Latest trust commentaryQ3 2023
Over the quarter, the fund edged lower and trailed the reference regional index. Sentiment towards Chinese stock markets remained poor as few new concrete policy measures were announced to alleviate the slowdown to the economy. Despite the fund’s significant underweight exposure to Chinese stocks, concerns around China also weighed on some of our Hong Kong holdings, including regional life insurer, AIA, which faced selling pressure from international money managers as a proxy for sluggish Chinese consumption despite delivering healthy business growth since the reopening of China.
Outside of Hong Kong, market concerns around softer macro prints saw our consumption-related names detract from performance. In Taiwan, bicycle maker, Merida, edged lower due to slowing bike demand in Europe and a longer inventory cycle for the bike maker. Macau’s casino operator, Las Vegas Sands, traded lower given negative speculations on a clampdown on unauthorised money changing activities in Macau. Meanwhile, French luxury group, LVMH, lagged on deceleration in tourist spending in the US and Europe, while a toned-down guidance in recent results across most luxury brands also impaired the near-term outlook on the industry.
On the positive side, the fund’s select financial holdings across the region registered robust returns given solid results delivery. These included Bank Mandiri in Indonesia, where the bank posted strong YTD results underpinned by a solid ROE amid consistent improvement in both credit costs and operating costs. Singaporean bank, DBS, also performed well as net interest margins (NIMs) are likely to remain at healthy levels for longer given the robust economic and inflation backdrop in the US, which also keeps further monetary tightening and higher rates a possibility.
In China, education service provider, New Oriental Education, saw strong share price rally as near-term regulatory risks appear to have dissipated, while the company gained stronger business momentum in its overseas test prep and its new education businesses. India also registered positive performance on the back of resilient macro over the quarter. Share price of our position in MakeMyTrip, an online travel platform, rose on better-than-expected 1QFY24 profitability, driven by its improving competitive position and lower promotion spend as competition eased in the industry.
In terms of capital protection, we added to our position some Korean puts given readings from our short-term tactical models, which flagged some risks and complacency in the market. Capital protection from the put options has kicked in over the quarter to help offset some market drag as the Korean market cooled after the retail market fervour in July.
Asian equities had another disappointing quarter in Q3, despite a stronger start to the quarter as the market cheered the announcement post the Chinese Politburo meeting that further measures will be introduced to stimulate consumption, stabilise the property market, help local governments, and encourage private investment. However, subsequent sentiment towards Chinese stock markets turned negative again as few new concrete policy measures were announced to alleviate the economic slowdown in the country. The Chinese property market also remained weak and the slow-moving car crash in the listed-property sector continues, whether this leads to wider financial sector problems we believe remains a material risk. Geo-politics continued to rumble on in the background with repeated mainland Chinese incursions into Taiwanese airspace and the attempted erection by China of barriers in waters recognised as belonging to the Philippines by international committees.
With the difficult macro backdrop and ongoing structural challenges facing China, which had been discussed at length in our previous comments, it is perhaps worth taking a closer look at the next biggest economy in Asia – India, to assess how the economy has developed over the years and see how real the much vaunted / hyped China-plus-one investment boom was (i.e., factory relocation from China to India), and whether it makes the current Indian stock market attractive.
Towards the end of Q3 we had our first trip to India since we were last there four years ago, where we met with a range of companies in both Mumbai and Chennai. Post the trip we left relatively positive on the economic outlook. On the ground, whilst we didn’t notice too much physical difference in terms of infrastructure there was clearly a large amount of chaotic construction going on in both cities we visited. In general, our meetings with management and analysts were all fairly upbeat with most feeling positive on the outlook, though quite a few corporates flagged that current demand remained sluggish especially in rural areas given high oil and food prices and a patchy monsoon.
On social infrastructure, increased digitisation in India in recent years has raised the potential growth rate by bringing huge numbers into the formal economy, thus enabling better credit growth, tax collection and disbursement of government benefit schemes. This combined with better road, rail and telecom infrastructure has indeed raised India’s potential growth rate. Meanwhile, key areas such as education (very poor for lower income segments), local infrastructure, red tape, logistics and supply chains remain issues. If we draw a comparison with Vietnam, which we visited at the end of last year, India on a relatively basis still feels some way behind in terms of efficiency or ease of doing business especially as a manufacturing hub.
During our trip to Chennai, we visited several factories and met management teams to discuss the outlook and challenges of manufacturing in India. We came away with a feeling that from a low base Indian manufacturing should grow but that significant challenges remain in terms of local supply chains, logistics, red tape, and infrastructure. With labour costs a small portion of most manufacturing activities it feels like growth here is a long multi-year gradual story not a sudden surge. For listed players in both the manufacturing space and related capital expenditure areas we think the risk is of disappointment given the hype and low valued added nature of the many of these manufacturing activities currently taking place in India.
Outside of manufacturing, we have also met with several Indian consumer staple companies during our trip to Mumbai. Most of the companies we saw have been struggling at the top line (revenue) level as weak rural consumption has led to disappointing growth. This has been a feature of these stocks for some time. All companies we saw though continue to guide for a hoped-for material pick up in top line growth rates. This has been the same story we have heard for the last five years, so we have our doubts. For the first time we had two of the consumer staple stock admitting that their categories (soaps, toothpaste) were well penetrated even in rural areas, so the focus now was to compete in new categories. We suspect the consumer space is about to become more competitive as competition heats up and, as modern trade takes off, margins may start to be squeezed.
Meanwhile, sectors that we remain more comfortable with include the healthcare (hospitals) and some parts of financial names. For the private-run hospital operators, while valuations are indeed high, they are trading at a slight discount to many of the consumer stocks in India. While we had some concerns about the amount of capital going into the hospitals industry, for the better, larger existing operators, we believe the runway to growth remains positive given substantial under-provision, rising obesity levels / aging population and rapidly rising private insurance healthcare provision. For the well-known established operators, we therefore continue to take the long-term view despite optically high valuations and recent strong share price performance. We are also looking to do more follow-up work on several smaller names in this area.
Financials, on the other hand, felt a bit more mixed. Long-term, we continue to favor large India private sector banks such as HDFC Bank and ICICI Bank. While share price of HDFC Bank has lagged the Indian market year-to-date over worries of its merger with associated housing finance company HDFC, longer-term we expect these banks to perform well as we believe their franchises remain structurally high return given their funding advantages (low-cost deposits) and better efficiency (IT systems, people) especially versus public sector peers. Where we felt more cautious are NBFCs (non-bank financials) where we have seen sharp share price rally over the past six months, despite large rights issues announced by companies like Bajaj Finance. While this is obviously short-term dilutive to share price and appears opportunistic given its already high capital ratio, these red flags did not seem to concern most retail investors who continued to bid up share prices on hopes that these earnings dilution could make the stock more attractive by pushing down P/B ratios.
Meanwhile, with the widening digitisation efforts and a functioning central credit database, India is now seeing much more aggressive loan growth in parts of the consumer sector, especially in the unsecured consumer lending space and credit card loan extension. This is starting to make us worry as the aggressive loan growth are now moving into the lower income segments which could lead to rising defaults and other asset quality problems down the line. Overall, we are less concerned about the large private sector banks which tend to target different segments, but we are increasingly worried that some of the monoline NBFCs (e.g., gold lenders, motorcycles, credit cards) will start to face rising risks of defaults. Our past experience in Asia (South Korea, Thailand, Indonesia) of unsecured consumer lending booms would also suggest caution is warranted.
Overall, post the trip we came away relatively upbeat on the India economy, but more cautious on the stock market. The much-vaunted China-plus-one manufacturing relocation to India looks overhyped in the near term and the companies we visited showed that many of the manufacturing shifts were very much in the low value-added segment. We would also caution that significant build-up of capacity in India could lead to further global overcapacity in certain industries as countries everywhere try to enforce localisation policies. This left us increasingly cautious on many manufacturing sectors in India and rest of the region. Other sectors in India such as consumer names and non-bank financials look materially overvalued and vulnerable to disappointment. Meanwhile, we remain comfortable holding our large private sector banks, selected IT, and healthcare names. Overall, we feel much of the good news on the macroeconomic front is now reflected in stock market valuations, which are now trading at very elevated levels both versus its own history and other markets.
Looking at the broader region, the recent weakness in markets has seen value starting to emerge in pockets of the equity market. We see selective opportunities in developed Asia where valuations / dividend yields look attractive for well-run companies with strong governance. We continue to like technology leaders in Taiwan and Korea which despite the cyclical weakness remain key beneficiaries of the strong secular growth dynamics from increased semiconductor usage. We can also find good opportunities in India and Asean where despite the more demanding valuations we hold select domestic businesses and financials that are of high-quality and offer upside to our analysts’ fair values.
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