Frontier Markets Portfolio

Transcription

1 MORGAN STANLEY INSTITUTIONAL FUND Frontier Markets Portfolio ACTIVE FUNDAMENTAL EQUITY EMERGING MARKETS EQUITY TEAM COMMENTARY DECEMBER 31, 2017 Performance Review For the quarter ending December 31, 2017, the MSIF Frontier Markets Portfolio (Class I shares, net of fees) returned 2.78% versus the MSCI Frontier Markets Index return of 5.61%. In aggregate, country allocation and stock selection detracted from returns. Our stock selection in and underweight allocation to Vietnam was the biggest detractor during the quarter, followed by our overweight allocation to Pakistan. Our overweight allocations to the United Arab Emirates and Saudi Arabia also detracted. Our stock selection in and underweight allocation to Morocco was the top contributor during this period, followed by our zero allocations to Bahrain and Oman. Our underweight allocation to Kuwait also contributed. From a sector perspective, our stock selection in industrials and financials contributed to returns, while our stock selection in and underweight allocation to consumer staples and real estate detracted. Our overweight allocation to consumer discretionary hampered returns, but losses were more than offset by our strong stock selection in the sector. Market Review The MSCI Frontier Markets Index (+5.61%) outperformed the MSCI Emerging Markets Index (+7.44%) this quarter. Vietnam (+36.25%) led market returns, followed by Kazakhstan (+25.33%), Estonia (+14.37%) and Serbia (+11.46%). Kuwait (-7.22%) was the worst-performing market during the quarter, followed by Sri Lanka (-5.33%). Pakistan (-5.46%) and United Arab Emirates (-4.64%), both of which are no longer in the MSCI Frontier Markets Index, also underperformed the region. Portfolio Activity During the quarter we added to our position in the Argentine banking sector. With loan penetration the lowest in the region and one of the lowest globally, especially when regressed to gross domestic product (GDP) per capita, we believe loan growth should be strong over at least the medium term, with a pick-up in corporate loan growth adding to strong demand from retail. Net interest margins have been more resilient than expected and could remain stable in There could also be upside from efficiency gains. To play on this secular growth story, we added BBVA Banco Frances (2.1% of the portfolio), the fifth largest bank in Argentina by market share, to the portfolio. Banco Frances is currently executing its new growth strategy and, based on our meetings with company management and the company financials, we believe it has a solid franchise on which to build this potential operational and strategic turnaround. 1

2 We also added Argentine cement company Loma Negra (1.7%) to the portfolio. We believe Argentina may be on the brink of a cyclical investment boom, after years of underinvestment during the Kirchner administration, and Loma Negra gives direct exposure to the investment pickup. The market is currently running at nearly full capacity, which has translated to pricing power for the three main cement companies who control the market. We funded this trade by selling out of Globant, whose majority of business is conducted in the U.S. and tends to trade more in line with U.S. equities. We believe that Loma Negra will bring us more direct exposure to the Argentine economic expansion. Elsewhere in Argentina, we sold energy companies YPF and Pampa Energia. In regards to the oil and gas sector, there is little upside near-term, as most of the price adjustments have already been made. Through PlanGas pricing, the government narrowed its definition of what unconventional production qualifies for the higher subsidized price, allowing only incremental production from these unconventional fields to have the higher pricing. YPF and Pampa Energia are heavily impacted by this measure and will likely see little price increase in 2018, and thus the portfolio exited its Argentine oil and gas exposure. We also added Vincom Retail (1.8%), the largest and fastest-growing mall developer, owner and operator in Vietnam. The company plans to double its gross leasable area by Vincom currently operates 41 malls, reaching low-, mid- and high-income consumers with its various formats, including mega malls and plazas. Vietnam s consumption and retail sales continue to grow at very high levels due to rising wages, a shift toward modern trade, a growing middle class, formalization of the workforce and continued urbanization. We added KAZ Minerals (1.2%), a large low-cost copper producer in Kazakhstan. KAZ is in the final stage of ramping up its recent Greenfield developments, which could drive strong earnings growth, deleveraging and value transfer from debt holders to equity holders through dividends. Production volumes are expected to triple to 300,000 tons from 2015 to We believe KAZ is well-positioned as one of the lowest-cost copper producers in the world, and that remaining upside of the name may come from the execution of the final rampup of its projects. Outlook We continuously assess the growth levers providing tailwinds to frontier economies, such as strong demographics with labor force growth sufficient for high GDP growth, an underpenetrated credit cycle, a relatively low level of private debt to GDP and healthy domestic demand. Many of the frontier markets are recovering off a low in GDP growth and experienced significant resets in the economy, including markets like Argentina, Nigeria and select markets across the Middle East. This is in contrast to emerging markets where there is widespread declining labor force growth, an overpenetrated credit cycle, especially in some of the largest countries such as China, and high exposure to interest rate hikes given the level of private debt to GDP held by both the corporates and consumers. 1 Source: KAZ Minerals 2018 Morgan Stanley. Morgan Stanley Distribution, Inc Exp. 1/31/2019 2

3 From a thematic perspective, we continue to own and seek companies benefiting from healthy domestic demand, particularly in regards to health care, and select consumer discretionary and staples. We also see demand for financial services in countries with low credit penetration. We are seeking to minimize our exposure to countries highly dependent on trade as protectionism is increasingly part of the platform of new populist leaders. We are closely monitoring the oil-dependent countries in the Middle East, including United Arab Emirates and Saudi Arabia. Longer-term tailwinds, including demographics and political reforms, are also positive, in addition to the market announcement by MSCI that Saudi Arabia was added to the watch list for index inclusion. Though Pakistan moved to the MSCI Emerging Markets Index earlier this year, we still consider it part of our investible universe. Pakistan is facing a few headwinds, notably an overvalued currency, a sliding current account and uncertainty in politics surrounding former Prime Minister Nawaz Sharif s involvement in the Panama Papers. The overvalued currency had been supported by flows coming into the market but build in reserves have now come off. However, we still remain positive on the banking system as it has healthy loan deposit ratios and private credit to GDP ratios against the other frontier countries. We remain positive on Argentina as the government moved aggressively last year to adjust economic policy by removing capital controls, devaluing the currency and decreasing subsidies. The government s message was that the unpleasant medicine of 2016 would give way to a strong recovery. Indeed, after the economy contracted by over 2.5% in 2016, the outlook has turned and economic growth is expected to continue through A pick-up in investment could lead to growth after a decade of low investment levels. Private consumption has picked up with consumer confidence and will also be a key contributor to economic expansion. Monetary policy has tightened on the back of stickier-than-expected inflation. President Macri s Cambiemos party was successful in October midterm elections, which has improved governability and reform momentum. The first round of Macri s reforms stabilized the economy, and the next round of longer-term reforms looks to target uncompetitive legacy taxes and pension and labor policies. We are carefully monitoring increasing economic and political risks in Romania. The economy is growing well above its potential growth, with third quarter 2017 GDP growth coming in at 8.8%, acceleration from the already high 6.0% recorded in full year This has begun to stoke higher inflation. Real rates are negative, keeping monetary policy expansionary, and rates are likely to rise substantially in Due to populist measures and additional tax cuts, the government is struggling to keep the budget deficit at 3% of GDP. We believe the Romania macro story has reached an inflection point, where growth will slow as both monetary and fiscal policy become more contractionary. We are increasingly concerned about the Kenya macro story. The country has consistently run twin deficits, but we are concerned that both the current account deficit and fiscal deficit are deteriorating. The current 2 Source: National Institute of Statistics - Romania 2018 Morgan Stanley. Morgan Stanley Distribution, Inc Exp. 1/31/2019 3

4 account deficit has deteriorated to 6.2% of GDP and the fiscal deficit to nearly 8% of GDP. 3 External debt to GDP remains relatively low at about 30%. 4 Only a fraction of the current account deficit is covered by foreign direct investment (FDI). The funding of these large deficits would be challenging in a global risk-off environment. We believe that the overall outlook and key metrics in Morocco are slowly trending in the right direction. Growth is rebounding this year following an exceptionally weak agriculture harvest in 2016, which trickled through to consumption growth. The investment case for Morocco lies strongly in its growing position as a manufacturing hub for Europe. European and Chinese firms continue to open new manufacturing plants in Morocco due to its proximity to Europe, low wages, investment-friendly regulation and the best infrastructure in the frontier markets. Non-agriculture GDP growth is most highly correlated with European growth due to exports and tourism. A key risk to growth is social unrest, caused by non-inclusive growth, which could result in a reversal of the fiscal consolidation. 3 Source: The National Treasury of Kenya 4 Source: International Monetary Fund 2018 Morgan Stanley. Morgan Stanley Distribution, Inc Exp. 1/31/2019 4

5 Performance (%) As of December 31, 2017 MTD QTD YTD 1 YEAR 3 YEAR 5 YEAR SINCE INCEPTION 8/25/08 MSIF Frontier Markets Portfolio MSCI Frontier Markets Index Performance data quoted represents past performance, which is no guarantee of future results, and current performance may be lower or higher than the figures shown. For the most recent month end performance figures, please visit morganstanley.com/im. Investment returns and principal value will fluctuate and fund shares, when redeemed, may be worth more or less than their original cost. Performance shown for the Fund s Class I shares reflects the performance of the common shares of the Frontier Predecessor Fund for periods prior to September 17, Pursuant to an agreement and plan of reorganization between Morgan Stanley Institutional Fund, Inc., on behalf of the Fund, and Morgan Stanley Frontier Emerging Markets Fund, Inc. (the Frontier Predecessor Fund ), on September 17, 2012 the Fund acquired all of the assets and liabilities of the Frontier Predecessor Fund in exchange for Class I shares of the Fund (the Frontier Reorganization ). As a result of the Frontier Reorganization, the Fund is the accounting successor of the Frontier Predecessor Fund. The historical performance information shown reflects, for the period prior to the Frontier Reorganization, the historical performance of the Frontier Predecessor Fund. The Frontier Predecessor Fund may have performed differently if it were an open-end fund since closed-end funds are generally not subject to the cash flow fluctuations of an open-end fund. The gross expense ratio is 1.69% for Class I shares and the net expense ratio is 1.69%. Where the net expense ratio is lower than the gross expense ratio, certain fees have been waived and/or expenses reimbursed. These waivers and/or reimbursements will continue for at least one year from the date of the applicable fund's current prospectus (unless otherwise noted in the applicable prospectus) or until such time as the fund's Board of Directors acts to discontinue all or a portion of such waivers and/or reimbursements. Absent such waivers and/or reimbursements, returns would have been lower. Expenses are based on the fund's current prospectus. The minimum initial investment is $5,000,000. Returns are net of fees and assume the reinvestment of all dividends and income. They are compared to an unmanaged market index. Returns for less than one year are cumulative (not annualized). Performance for one year or more is based on average annual total returns. The returns are reported for Class I shares. Performance for other share classes will vary. Please keep in mind that high double-digit returns are highly unusual and cannot be sustained. Investors should also be aware that these returns were primarily achieved during favorable market conditions. Effective March 31, 2017, The name of the Portfolio was changed from Morgan Stanley Institutional Fund, Inc. Frontier Emerging Markets Portfolio to Morgan Stanley Institutional Fund, Inc. Frontier Markets Portfolio. There were no other changes to the Portfolio or investment process. 5

6 The views and opinions expressed are those of the portfolio management team at the time of writing and are subject to change at any time due to market, economic, or other conditions, and may not necessarily come to pass. These comments are not representative of the opinions and views of the firm as a whole. Holdings and sectors/region weightings are subject to change daily. All information provided is for informational purposes only and should not be deemed as a recommendation to buy or sell securities in the sectors and regions referenced. This material is a general communication, which is not impartial and all information provided has been prepared solely for informational and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The information herein has not been based on a consideration of any individual investor circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision. RISK CONSIDERATIONS: There is no assurance that a Portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the Portfolio will decline and that the value of Portfolio shares may therefore be less than what you paid for them. Accordingly, you can lose money investing in this Portfolio. Please be aware that this Portfolio may be subject to certain additional risks. In general, equities securities values also fluctuate in response to activities specific to a company. Investments in foreign markets entail special risks such as currency, political, economic, market and liquidity risks. The risks of investing in frontier emerging markets are greater than risks associated with investments in other foreign or U.S. issuers and they are often considered highly speculative in nature. Investment opportunities in many frontier emerging markets may be concentrated in the banking industry, which could have a disproportionate impact on the portfolio s performance. Stocks of small- and medium- capitalization companies entail special risks, such as limited product lines, markets and financial resources, and greater market volatility than securities of larger, more established companies. By investing in investment company securities, the portfolio is subject to the underlying risks of that investment company's portfolio securities. In addition to the Portfolio's fees and expenses, the Portfolio generally would bear its share of the investment company's fees and expenses. Derivative instruments may disproportionately increase losses and have a significant impact on performance. They also may be subject to counterparty, liquidity, valuation, correlation and market risks. Illiquid securities may be more difficult to sell and value than public traded securities (liquidity risk). The MSCI Frontier Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of frontier markets. The term "free float" represents the portion of shares outstanding that are deemed to be available for purchase in the public equity markets by investors. The MSCI Frontier Markets Index currently consists of 29 frontier market country indices. The performance of the Index is calculated in U.S. dollars and assumes reinvestment of net dividends. Net dividends reflects a reduction in dividends after taking into account withholding of taxes by certain foreign countries represented in the Index. The MSCI Emerging Markets Net Index is a free float-adjusted market capitalization weighted index that is designed to measure equity market performance of emerging markets. The term free float represents the portion of shares outstanding that are deemed to be available for purchase in the public equity markets by investors. The MSCI Emerging Markets Index currently consists of 24 emerging-market country indices. The performance of the index is listed in U.S. dollars and assumes reinvestment of net dividends. The Indexes are unmanaged and do not include any expenses, fees or sales charges. It is not possible to invest directly in an Index. Please consider the investment objectives, risks, charges and expenses of the fund carefully before investing. The prospectus contains this and other information about the fund. To obtain a prospectus, contact your financial advisor or download one at morganstanley.com/im. Please read the prospectus carefully before investing. Morgan Stanley Investment Management is the asset management division of Morgan Stanley. NOT FDIC INSURED OFFER NO BANK GUARANTEE MAY LOSE VALUE NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY NOT A DEPOSIT 2018 Morgan Stanley. Morgan Stanley Distribution, Inc Exp. 1/31/2019 6