’s transition from a niche services provider to the dominant telecom carrier for the country of Macau.

Other notable contributors for the quarter included Aselsan Elektronik, Hang Lung Properties, and the Market Vectors Vietnam exchange-traded fund (ETF).

Aselsan Elektronik is a Turkish firm that produces electronic systems and communication equipment for military and civilian markets. The company has existed for several decades, yet it has only recently undertaken efforts to operate on a truly commercial basis. In the past, the company operated essentially as a captive supplier to (and subsidiary of) the Turkish Army; consequently, Aselsan’s financial performance took a back seat. However, the company has recently begun to improve upon its commercial potential, expanding into new markets and accelerating its growth. Aselsan’s shares rose ostensibly in reflection of the company’s improved performance.

Hang Lung Properties (HLP) is a developer with interests spanning Hong Kong luxury residential units (where it has made most of its money in the past) to large-scale luxury retail malls in mainland China (where it hopes to make money in the future). HLP saw its shares gain in December, largely in sympathy with a gain in cyclical stocks in China. There are some signs that inflationary pressures in China have abided, and that the economy has cooled while avoiding collapse; this result, coupled with the fact that a new government is in power, has apparently led many analysts to conclude that supportive policy measures will bolster growth (and stocks) in 2013. Cyclical stocks, from property developers to industrial companies, have risen sharply on such hope. My own view is that such hope is at least partially misplaced: it is true the economy has avoided collapse, and there is room for policy to maneuver; yet I am skeptical that even with the best intentions the new government can catalyze a dramatic resumption in growth. Growth is by no means terrible in China; but it is unlikely to get vastly better anytime soon, at least not in my view.

Meanwhile, the Vietnam ETF’s gains mark a turnaround of a similar sort: the Vietnamese market rallied very sharply at year-end (and on into the new year), again mostly on hope rather than on fact. The country’s central bank cut interest rates for the sixth time this year; the move was interpreted as a bid to spur growth, and not necessarily because the country’s stubborn inflation had subsided in any way. The market jolted upward on hints of new policy actions by the government to clean up bad debts within the country’s banking system, and to relax the country’s notoriously stringent controls on foreign ownership of domestic industries. Happily, these steps are exactly the right ones for the country to pursue, in my opinion; but if experience is any guide, the promise of change will outpace the practical reality. Also, it’s likely that a substantial recapitalization lies ahead for the country’s banking system, and this may cause markets to retreat at some point in the future. Yet my long-term enthusiasm for the country remains undimmed: valuations on many shares in the market are attractive; and the country’s economic challenges – as many as there are – are entirely tractable in my view, provided the right sort of policy approach is brought to bear.

Allocation

During the quarter, there were no major shifts in the portfolio’s construction, though several minor changes did occur:

• The Fund added new positions in Brazil, Japan, Korea and Vietnam;
• The Fund shed one holding in Hong Kong, due to concerns that the issuer’s financial health had deteriorated at the margin (CLP, an electric utility);
• The Fund exited a position in Singapore, due to a successful takeover tender (Cerebos, as discussed in the portfolio review in the Fund’s Semi-annual Report for the period ended October 31, 2012);
• And lastly, the Fund swung gradually toward mid-capitalization stocks once again, though more so because of price appreciation in the category than by design. (For reference, mid-caps have comprised the bulk of the Fund’s holdings since its inception.)

As noted above, the Fund added a new position in Vietnam; this occurred because after nearly ten months of efforts to register in the local market, the Fund was granted access to trade Vietnamese equities in the local market in December. I am excited by the opportunities this will afford the Fund over the next decade, and I imagine the portfolio’s allocation to the country will grow slowly but steadily in the coming quarters.

Looking forward, I wish to sound a note of concern (but not alarm) about equity valuations in emerging markets. To be clear: most stocks in the developing world are not excessively priced in my view. Valuations are reasonable relative to many historical measures, and also in light of prospective growth. However, to be blunt: the recent upsurge in valuations has occurred without much fundamental evidence to support it. I don’t see many signs that growth has accelerated, or that manifold economic uncertainties have abated. Whether this upsurge is due to global monetary conditions (“QE3,” etc.), shifting perceptions of risks, or simply more enthusiasm for the emerging world, I do not know. Whatever the case, the bottom line is that investors are willing to pay more “P” (price) for every dollar of “E” (earnings) than they were willing to do a short while ago. The result is that valuations offer less room for error, and my hope is that investors proceed, but with caution rather than zeal.

The performance data quoted represents past performance and does not guarantee future results. Future returns may be lower or higher. The investment return and principal value will fluctuate so that an investor's shares, when redeemed, may be worth more or less than the original cost. View the Fund’s most recent month-end performance.

The MSCI Emerging Markets Total Return Index, Standard (Large+Mid Cap) Core, Gross (dividends reinvested), USD is a free float-adjusted market capitalization index designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Total Return Index consists of the following 21 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey. Index code: GDUEEGF. It is not possible to invest directly in this or any index.

The views and information discussed in this commentary are as of the date of publication, are subject to change, and may not reflect the writer's current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. It should not be assumed that any investment will be profitable or will equal the performance of the portfolios or any securities or any sectors mentioned herein. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Seafarer does not accept any liability for losses either direct or consequential caused by the use of this information.

As of 12/31/2012, Citic Telecom International Holdings, Ltd. comprised 3.0% of the Seafarer Overseas Growth and Income Fund; Aselsan Elektronik Sanayi Ve Ticaret AS comprised 3.6% of the Fund; Hang Lung Properties, Ltd. comprised 3.3% of the Fund; and Market Vectors Vietnam ETF comprised 2.6% of the Fund. As of 12/31/12 the Fund had no economic interest in Macau Telecom (Companhia de Telecomunicacoes de Macau SARL), Cable and Wireless Worldwide, CLP Holdings, Ltd., and Cerebos Pacific, Ltd. View the Seafarer Overseas Growth and Income Fund’s Top 10 Holdings. Holdings are subject to change.