Baron Emerging Markets Fund: Latest Insights and Commentary

The principal catalyst driving global capital markets during the quarter was a change in consensus thinking regarding U.S. foreign policy and the role of U.S. tariffs. As the quarter progressed, hopes that immigration and tax reform priorities would dominate began to fade as foreign policy isolationism and economic nationalism/protectionism moved to center stage. Protectionist rhetoric that had been rationalized as negotiating leverage exerted by a transactional president increasingly became viewed as perhaps a means to an end, with the likely economic impact being higher inflation and lower growth than expected, at least in the near term. 

We believe the market reaction to Trump’s “Liberation Day” tariffs was unfortunately appropriate, and suggests that, contrary to the spin, the U.S. is actually the disproportionate beneficiary of the status quo global trade and security equilibrium. Early in the second quarter, the jury is still out on whether the Trump administration pivots back to a more transactional posture, but concerns are growing that the U.S. is signaling an exit from the established rules-based global trade and security compact in place since the aftermath of WWII. Should the paradigm of economic nationalism and foreign policy isolationism gain momentum and take hold, we believe such a new world order would initially elevate the equity risk premium, and it could take considerable time to establish a new equilibrium. The silver lining for emerging market (EM) investors is that, if such a shift were to take place, we would likely see a further re-pricing in favor of non-dollar assets.

Current U.S. economic and trade policy is turning economic orthodoxy on its head.  While the U.S dishonors this orthodoxy, capital is migrating offshore. Rather than the protector of global security and democracy, free trade and free markets, the U.S. has become a source of disruption with an agenda to unwind decades of disinflation and capital efficiency. While the U.S. Congress may yet reclaim its mandate over U.S. trade and tariff policy and slow the protectionist momentum, to some extent, and in the eyes of our trading partners and geopolitical allies, the genie is out of the bottle. We believe the extremity of U.S. protectionism and its foreign policy pivot represent the catalyst that will turn the tide of EM equity underperformance.

CONTRIBUTORS

• Alibaba Group Holding Limited is the largest retailer and e-commerce company in China. Alibaba operates shopping platforms Taobao and Tmall, as well as businesses in logistics, local services, digital media, and cloud. Shares were up this quarter, as the company announced investment and progress in generative AI, and core domestic commerce growth accelerated. Alibaba is ramping its capital expenditures over the next three years to build out its cloud infrastructure layer and add AI capabilities to existing apps (e.g., consumer search). Within its commerce business, the core market is showing positive signs of stabilization, and improved profitability should follow. We retain conviction that Alibaba is well positioned to benefit from China's ongoing growth in e-commerce and cloud, although competitive concerns remain.
• Tencent Holdings Limited operates the leading social network and messaging platforms (QQ, WeChat), the largest online entertainment and media business, and the largest online gaming business in China. Shares of Tencent were up, as core gaming growth reaccelerated, profitability again beat expectations, and the company announced a step-up in AI investments. Tencent has already seen benefits from AI in its core advertising technology, with better targeting, content ranking, and new ways of engagement (e.g., AI-based search); the company also remains a notable player in the frontier AI model space. We continue to believe in Tencent’s ability to compound earnings, given its growth structure, massive scale, and focus on efficient operations. Longer term, we also believe Tencent could be the largest generative AI beneficiary in China, given its ability to improve its existing products and enter adjacent markets with massive scale and distribution. We continue to monitor the regulatory environment.
• Shares of Kingdee International Software Group Company Limited, a leading Chinese Enterprise Resource Planning (ERP) provider, increased during the quarter due to optimism that new AI features will improve enterprise customer productivity, accelerate revenue growth, and expand its competitive edge. We believe Kingdee will be a key beneficiary of the digital transformation and software localization of Chinese companies. We expect Kingdee will take market share from foreign ERP providers while continuing to transition to a subscription, cloud-based model that should lead to increased recurring revenue and earnings visibility.

 

DETRACTORS

• Semiconductor giant Taiwan Semiconductor Manufacturing Company Limited (TSMC) detracted in the first quarter due to uncertainty around tariffs, rumors about a potential joint venture with Intel, concerns about long-term margin dilution from increasing manufacturing capacity in the U.S., and fears of a slowdown in AI-related semiconductor demand. We retain conviction that TSMC’s technological leadership, pricing power, and exposure to secular growth markets, including AI/high-performance computing, automotive, 5G, and internet of things, will allow the company to sustain strong double-digit earnings growth over the next several years.
• Swiggy Limited is a leading food delivery platform in India, with approximately 45% market share. Shares were down due to greater-than-expected losses in its quick commerce business, as the company increased investment amid rising competition. We retain conviction in Swiggy as we believe India’s food delivery and quick commerce industries are still in their infancy and will continue to scale over the next several years, driven by a growing middle class, rising disposable income, higher smartphone penetration, and a structural shift in consumer preference given a technology-savvy younger population.
• Kaynes Technology India Limited is a leading electronics manufacturing service (EMS) player in India, offering services across the automotive, industrial, railway, medical, and aerospace and defense industries. Shares were down this quarter due to lower-than-expected quarterly sales, as execution on a subset of industrial-related orders was temporarily delayed. We retain conviction in Kaynes Technology, as we believe it is well positioned to benefit from the government's Make in India initiative, which encourages domestic manufacturing of electronic components by providing attractive tax subsidies and manufacturing infrastructure. We are excited about the company's decision to set up an Outsourced Semiconductor Assembly and Test facility, which we believe represents significant incremental growth opportunity in the medium term. We expect the company to deliver over 30% compounded EBITDA growth over the next three to five years.