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Emerging Markets

26 Nov 2018

The Brandes Emerging Markets Equity Strategy slightly outperformed its benchmark, the MSCI Emerging Markets Index, which fell 1.1%.

Positive Contributors

Highlighting how volatility is often part and parcel of emerging markets investing, two of this period’s major positive contributors were detractors to returns in the second quarter. Brazilian Petrobras and Argentinian YPF rebounded sharply as short-term concerns that weighed on their shares last quarter abated. As with our other oil & gas holdings, both companies continued to benefit from improved earnings and cash flows in a higher oil-price environment.

Holdings in Mexico also aided returns, led by real estate investment trusts (REITs) PLA Administradora Industrial (Terrafina) and Macquarie Mexico Real Estate Management. Investors seemed to welcome the prospect of the new trade deal between the United States and Mexico, which lifted some uncertainty regarding future relations between the two countries.

Additionally, our underweight to China helped relative performance.

Performance Detractors

The strategy’s exposure to Turkey, most notably our commercial bank holdings, hurt performance amid the country’s currency crisis. President Erdogan’s interference in monetary policy and the appointment of his son-in-law as treasury and finance minister shook investor confidence. Furthermore, weakened diplomatic relations with western partners added fuel to the lira’s tumbling. While fears of contagion momentarily spread throughout emerging markets, they have since dissipated.

As the risks of investing in the country intensified, we exited our position in bank Vakif Bankasi, especially given the company’s direct government control. We continuously monitor the situation in Turkey and maintain measured positions in Akbank, Garanti Bankasi and REIT Emlak Konut.

Holdings in Brazil also declined as the country’s upcoming election led to increased volatility. Notable detractors included food producer Marfrig Global Foods, regional jet manufacturer Embraer, health insurer Hapvida Participacoes and payment processor Cielo.

In early July, Boeing and Embraer released a non-binding agreement to establish a new joint venture (JV) for commercial aircraft. The deal values Embraer’s commercial aircraft business unit, which will be fully transferred to the new JV, at $4.75bn. Based on the proposed terms, Boeing will own an 80% stake in the JV, while Embraer will hold the remaining 20%. Embraer will also retain control of its defense and business jet operations. The deal is expected to close by the end of 2019, subject to regulatory clearance.

Embraer’s shares fell as many investors appeared unsatisfied with the offered price. However, in our opinion, the price was adequate, especially considering the other terms outlined in the agreement. Through its 20% stake, Embraer will be able to participate in the potential synergies that may materialize within the JV. Additionally, as the commercial aviation segment has faced increased competition, particularly from Chinese, Russian and Japanese newcomers, we believe the deal actually “neutralizes” a major long-term business threat for Embraer.

In August, Marfrig announced that it would sell about 90% of its stake in Keystone, a fully owned subsidiary, to Tyson Foods. Keystone supplies protein to fast food chains mostly in the United States and Asia. The deal is expected to close by year-end at an enterprise value of $2.4bn, which was below the market’s initial expectations. Nevertheless, we believe Marfrig remains undervalued. We are encouraged by the company’s continued balance sheet improvements and its efforts to streamline its business model.

Select Activity in the Third Quarter

The investment committee added X5 Retail Group to the strategy.

X5 is Russia’s largest food retailer by revenue, with an approximately 9% market share in food retailing and a strong footprint in big cities such as Moscow and St. Petersburg. The company operates in three retail formats, namely proximity/convenience stores (78% of 2017 sales), supermarkets (15% of sales) and hypermarkets (7% of sales). The company has a vertically integrated supply chain and delivers over 90% of the items sold in its stores from internal distribution centers.

A number of factors have weighed on X5’s shares, including an increasing pressure on margins (an industry-wide challenge), a recent move of management personnel to a main competitor and the potential impact of further sanctions against Russia. We believe these concerns have been more than reflected in the current share price. Despite the pressure on margins, the food retailing industry in Russia is still underpenetrated relative to developed countries, with fewer grocery stores per 1,000 inhabitants.

Trading at less than 10x forward earnings and offering a dividend yield of 5.5% as of September 30, X5 represents an appealing investment opportunity to us.

Year-to-Date 2018 Briefing

The Brandes Emerging Markets Equity Strategy underperformed the MSCI Emerging Markets Index, which fell 7.7% for the nine months ended September 30, 2018.

Similar to what happened in the quarter, holdings in Turkey and Brazil detracted from year-to-date returns. Turkish Akbank, Vakif Bankasi and Emlak Konut performed poorly, as did Brazil’s Marfrig Global Foods and Embraer.

Other detractors included Indian electric utility Reliance Infrastructure and Argentinian oil & gas firm YPF.

We saw positive contributions from our oil & gas holdings, specifically Lukoil, Surgutneftegas and Petrobras. Retailers with exposure to China—namely Lifestyle International, Bosideng and Luk Fook Holdings—also helped performance. Additionally, Indian technology company Infosys aided returns.

Current Positioning

We have increasingly found investment opportunities in China amid the country’s trade war with the United States, coupled with increased market volatility.

The strategy’s exposures have been relatively unchanged, as Brazil, Russia and Mexico continue to represent overweight positions. We also maintained higher allocations to consumer discretionary and telecommunication services companies than the benchmark.

China remained one of our largest underweights at quarter end, along with Taiwan. From a sector perspective, we held material underweight allocations to information technology and financials.

We remain convinced that the current positioning of the Brandes Emerging Markets Equity Strategy, which results from our careful bottom-up stock selection, bodes well for the long term.

Thank you for your continued trust.

Cash Flow: The amount of cash generated minus the amount of cash used by a company in a given period.

Dividend Yield: Dividends per share divided by price per share.

Enterprise value: Market capitalization plus debt, minority interest and preferred shares, minus total cash and cash equivalents.

Forward Earnings: Sell-side analysts’ consensus earnings estimates for the next fiscal year.

Forward Price/ Earnings: Price per share divided by earnings estimates for the next fiscal year.

The declaration and payment of shareholder dividends are solely at the discretion of the issuer and are subject to change at any time.

The MSCI Emerging Markets Index with net dividends captures large and mid cap representation of emerging market countries. Data prior to 2001 is gross dividend and linked to the net dividend returns.

MSCI has not approved, reviewed or produced this report, makes no express or implied warranties or representations and is not liable whatsoever for any data in the report. You may not redistribute the MSCI data or use it as a basis for other indices or investment products.

The foregoing Quarterly Commentary reflects the thoughts and opinions of Brandes Investment Partners® exclusively and is subject to change without notice. The information provided in the commentary should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any security transactions, holdings or sectors discussed were or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance discussed herein. International and emerging markets investing is subject to certain risks such as currency fluctuation and social and political changes; such risks may result in greater share price volatility. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that the securities sold have not been repurchased. The actual characteristics with respect to any particular account will vary based on a number of factors including but not limited to: (i) the size of the account; (ii) investment restrictions applicable to the account, if any; and (iii) market exigencies at the time of investment. Unlike bonds issued or guaranteed by the U.S. government or its agencies, stocks and other bonds are not backed by the full faith and credit of the United States. Stock and bond prices will experience market fluctuations. Please note that the value of government securities and bonds in general have an inverse relationship to interest rates. Bonds carry the risk of default, or the risk that an issuer will be unable to make income or principal payment. There is no assurance that private guarantors or insurers will meet their obligations. The credit quality of the investments in the portfolio is not a guarantee of the safety or stability of the portfolio. Investments in Asset Backed and Mortgage Backed Securities include additional risks that investors should be aware of such as credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments. Securities of small companies generally experience more volatility than mid and large sized companies. Although the statements of fact and data in this report have been obtained from, and are based upon, sources that are believed to be reliable, we cannot guarantee their accuracy, and any such information may be incomplete or condensed. Strategies discussed are subject to change at any time by the investment manager in its discretion due to market conditions or opportunities. The Brandes investment approach tends to result in portfolios that are materially different than their benchmarks with regard to characteristics such as risk, volatility, diversification, and concentration. Please note that all indices are unmanaged and are not available for direct investment. Past performance is not a guarantee of future results. No investment strategy can assure a profit or protect against loss. Market conditions may impact performance. The performance results presented were achieved in particular market conditions which may not be repeated. Moreover, the current market volatility and uncertain regulatory environment may have a negative impact on future performance. The margin of safety for any security is defined as the discount of its market price to what the firm believes is the intrinsic value of that security. The declaration and payment of shareholder dividends are solely at the discretion of the issuer and are subject to change at any time.

United States: Issued by Brandes Investment Partners, L.P., 11988 El Camino Real, Suite 600, San Diego, CA 92130.

30 Jun 2018

Brandes Investment Partners, L.P. Emerging Markets Equity Strategy Notes Second Quarter 2018 (April 1 – June 30, 2018)

The Timothy Plan Mutual Fund Emerging Markets portfolio declined 9.8% (gross of fees) in the second quarter, underperforming its benchmark, the MSCI Emerging Markets Index, which fell 8.0%.

Performance Detractors

Currency impact, geopolitical turmoil and fears of economic slowdown due to trade wars and rising U.S. interest rates were the main factors pressuring many of our holdings.

Our positions in countries with external financing vulnerabilities or current account deficits, namely Turkey, Brazil and Argentina, were the hardest hit. Currency declines in these three countries, where we were overweight relative to the MSCI Emerging Markets Index, accounted for the largest driver of the quarter’s underperformance. We believe the challenges associated with the currency fluctuations are short term in nature and we remain optimistic about the prospects of our holdings.

Notable detractors included Turkish banks Vakif Bank and Garanti Bank, as well as real estate investment trust Emlak Konut.

Among our Brazilian holdings, education companies Kroton Educacional and Estacio Participacoes, as well as integrated oil company Petrobras and its subsidiary Petrobras Distribuidora weighed heavily on returns.

Kroton and Estacio reported lower-than-expected near-term results and weak 2018 earnings guidance. The companies have also been facing regulatory policy uncertainties and a muted economic environment coupled with high unemployment in Brazil. We believe this negativity has been more than accounted for in Kroton’s and Estacio’s share prices. Our longer-term investment theses for the companies remain positive as they traded at 9.0x (Kroton) and 9.5x (Estacio) on a forward price-to-earnings basis as of June 30.

Over the past two months, Petrobras has been struggling with a diesel fuel pricing fiasco and investor concerns that its 2011-2014 pricing restriction issues may reappear. In late May, Brazilian truck drivers went on strike after Petrobras raised diesel fuel prices by 10%. The strike triggered a number of events, including the resignation of Petrobras’ chief executive officer after the government intervened to require concessions in diesel prices. Non-intervention of government in management was a key demand when he accepted the role.

Despite government commitment to reimburse Petrobras for any losses from the lower diesel prices, its shares declined, as many investors were worried that the company would lose independence in setting domestic fuel prices or that the government would not fully reimburse the losses. We believe the market has overreacted and we took advantage of the sell-off to add to our position in Petrobras.

Meanwhile, sizeable foreign exchange depreciation and the spillover effects from higher inflation and lower gross domestic product growth estimates hurt Argentinian shares, including those of oil & gas firm YPF. In early May, the Argentinian government announced a fuel-price freeze agreement with YPF and two other major oil companies operating in the country as part of its efforts to control consumer prices.

Positive Contributors

Positive contributors included Hong Kong and Chinese retailers, most notably Lifestyle International and Lifestyle China, as well as Bosideng, which all continued to enjoy improvements in the Chinese retail market. For Bosideng, a strong increase in its profitability, which was up almost 60% year-over-year, drove up the share price. Additionally, the down clothing company has been in talks with a major e-commerce player, Alibaba Group, about a strategic partnership.

Indian technology company Infosys and Brazil-based food producer Marfrig Global Foods also helped performance.

In early April, Marfrig announced the acquisition of a majority stake in U.S. meatpacker National Beef from Leucadia National. The deal made Marfrig the second-largest beef producer in the world and strengthened its footing in the U.S. meat industry. Marfrig has also been in discussions with several companies to sell its subsidiary, Keystone, a major supplier of meat to McDonalds. The company plans to use some of the sale proceeds to continue to improve its levered balance sheet.

Select Activity in the Second Quarter

The Emerging Markets Investment Committee exited the strategy’s position in Lifestyle China as the shares strongly appreciated this year and reached our estimate of intrinsic value.

Moreover, the increased market volatility in the quarter provided the opportunity to initiate positions in a number of companies that we believe are undervalued based on our long-term purview.

New purchases included Mexican consumer finance company Gentera and U.K.-domiciled Vivo Energy, a leading fuel retailer in Africa. The investment committee also added Brazil-based credit and debit card operator Cielo and health care insurer Hapvida Participacoes.

Cielo is Brazil’s largest merchant acquirer/processor with 51% market share of credit and debit transaction volumes. Banco do Brasil and Banco Bradesco collectively own a 58.7% controlling stake in Cielo.

A merchant acquirer enables card payments by renting or selling a merchant a point-of-sale (POS) terminal, which captures pertinent information for a transaction and routes it for processing and settlement. Although its market share and fees per transaction have declined over the past seven years due to intensifying competition, Cielo has managed to double its earnings over the same period. It has offset pricing pressure with volume growth and increased revenues from renting its POS machines, as well as by entering the business of receivables discounting (i.e., providing faster payment to merchants as there is a 30-day settlement period for credit card purchases).

In our view, Cielo’s resilience in navigating the increasingly competitive market reflects the strength of the franchise. We believe Cielo’s revenues are cyclically geared to an uptick in consumer spending as the Brazilian economy recovers from recession, and the company should benefit as more and more people choose card payment over cash.

A key investment consideration is that Cielo’s current level of profitability does not appear sustainable. While transaction volumes should continue to grow over time, profits per transaction are likely to decline further from continued fee compression or cost increases due to more intense market rivalry. Additionally, future regulatory changes could have an adverse impact to profitability of the industry.

Given Cielo’s good balance sheet and competitive positioning, we consider it well placed to deal with these uncertainties and that the company’s share price seems to adequately imply the risks.

Current Positioning

As discussed earlier, we took advantage of the recent market challenges (e.g., increased volatility, currency pressure, geopolitical tension) to allocate to what we consider undervalued businesses with solid fundamentals. While many have fled the asset class, we continue to believe it is an exciting time to invest in emerging markets companies, in particular for value investors.

As of June 30, emerging markets value stocks were among the very few asset class subsets that traded at a valuation level in line with its 10-year historical average. In comparison, emerging markets growth stocks traded at two standard deviations above historical average. There was only one other time in the last 20 years where emerging markets growth stocks were more expensive on a forward P/E basis.*

Furthermore, while growth companies tend to be perceived as higher “quality” as they have generally enjoyed stronger margins and returns on equity, as well as better sales and earnings growth than their value counterparts, the gap in these fundamentals (for value vs. growth companies) has actually narrowed over the last several years. Earnings growth discrepancy is at a 20-year low, while margin differentials have compressed.

In our view, the wide valuation gap, combined with narrowing differences in fundamentals between value and growth stocks, makes a compelling case for value investing in emerging markets.

In terms of strategy exposures, Brazil, Russia and Mexico remained key overweight positions as of June 30. Our weightings to Brazil and Mexico increased in the quarter as we added Hapvida Participacoes, Cielo and Gentera, and selectively averaged down on a number of our existing holdings given the market weakness.

On a sector basis, we maintained higher allocations to consumer discretionary and telecommunication services than the benchmark.

Our largest underweight positions remained in China and Taiwan, which coincided with our significant underweight to the information technology sector.

We believe the current positioning of the Brandes Emerging Markets Equity Strategy bodes well for the long term. Thank you for your continued trust.

*Based on forward price-to-earnings. EM value stocks represented by the MSCI Emerging Markets Value Index; EM growth stocks represented by the MSCI Emerging Markets Growth Index.

Forward Price/Earnings: Price per share divided by expected earnings per share.

Intrinsic Value: The actual value of a company or an asset based on an underlying perception of its true value.

Return on Equity: Net income divided by shareholder’s equity.

Standard Deviation: The dispersion of a data set relative to its mean.

The MSCI Emerging Markets Index with net dividends captures large and mid cap representation of emerging market countries. Data prior to 2001 is gross dividend and linked to the net dividend returns.

The MSCI Emerging Markets Growth Index with gross dividends captures large and mid cap securities exhibiting growth style characteristics, defined using long-term forward earnings per share (EPS) growth rate, short-term forward EPS growth rate, current internal growth rate, long-term historical EPS growth trend, and long-term historical sales per share growth trend.

The MSCI Emerging Markets Value Index with gross dividends captures large and mid cap securities exhibiting value style characteristics, defined using book value to price, 12-month forward earnings to price, and dividend yield.

MSCI has not approved, reviewed or produced this report, makes no express or implied warranties or representations and is not liable whatsoever for any data in the report. You may not redistribute the MSCI data or use it as a basis for other indices or investment products.

The foregoing Quarterly Commentary reflects the thoughts and opinions of Brandes Investment Partners® exclusively and is subject to change without notice. The information provided in the commentary should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any security transactions, holdings or sectors discussed were or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance discussed herein. International and emerging markets investing is subject to certain risks such as currency fluctuation and social and political changes; such risks may result in greater share price volatility. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that the securities sold have not been repurchased. The actual characteristics with respect to any particular account will vary based on a number of factors including but not limited to: (i) the size of the account; (ii) investment restrictions applicable to the account, if any; and (iii) market exigencies at the time of investment. Unlike bonds issued or guaranteed by the U.S. government or its agencies, stocks and other bonds are not backed by the full faith and credit of the United States. Stock and bond prices will experience market fluctuations. Please note that the value of government securities and bonds in general have an inverse relationship to interest rates. Bonds carry the risk of default, or the risk that an issuer will be unable to make income or principal payment. There is no assurance that private guarantors or insurers will meet their obligations. The credit quality of the investments in the portfolio is not a guarantee of the safety or stability of the portfolio. Investments in Asset Backed and Mortgage Backed Securities include additional risks that investors should be aware of such as credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments. Securities of small companies generally experience more volatility than mid and large sized companies. Although the statements of fact and data in this report have been obtained from, and are based upon, sources that are believed to be reliable, we cannot guarantee their accuracy, and any such information may be incomplete or condensed. Strategies discussed are subject to change at any time by the investment manager in its discretion due to market conditions or opportunities. The Brandes investment approach tends to result in portfolios that are materially different than their benchmarks with regard to characteristics such as risk, volatility, diversification, and concentration. Please note that all indices are unmanaged and are not available for direct investment. Past performance is not a guarantee of future results. No investment strategy can assure a profit or protect against loss. Market conditions may impact performance. The performance results presented were achieved in particular market conditions which may not be repeated. Moreover, the current market volatility and uncertain regulatory environment may have a negative impact on future performance. The margin of safety for any security is defined as the discount of its market price to what the firm believes is the intrinsic value of that security. The declaration and payment of shareholder dividends are solely at the discretion of the issuer and are subject to change at any time.

United States: Issued by Brandes Investment Partners, L.P., 11988 El Camino Real, Suite 600, San Diego, CA 92130.

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