Emerging Markets Growth Commentary

December 31, 2009

The Driehaus Emerging Markets Growth Composite (the “Strategy”) modestly underperformed its benchmark, the MSCI Emerging Markets Growth Index (the “Benchmark”), by 49 basis points for the quarter. The Strategy also modestly underperformed the MSCI Emerging Markets Index (the “Index”) by 13 basis points during that same time frame.

At quarter end, the Strategy’s two largest underweightings versus the Benchmark were in the Telecommunication Services and Financials sectors.  A combination of the Strategy’s underweight allocation and stock selection in the Financials sector and stock selection in the Telecommunication Services sector detracted from return. The underweight allocation to the Telecommunication Services sector, however, contributed to return. As a result of accelerating sales and increased earnings growth rates, the Strategy’s two largest overweightings versus the Benchmark were in the Consumer Staples and Information Technology sectors. A combination of the Strategy’s overweight allocation and stock selection to the Information Technology sector and the overweight allocation to the Consumer Staples sector contributed to return. Stock selection in the Consumer Staples sector, however, detracted from return. The Industrials sector was the biggest contributor to return, while the Financials sector was the largest detractor from Strategy return.

From a country perspective, the Strategy’s largest overweightings versus Benchmark were in Hong Kong (primarily Chinese stocks), Canada and the United Kingdom, and the largest underweightings were in Brazil, South Africa and Taiwan. Currently, the Strategy’s investments in the developed markets are focused on investments with a substantial (nearly 100%) portion of their operations conducted overseas. The Strategy benefited from the overweight allocation in Hong Kong and Canada. The overweight allocation in the United Kingdom, however, detracted from the Strategy’s return. The Strategy remains overweight in Hong Kong, Canada and the United Kingdom due to their strong earnings growth outlook. The underweight allocation in Taiwan and South Africa contributed to the Strategy’s return; however, the underweight allocation within Brazil detracted from return. Stock selection within Brazil, South Africa and Taiwan contributed to the Strategy’s return. The Strategy remains underweight versus the benchmark in those countries.

Holdings in the United Arab Emirates and Indonesia were the largest detractors from return during the quarter. Credit concerns in the United Arab Emirates and stock selection in Indonesia constrained returns.

Positions in Korea and Hong Kong were the top contributors to return during the quarter. Within Korea, the Strategy benefited from a substantial underweight and stock selection. Additionally, holdings in the Consumer Discretionary sector contributed to returns in Hong Kong. 

While 2009 was largely a macro-driven environment characterized by high correlations within the emerging market universe, Driehaus Capital Management LLC (the “Adviser”) expects 2010 to transition to a period of greater differentiation, providing a more conducive environment for “stock-picking” and favorable backdrop for quality growth names to outperform. We have seen a strong economic recovery in many parts of the developing world in 2009, and while the Adviser remains optimistic long-term on emerging market economies, we do expect the developed markets, namely the United States, to exhibit an improvement in growth in 2010 as they rebuild inventories.  This should be positive for commodity exporters and shipping companies. During 2009, we saw the implementation of significant policy measures, both fiscal and monetary.  We are cognizant of the potential for central banks to begin to exit some of the policies that have added significant liquidity to the system, as well as the end of many fiscal stimulus packages.  While Brazil and India are likely to see tightening liquidity, policy in Eastern Europe and Russia remains accommodative.  Given that environment, we are adding to the Strategy’s holdings in companies that exhibit strong pricing power and operating leverage, as opposed to those that rely heavily on cost-cutting, which we see as less sustainable, to generate earnings growth.

In terms of themes, the Adviser continues to favor Russia, where stronger commodity prices have led to improving profitability and cash flows, causing credit concerns to subside.  As Russia’s fiscal stimulus started to take hold during the fourth quarter, and the central bank continued to pursue monetary easing, this supported the Strategy’s domestic demand theme, which we are playing through select food retailers, banks, and cosmetic companies. The Adviser added to the Strategy’s allocation to China focusing on select media companies to gain exposure to an acceleration in the Chinese advertising market. Additionally, we remain optimistic on the Chinese consumption theme in the long-term and continue to hold several names levered to the consumer. From a sector perspective, the Adviser favors Information Technology (inventory levels remained below normal and sales data pointed to continued strong demand for LCD TVs and netbooks) and Materials (increasing exposure to companies that produce raw materials for the steelmaking industry, such as iron ore and coking coal).  

NOTES

Sources: Driehaus Capital Management LLC, FactSet, Morgan Stanley Capital International and Standard & Poor’s Global Industry Classification Standard, Russell Indices, and the Wall Street Journal.

The performance numbers represent a composite of emerging markets growth accounts managed by Driehaus Capital Management LLC.  These numbers are estimated for the period as all underlying accounts have not yet been reconciled. All rates of return include reinvested dividends and other earnings and are net of fees and brokerage commissions. The performance data shown above represents past performance and does not guarantee future results. Current performance may be lower or higher than the performance data quoted.

The Morgan Stanley Capital International Emerging Markets Growth Index (MSCI Emerging Markets Growth Index) is a subset of the MSCI Emerging Markets Index and includes only the MSCI Emerging Markets Index stocks which are categorized as growth stocks.

The Morgan Stanley Capital International Emerging Markets Index (MSCI Emerging Markets Index) is a market capitalization-weighted index designed to measure equity market performance in 27 global emerging markets. 

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