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Performance Review

Asian equities gained in the first quarter despite an initial challenging start to the year.  The rate cut outlook has lent support to the AI-fuelled rally in Taiwan and Korea, while the robust holiday spending in China during the week-long Lunar New Year holiday, and accommodative monetary policies by the PBoC supported sentiment.  Against such backdrop, the fund posted gains over the period and outperformed the reference regional index.

Our large underweight in China continued to add to relative performance over the quarter. Investor sentiment failed to improve given the deteriorating property market which continues to undermine consumer confidence.  Some of China’s largest developers such as Country Garden and China Vanke are teetering on the brink of default or in some case bankruptcy.  In terms of stock selection, our decision to steer clear of major ecommerce players in China also shielded the fund from their share price declines. In particular, share price of PDD saw a 20% decline as investors are increasingly concerned about US-China tensions ahead of US elections and the potential impact it could have on its US business, which has been a key growth driver for the company of late.

Another key area of contribution was our core positions in select technology leaders in Taiwan, including TSMC and Mediatek, which registered strong returns on the solid growth outlook for the semiconductor sector in 2024, driven by robust AI demand where demand for advanced chips should drive continuous margin expansion over the coming years.  Asean was another key contributor.  Philippines-based port operator ICTSI continues to see share price move higher on the back of improving sentiment around global trade and its strong earnings delivery.  Indonesia’s Bank Mandiri was another top contributor thanks to the improving domestic macro and removal of election uncertainty following the completion of general election in February.

Conversely, a number of our financial holdings detracted during the period. In India, HDFC Bank was among the top detractors after it reported weaker than expected margins.  However, we believe this is a near-term issue and margins are likely to bottom and start to improve from here as the expensive wholesale liabilities get replaced by cheaper retail liabilities over time.  Regional insurer, AIA, was another detractor as investors remain wary of macro headwinds in Hong Kong and China.  Outside of financials, our position in Australian mining company, Rio Tinto, saw share price decline on the back softening iron ore demand from China given the weak macro.

In terms of capital protection, our short-term model reading was in the neutral / slight positive range at the start of the year.  We have therefore let most of our put options expire during the period, leading to a marginal negative impact on performance during the period.

Strategy Outlook

After a difficult start to the year, broader Asian equity indices have continued to rebound and were modestly higher in the first quarter, tracking gains in broader global equities. Expectations for US monetary policy continue to ebb and flow with incoming data.  Since the beginning of 2024, Fed fund futures have moved from pricing in six quarter-point interest-rate cuts this year to only three currently, with the first cuts now not expected until June.  Despite this more hawkish rate outlook, sentiment towards equity markets remains benign as investors continue to discount a soft landing for the US economy.  Equity markets have also been buoyed by continued optimism around the AI theme globally, with bellwether stock Nvidia seeing a very strong rally as it unveiled its latest generation of processor chips; the shares are now up about 80% year to date.

This ‘goldilocks’ US economic scenario – growth not too hot, or too cold – and the momentum behind large-cap technology stocks are a favourable backdrop for Asian markets. Taiwan and Korea were the strongest regional markets over the quarter, benefiting from their heavy exposure to semiconductor stocks which are key beneficiaries of the accelerating rollout of AI server infrastructure globally.  Worryingly the A.I. hype has now led to bubble like conditions forming for some of the small and mid-cap names in Taiwan, with retail investors chasing baskets of supposed A.I. plays regardless of whether there is a genuine basis to the underlying claims.   At this point we are not chasing supposed A.I. beneficiaries in the technology sector.

Meanwhile sentiment around China remains challenging with the onshore market trading broadly sideways, while Hong Kong ended the quarter as the weakest market in the region following the passing of the controversial Article 23 into law which some investors fear may lead to a reduced role of Hong Kong as a global center for business over time.

One significant policy event that took place in China over the quarter was the annual meeting of China parliament, the National People’s Congress (NPC).  This is normally a rather dull rubber stamp affair that we pay little attention to however this year we did think there was some noteworthy “highlights”.   With parts of the Chinese domestic economy in huge difficulty most obviously the property sector where even well-connected blue-chip developers like China Vanke are close to default, we were waiting to see if there would be any policy pivots away from the supply side (i.e. investment driven growth) to instead focus on the demand side of the economy (i.e. how to boost consumption).

Following pronouncements from the meeting, it would be fair to say we saw no evidence of policy pivots.  Instead, the focus was on more investment in “new productive forces” – effectively the same “Made in China 2025” policy of huge state directed investment in industries considered strategic, such as semiconductors, green energy, high-tech manufacturing, electric vehicles, bio-technology, A.I. etc., etc.  The renewed policy focus on the supply / investment side will likely lead to further overcapacity across a wide range of industries and exacerbate the deflationary forces in China where PPI is already running at negative levels and CPI barely positive.  This, alongside worries over US-China geopolitics in a US election year, leaves us increasingly cautious on the long-term outlook for Chinese equities.   If the policy focus is to remain overwhelmingly on investment and the supply side of the economy (as directed by the state), then this increases our conviction to limit our China exposure to a few sectors that are out with the direct remits of state policy, and this appears to be an increasingly narrow investment universe.

Meanwhile, our recent research trip to Australia proved to be a fruitful one.  We caught up with over 20 companies across a wide range of industries and made several plant/site tours, and we came away with increased conviction that this is a market full of genuinely good companies - whether it be healthcare, services, staples, materials, financials, etc., and yet the market is often overlooked and rarely discussed by Asian investors.

We find that many of the companies in Australia are operating as quasi-oligopolies given the relatively remote location of Australia in the region and small (lish) size of its economy, but these companies are by no mean lazy ones.  Instead, many of these companies are competitive ones e.g. Woolworths and Coles who compete aggressively on the quality of offering, REA and Domain a duopoly in real estate listings, the big 4 banks, RIO and BHP.   All of these are well run businesses operating in a rational, competitive market.  This means the Australian stockmarket tends to exhibit a relatively stable return on equity one that is comfortably above the cost of equity, which of course tends to mean good long-term stockmarket returns.

One key reason Australian companies are good investments is capital has a cost (interest rates at 5%), management is professional and often brutally held to account by the market and press, and dividend franking credits mean companies are properly focused on Return on Invested Capital (i.e. whether to pay dividends or undertake new investments).  Australia also has good infrastructure, a mostly pleasant climate, sensible politics, a working healthcare and schools’ system.  Australia (Melbourne and Sydney at least) feels young and dynamic versus many other places in Asia where aging demographics is likely to be an increasing drag on the economy.  Lots of skilled people, clustering together means you do find companies with genuine intellectual property in areas of technology and healthcare.  This is a vibrant place – one of best combination of skills and demographics in Asia.

We are also seeing lots of industry disruption going on in Australia – technology (whether AI hyped or not) is bringing new applications and opportunities.  This is in the on-line space e.g. for REA, Domain in the real estate sector, in healthcare where Cochlear, Resmed, Sonic see technology expanding their addressable markets or industrials where companies like Brambles and Orica can use technology to cut costs whilst providing better services to customers.  Most companies were increasing R&D and tech spend (AI a big focus).  Overall, we came away positive post our research trip and we would look to add to our Australia exposure on market pull backs.   There are good reasons why Australia has been one of best performing stockmarkets in Asia on a Total Return basis and we would expect it to continue to be so.   

Elsewhere in the region, while Korea and Taiwan have seen a relatively strong run in the technology sectors, the two markets still look reasonable given it is relatively early in the tech cycle.  Outlook for India and some of the ASEAN stock markets, which are more domestically focused, still looks quite promising given the improving macroeconomic backdrop (albeit valuations increasingly reflect this in India).  The key for investors in Asia remains to take long-term views, look through the noise, and to focus on likely long-term trends in return on invested capital (ROIC).  This also underscores our long-held belief that a true active approach focusing on the best bottom-up ideas with strong long-term fundamentals and attractive valuations remains the optimal strategy for investing in the region.

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. 

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 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. 

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 Company 

The fund can use derivatives to protect the capital value of the portfolio and reduce volatility, or for efficient portfolio management.