Investment Trusts

Investing in Asia: Challenge or Opportunity?

Asia has long been is an important component of a diversified global strategy, but how can investors ensure that they participate fully in the potential of Asia, while reducing vulnerability to its risks?

26 Aug 2015

Rising to the challenge

The benefit of selective investing in Asia has long been recognised by many investors as a component of a diversified global strategy. The region has structural advantages that are likely to be supportive of economic and corporate growth in the long term. However, the countries within the region vary greatly in terms of economic development and political stability. How can investors ensure that they participate fully in the potential of Asia, while reducing vulnerability to its risks?

Asian economies have a number of key strengths. Across Asia, governments are moving from dominant state ownership to supporting the private sector, creating a benign environment for entrepreneurship and fresh thinking. Many Asian economies can claim strong demographics, with the region home to 60% of the world’s population and a predominantly young, aspirational workforce.

The two largest economies in the region – China and Japan – are in monetary easing mode, which is supporting the region as a whole. As net importers of energy, many countries are beneficiaries of the lower oil price, which is reducing costs for companies and consumers. Equally, rising wages, relatively low debt and the emergence of a new middle class are supporting flourishing consumer economies.

For stockmarket investors, Asian companies generally have stronger balance sheets with less aggregate debt than their Western peers. Corporate governance is improving, with companies increasingly recognising the importance of paying dividends, even in countries such as Japan. The stockmarkets have generally lagged other regions’ since the 2007-2008 financial crisis, leaving a slew of attractively valued companies.

These factors make Asia an increasingly attractive place to invest. However, the opportunities they create are not made equal and the region demands selectivity. The divergence in economic prospects is illustrated by contrasting the fortunes of India and China. In India, a year since taking office, Prime Minister Narendra Modi’s economic agenda is already making a difference, with meaningful structural reform improving infrastructure and capital allocation across the economy. In common with countries such as Indonesia, it is tackling its deficit, for example. India is at the trough of its capital cycle and there is plenty of ‘unlit’ capacity that could be unlocked by infrastructure improvements. For example, delays on the roads and at airports, plus a lack of power continue to hamper manufacturing distribution. Modi’s commitment to improving the rail network should go some way to address these issues.

In contrast, recent news from China has been mixed at best: 2015 will be the seventh year with new credit growth, which is now more than 32% of GDP. This type of credit expansion has historically been associated with economic instability. Infrastructure investment as a percentage of GDP has risen, suggesting policymakers are still relying on government spending to boost growth.

Significant structural imbalances also remain within the economy. Domestic Chinese investors have driven the stockmarket to new highs over the past year, spurred on by interest rate cuts and large-scale margin financing. Valuations for A-shares, even after the most recent sharp falls, remain stretched in many cases and the major indices are still only at levels seen as recently as December 2014.

That is not to say there aren’t opportunities: there are strong structural growth stories in each market. For example, in China, there is still considerable value in sectors such as healthcare, e-commerce, insurance and renewable energy. However, the region has risks that need to be negotiated.

The case for investment trusts

How can investors make the most of this environment? The region requires a flexible mandate that enables a fund manager to direct capital to the areas of strongest growth. In this, investment trusts have some natural advantages. Unlike unit trusts, managers of investment trusts do not have to sell assets when investors sell their shares if they believe that holding a stock is the right long-term strategy. For the same reason, trusts can invest in more illiquid investments if they believe the opportunity is justified. The investment trust structure gives the fund managers flexibility and allows them to take a long-term view less influenced by quarterly benchmarks. For example, the Schroder AsiaPacific Fund plc has a lower weighting in financials than its benchmark. It has also taken positions in out-of-favour countries such as Indonesia. The Schroder Japan Growth fund plc uses a similarly flexible mandate. The Asian Total Return Investment Company plc also uses the investment trust structure to focus on small and mid-cap companies, where there is less liquidity. It can make tactical use of derivatives – allowable within investment trusts – to offer a greater degree of capital preservation.

Investment trusts are able to smooth returns through periods of volatility as again, unlike unit trusts, their structure permits income reserves to be built to support returns in the leaner years, a particularly important benefit for investors looking for consistent income. In the Schroder Oriental Income Fund plc, this flexibility has enabled the trust to grow the dividend year on year since its launch in 2005.

Trusts can trade at a discount to their net asset value but this will often close as a fund’s area of investment becomes more popular. In a region such as Asia, where sentiment for individual markets can change quickly, this can provide an extra level of return for the patient investor. This makes them a good option in areas of structural, long term growth, as is being seen across Asia.

A compelling combination

Whatever the investment vehicle, the fundamentals of investing in Asia remain the same. Whilst macro-trends give an overall context, real value is delivered by individual stockpicking in quality companies based on local knowledge and extensive experience. Such a perspective enables a focus on a stock’s long-term potential as well as its current valuation and the confidence to follow a carefully-considered judgement in markets where there are sometimes as many opinions as there are analysts.

The four Schroders investment trusts that invest in Asia combine these fundamentals within the beneficial structure of investment trusts to deliver a compelling proposition for investors.

Schroders has had an on-the-ground presence in Asia for over 40 years. Two of the managers have over 30 years’ experience of investing in the region: Andrew Rose, who manages the Schroder Japan Growth Fund, and Matthew Dobbs, who runs the Schroder Oriental Income Fund and the Schroder AsiaPacific Fund. All managers are supported by a dedicated team of investment analysts, many of whom live and work in the regions they research.

Schroders’ range of trusts in Asia:

Asian Total Return Investment Company plc

The trust seeks to provide a high rate of total return through investment in equities and equity related securities of companies trading in the Asia Pacific region (excluding Japan). The trust seeks to offer a degree of capital preservation through tactical use of derivative instruments.
The trust targets attractive investment opportunities across diverse Asian equity markets. The fund is co-managed by Robin Parbrook and King Fuei Lee who both head teams for Schroders in Asia leveraging the local knowledge of Schroders’ extensive network of analysts in the region.

Schroder AsiaPacific Fund plc

The trust’s principal investment objective is to achieve capital growth through investment primarily in equities of companies located in the continent of Asia (excluding the Middle East and Japan), together with the Far Eastern countries bordering the Pacific Ocean, with the aim of achieving growth in excess of the MSCI All Countries Asia excluding Japan Index in Sterling terms (Benchmark Index) over the longer term.
Providing exposure to Asia’s superior long-term growth potential, the trust leverages the local knowledge of Schroders’ extensive network of analysts in the region and has been managed by Matthew Dobbs since launch in 1995.

Schroder Japan Growth Fund plc

The trust’s principal investment objective is to achieve capital growth from an actively managed portfolio principally comprising securities listed on the Japanese stock markets, with the aim of achieving growth in excess of the TSE First Section Total Return Index over the longer term.
The portfolio is managed by Andrew Rose, who has over 30 years of experience investing in Japan, supported by a long-established and highly-experienced local team of analysts.

Schroder Oriental Income Fund Limited

The trust’s investment objective is to provide a total return for investors primarily through investments in equities and equity-related investments, of companies which are based in, or which derive a significant proportion of their revenues from, the Asia Pacific region and which offer attractive yields.
The trust targets the attractive income and income growth potential provided by Asian companies. Managed by Matthew Dobbs who has been investing in Asia for 30 years, with the support of Schroders’ extensive network of analysts in the region.

Find out more at www.schroders.co.uk/invtrusts

Important Information:

For professional advisers only. This material is not suitable for retail clients.

This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Schroders has expressed its own views and opinions in this document and these may change. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.

Schroder AsiaPacific Fund plc: Investors in the emerging markets and the Far East should be aware that this involves a high degree of risk and should be seen as long term in nature. Less developed markets are generally less well regulated than the UK, they may be less liquid and may have less reliable arrangements for trading and settlement of the underlying holdings. The trust holds investments denominated in currencies other than sterling, investors should note that exchange rates may cause the value of these investments, and the income from them, to rise or fall. The trust Invests in smaller companies that may be less liquid than in larger companies and price swings may therefore be greater than investment trusts that invest in larger companies. The trust may borrow money to invest in further investments, this is known as gearing. Gearing will increase returns if the value of the investments purchased increase in value by more than the cost of borrowing, or reduce returns if they fail to do so. Investments such as warrants, participation certificates, guaranteed bonds, etc will expose the fund to the risk of the issuer of these instruments defaulting on paying the capital back to the fund.

Schroder Japan Growth Fund plc: The trust Invests in smaller companies that may be less liquid than in larger companies and price swings may therefore be greater than investment trusts that invest in larger companies. The trust will invest solely in the companies of one country or region. This can carry more risk than investments spread over a number of countries or regions. The trust holds investments denominated in currencies other than sterling, investors should note that exchange rates may cause the value of these investments, and the income from them, to rise or fall. The trust may borrow money to invest in further investments, this is known as gearing. Gearing will increase returns if the value of the investments purchased increase in value by more than the cost of borrowing, or reduce returns if they fail to do so.

Schroder Oriental Income Fund Limited: Investors in the emerging markets and the Far East should be aware that this involves a high degree of risk and should be seen as long term in nature. Less developed markets are generally less well regulated than the UK, they may be less liquid and may have less reliable arrangements for trading and settlement of the underlying holdings. The company invests in smaller companies that may be less liquid than in larger companies and price swings may therefore be greater than investment trusts, companies and funds that invest in larger companies. The company holds investments denominated in currencies other than sterling, investors should note that exchange rates may cause the value of these investments, and the income from them, to rise or fall. The company may borrow money to invest in further investments, this is known as gearing. Gearing will increase returns if the value of the investments purchased increase in value by more than the cost of borrowing, or reduce returns if they fail to do so. Investment in warrants, participation certificates, guaranteed bonds, etc will expose the fund to the risk of the issuer of these instruments defaulting. Deducting charges from capital can result in the income paid by the company being higher than would otherwise be the case and the growth in the capital sum being eroded. As a result of the fees being charged partially to capital, the distributable income of the company may be higher, but the capital value of the company may be eroded.

Asian Total Return Investment Company plc: Investors in the emerging markets and Asia should be aware that this involves a high degree of risk and should be seen as long-term in nature. Less developed markets are generally less well regulated than the UK, they may be less liquid and may have less reliable arrangements for trading and settlement of the
underlying holdings. The Company holds investments denominated in currencies other than sterling, investors should note that exchange rates may cause the value of these investments, and the income from them, to rise or fall. The Company invests in smaller companies that may be less liquid than in larger companies and price swings may therefore be greater than investment companies that invest in larger companies. The trust may borrow money to invest in further investments, this is known as gearing. Gearing will increase returns if the value of the investments purchased increase in value by more than the cost of borrowing, or reduce returns if they fail to do so. Investments such as warrants, participation certificates,
guaranteed bonds, etc. will expose the fund to the risk of the issuer of these instruments defaulting on paying the capital back to the fund. The fund uses derivatives to achieve its investment objective. The way in which derivatives are used will increase the income paid to investors and reduce volatility, but there is the potential that performance or capital value may be eroded.

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