This letter to investors from Prince Street Capital is old (it’s dated January 22 2011), but it’s a good read (letters from Prince Street are a rare find).
Their main points are that inflation is on the rise, and that’s a risk. And that the emerging markets trade “got crowded.”
Their strategy as of late January was to deploy capital away from India and China, according to the letter.
In case you’ve never heard of the fund, David Halpert‘s Prince Street (which has ~$300 million in assets under management) was named Bloomberg’s sixth best performing hedge fund in emerging markets in 2010. The $100 million Prince Street Opportunities fund gained 34.2%. It was founded in 2001.
Key paragraphs are excerpted below.
[S]ome of the central banks (e.g. Malaysia) are acting more responsibly than others (e.g. Vietnam). On average, however, inflation is on the rise in EM and so are interest rates…
For reasons monetary, political, macroeconomic and technological, inflation has been in retreat for the entire careers of most people reading this letter. That baseline trend may at last have run its course, as the huge number of producers in the developing world increasingly become consumers, as current technologies for extracting resources like oil and copper run up against geological limits, as climate change disrupts the cost structure for food production, and as the exchange rates of the developing world continue to rise against the US dollar in particular.
In the longer term, strong disinflationary trends still exist. The demographics of the West but also of China and Russia show that the population is ageing, which implies eventual deflation (although short term labour shortages in China are pushing the other way). The real estate markets in the US remain oversupplied; excess indus- trial capacity and excess labour supply in many econo- mies suggests wage inflation in the West is nowhere in sight…
Vietnamese inflation is an issue for Vietnam, but Chinese inflation is an issue for the entire world. While our base case scenario for China is that the government will eventually get it right, the latest ambivalent signals from the policy makers suggest there is still some tail risk here. In the mean time, the inflation is being exported, and suggests that whatever challenges the smaller Asian central banks may have, they are amplified by China’s policy risks.
That said, there are still lots of ways to make money in both emerging and frontier markets. These countries between them still play host to most of the world’s energy, most of the world’s minerals, and most of the world’s agriculture. There are insurance stocks, emerging brands with real pricing power, fertiliser stocks and more than a few agribusiness companies. It will be important to watch how the central banks respond, but most of all, it is important not to panic.
In our portfolios, we have been steadily redeploying capital for several months now in favour of markets and companies that benefit from higher commodity prices, including in particular fertiliser stocks, but also mining companies, and also markets such as Russia which benefit from higher commodity prices in improved terms of trade. In the process, we have been taking profits in the “Bottom of the Pyramid” theme, which we have been playing quite aggressively over the last 18 months. We still believe that this sector – companies focused on low end consumer demand in the developing world – has great potential to create value going forward. But in the medium term, the trade got crowded, and inflation is an important cloud on the horizon. There are plenty of places to make money in emerging markets, but for 2011, that may not include China or India.
In short, the inflation challenge has required us to reposition capital somewhat in recent months. We still see plenty of opportunity, and we are watching this space.
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