Key highlights
• Strong NAV per share performance of the Company at 7.5% over the six months under review, considerably ahead of the MSCI AC Pacific ex Japan Index (the “Reference Index”) return of 1.9%, with a share price total return of 5.6%.
• The Company has enjoyed significant outperformance of the wider markets in recent years and this latest period builds upon that. In the three-year period to 29 February 2024, the Company’s NAV total return outperformed the Reference Index by 23.6%, testament to the fact that a skilful active management approach in Asia has the ability to deliver significant value to investors.
• Over the six-month period, we repurchased 5,670,000 shares at an average discount of 6.0%. Please be assured that we will continue to do so when we believe that it is in the best interests of shareholders.
• The Company has an 18-year track record of progressive and significant dividend growth having grown its dividend every year since launch. The Company is classed in the AIC’s next generation of dividend heroes.
• During the period under review, two interim dividends have been declared totalling 7.8 pence per share (2023: 7.6 pence per share).
CHAIRMAN’S STATEMENT
“As we approach our 20th anniversary, it is worth reflecting that, since inception, a shareholder has received a total return of 489.0%, whereas a passive investment in the Reference Index would have generated 288.5%.”
In the six month period to 29 February 2024, Asian equity markets largely ended up where they started. Our reference index, the MSCI AC Pacific ex Japan Index (the “Reference Index”), in Sterling terms, rose by a modest 1.9% over the period. Your Company performed much more strongly, the NAV total return producing a highly creditable 7.5% over the six months with the share price total return a little less at 5.6%.
The Company has enjoyed significant outperformance of the wider markets in recent years and this latest period builds upon that. In the three year period to 29 February 2024, the Company’s NAV total return outperformed the Reference Index by 23.6%, testament to the fact that a skilful active management approach in Asia has the ability to deliver significant value to investors. Of course, an active management approach can never assure consistent outperformance, but the Company has exceeded the Reference Index notably over one, three, five and 10 years, as well as since inception in 2005. Similarly, that outperformance is reflected against our peers where clear blue water lies between us and our nearest competitor. As we approach our 20th anniversary, it is worth reflecting that, since inception, a shareholder has received a total return of 489.0%, whereas a passive investment in the Reference Index would have generated 288.5%.
Asia’s performance over the six month period is in contrast to that seen across developed equity markets in North America and Europe. The relative lack of growth can be laid at the door of China: China on its own is not Asia as a whole, but it has been casting a shadow over the region in the last year or so. As outlined in the Investment Manager’s Review, sentiment towards Chinese equities is now very poor indeed, in contrast to the post-lockdown frenzy. Now, valuations are not at all demanding and are near multi-year lows. It is hard to predict when things may improve but when they do, any recovery could be swift. This would be likely to buoy the region as a whole. Our Investment Manager, having avoided significant China exposure for some years, is alert to this but they continue to believe that opportunities in other regional markets remain more compelling for the medium term, despite detailed re-analysis of individual Chinese shares. Fundamentally, we are stock pickers and do not seek to predict macro-economic trends or geopolitics. Opportunities in quality stocks with strong balance sheets, attractive dividends and good governance are easier to find elsewhere in the region. We are likely to remain underweight to China, albeit with a counterbalancing overweight to Hong Kong, which has also been under a pall.
Whatever the vagaries in the short term, our medium to long term returns will be driven by the quality of earnings from our portfolio of companies. It is in identifying these quality companies that our Investment Manager excels. Earnings from those companies is the power that drives our total return and our dividend to you, our shareholders. In the last couple of years, earnings growth has been muted in the Asian region but the cycle should turn soon as global interest rates begin to fall and the US dollar weakens, as is widely predicted. That should then be reflected in our dividend receipts because payout ratios in the region remain low, giving plenty of scope for dividend growth. The Company has an 18 year track record of progressive and significant dividend growth and, absent a catastrophe, we do not see any reason why this growth should not continue in the future. As we have grown our dividend over all those years, so too we have grown our revenue reserve. This reserve of undistributed income is important because it enables us, in a lean year, to maintain our own dividend growth. We are happy to use this “rainy day fund” for short periods, if needed, in order to give you the confidence to rely upon our dividend payments.
Despite the excellent performance and strong dividend growth, our shares continue to trade at a modest discount to NAV. This discount is all the more frustrating because it cannot reflect any discount for illiquidity which has plagued some investment trusts. Our underlying portfolio is highly liquid and there is good daily liquidity in our own shares. Rather, it seems that the position reflects poor sentiment towards the Asian region by global investors and poor sentiment towards investment trusts. Both of those factors should pass in due course and we should not be too despondent as our discount is modest in comparison to most. In the meantime, we have been doing two things. We have redoubled our efforts to spread the message of the Company’s attractions and, indeed, the Company has been recommended as an attractive investment in many national newspapers as well as specialist websites. This lays the foundations to broaden the investor base over time. Secondly, we have been happy to repurchase shares at a discount. Over the six month period, we repurchased 5,670,000 shares at an average discount of 6.0%. Please be assured that we will continue to do so when we believe that it is in the best interests of shareholders.
Finally, as noted in my last report to you, during the period, Kate Cornish-Bowden resigned as a director due to other commitments. We have commenced the recruitment process to appoint a new director and anticipate being able to make an announcement in early summer. My own tenure as a director is also drawing to a close as a part of long-term planning. I will not be standing for re-election at the Annual General Meeting in December this year, having completed nearly nine years as a director. Whilst we did not expect to lose Kate as a director when we did, good succession planning in the past has meant that, even with her departure and mine before year end, we will have a strong mix of continuity, corporate memory and new perspectives. My report to you in the autumn will be my last and I look forward to writing to you then.
INVESTMENT MANAGER’S REVIEW
The NAV per share of the Company recorded a positive total return of 7.5% over the six months to end February 2024. During the period under review, two interim dividends have been declared totalling 7.8 pence per share (2023: 7.6 pence per share).
Asian markets were volatile over the six months to end February 2024 finishing up 1.9% in Sterling terms. Although positive, this performance lagged global equity markets, which were up strongly over the period, driven by continuing disinflationary trends across major global economies, and the resultant increased confidence that developed market central banks would be moving into an interest rate-cutting cycle in 2024.
Mirroring global performance, the strongest sector in Asia over the period, by far, was IT, where stocks benefitted from the improving cycle, as well as the longer-term benefits to demand of the impact of Artificial Intelligence (“AI”). The excess inventory, which surged after economies opened-up post-Covid, has been a major overhang on IT stocks (and other goods exporters) throughout much of the last two years, as companies have had to slash prices and production to reduce inventory levels. The prospect of potentially improving end-demand as interest rates come down, alongside the hope that destocking is finally coming to an end, proved a potent catalyst for IT stocks with anything remotely AI related seeing additional gains. This helped Taiwan and Korea, the two Asian markets most exposed to the sector, outperform the Reference Index.
Australia was the only other major country which outperformed the Reference Index over the period. It benefitted from the same disinflationary trends seen in other major markets, with inflation appearing to be peaking, leading to hopes that rates can start to be cut following 13 successive hikes. Banks performed strongly against this backdrop.
The major laggard in the region was China. It has been a challenging period for Chinese stocks, as the ongoing slow recovery from Covid, lack of significant fiscal stimulus, rock-bottom consumer confidence, and international investor concerns around geopolitical and domestic regulatory risks all combined to see the market sell off once again. An announcement in December 2023 of tighter restrictions on videogames led to big falls in several index heavyweights in that sector. Although the government appeared to backtrack quite quickly following the negative market reaction, it was another reminder of the unpredictable policy environment of the last few years in China. On a more positive note, there was some relief around geopolitical tensions, with the meeting of Presidents Xi and Biden at the November 2023 APEC summit in California. Despite the handshakes, however, there is little sign of any easing of US policies towards China and, with a presidential election looming in the US later in the year, little reason to expect much on this front in the short-term.
Dividends continue to be largely driven by earnings, so for stocks in more cyclical areas such as Australian resources, or other economically-sensitive industries, where there has been some downward pressure in 2023 we have seen some cuts, but in areas such as financials, including the banks, interest rate rises have helped margins and earnings which has fed through into dividend increases in many cases. In year-on-year terms, Sterling has also generally been firmer against most currencies which has been a headwind.
Positioning and performance
The Company made a positive return over the period, with, as noted above, a NAV total return of 7.5% which was considerably better than the Reference Index return of 1.9%. Our significant underweight allocation to, and strong stock selection in, China was a major positive contributor to relative performance. Strong selection came from stocks such as Midea Group, a manufacturer of branded white goods including air conditioners, and an absence of internet platform companies that pay little or no dividend. Although our overweight to Hong Kong was a headwind, our stock selection there more than offset that, with telecom operator HKT Trust and HKT the standout performer. Positive stock selection in both Taiwan and Korea was also noteworthy, with IT companies including fabless design house MediaTek, foundry Taiwan Semiconductor Manufacturing Company (“TSMC”) and memory manufacturer Samsung Electronics all performing strongly. In Korea, increasing focus on companies that could benefit from an improvement in shareholder focus also did well, including non-life insurance company Samsung Fire and Marine. The smaller markets of Indonesia and the Philippines also made positive stock contributions through holdings such as Bank Mandiri and port operator International Container Terminal Services. Stock selection in Australia lagged, as our positive return in financials was offset by our positions in resources and telecom operator Telstra. From a sectoral perspective, stock selection in, and overweight to, IT, our underweight to consumer discretionary and stock selection in communication services all added value, as did our overweight to financials. The overweight to real estate was a drag.
The geographic exposure in the Company’s portfolio continues to be mainly spread between Taiwan, Australia, Korea, Singapore, and China. Over the period we added to positions in Australia and Korea as well as smaller markets such as Indonesia. China remains a substantial underweight but is, in part, offset by the overweight to the Hong Kong market which, in general, looks more attractive from a valuation perspective, albeit we have reduced exposure to some of the real estate names, such as Fortune REIT, which had performed relatively well. Elsewhere, we continue to like Singapore, with positions in the banks and Singapore Telecom, as well as overweights to some of the smaller markets such as Indonesia and the Philippines.
From a sectoral perspective our main additions were into some of the traditionally more defensive areas that had underperformed, such as consumer staples and health care, where we added to positions in Australia, such as supermarket operator Coles, and diagnostics company Sonic Healthcare. These were, in part, financed by reductions to banks, including the Australian names and Sumitomo Mitsui Financial Group in Japan, that had done well. We also reduced the overweight to real estate, trimming a number of names across the region. Financials and IT remain the Company’s two largest exposures, with the IT exposure predominantly coming through positions in Taiwan and Korea, where both the cycle and long term outlook remains favourable.
Investment outlook and policy
Most of 2023 and the start of this year have been disappointing for Asian markets relative to global equities, with the region lagging developed markets. Much of this performance gap was driven by a divergence in valuation multiples through the year, with China and Hong Kong in particular experiencing significant de-rating for reasons outlined above.
Geopolitics has been another concern overhanging the region, with tensions around US-China relations, Taiwan, Ukraine and most recently the Middle East all contributing to investor caution. Positively, despite having the potential to escalate cross-strait tensions, the recent Taiwanese election passed off uneventfully with a result which was broadly in line with expectations. However, later in the year, we have the US elections and there remains the potential for heightened market volatility as these approach, where rhetoric on China is likely to heat up once again after a more restrained period recently. This can already be seen by a number of bills and policies that are aimed at restricting Chinese growth and influence.
Nevertheless, there are some reasons to be a little more optimistic on the outlook for the Chinese market in 2024. Most obviously, consensus expectations are now very low, compared to the post-reopening euphoria seen in the market at the start of 2023, and this is reflected in lower valuations than a year ago. There is clearly therefore scope for better market performance, should growth surprise on the upside. Although sentiment around the property market remains very poor, activity in that industry is already subdued, and consumer confidence is again at extremely depressed levels. That is not to say that there can’t be further deterioration, of course, but a large degree of pessimism has already been priced in at this point. Given our underweight to China, we continue to look for higher-quality stocks that have sold off to levels which look attractive on a long-term view. However, the reality is that it has been hard for us to find new names that are attractive from an income perspective as many concerns remain when it comes to investing in the Chinese market – poor capital allocation, structurally lower nominal growth, unpredictable regulatory and policy shifts, high debt levels – and we remain significantly underweight the market.
We retain our preference for Hong Kong, where valuations are generally lower and shareholder returns are more of a focus for management teams. Although visitor numbers to Hong Kong have picked up significantly since the borders re-opened, the US dollar linked exchange rate system has meant that interest rates have followed the path of US rates which has depressed activity. If US rates do start to ease, the corollary for Hong Kong is expected to be that monetary conditions are likely to also improve which should be positive for the market.
Australia continues to be a market that has historically offered great long-term returns, in large part due to the reinvestment of dividends, but valuations are not obviously cheap versus the rest of the region, given its strong outperformance. Our principal exposure continues to be through the materials and financial sectors, but a de-rating of the health care sector and underperformance of consumer staples has seen us add to exposure there. More recently, the prospects of a soft landing have also seen banks perform strongly, which has led us to reduce our exposure to them. In the South-East Asian region, we are most exposed to Singapore, which is benefitting from its increasing status as a regional wealth management hub, as well as the growth of its ASEAN neighbours.
As noted above, the last 18 months or so have been tough for many Asian exporters, with excess inventories piling up in a variety of sectors whether in bicycles, textiles, power tools or semiconductors, to name a few. Of course, the demand outlook for Asian exports in 2024 remains uncertain, but the supply-side response of manufacturers, which is more under their control (i.e. cutting capital expenditure and production), has led to encouraging progress on destocking across many areas. Should expectations of a US “soft landing” come to pass, that would likely be positive for Asian goods exports, which historically has been supportive of Asian markets.
We remain overweight in IT, the best performing sector in 2023, as valuations moved higher on the back of normalising inventories, as well as the impact of AI on industry growth rates. Despite this, we view our holdings as still trading at relatively attractive valuations given the long-term growth outlook for the sector.
We also remain overweight to financials – a diverse sector spanning not only banks, but also insurers and exchange companies. The banks we own are generally well-capitalised, with strong deposit franchises. Many of our holdings are in more mature markets, such as Singapore, which in general trade at attractive valuations and decent dividend yields, but also have exposure to their faster growing hinterland. Direct exposure to faster growing markets, where credit penetration is relatively low, includes Indonesia. We also continue to be overweight Real Estate, albeit we have reduced the size of that overweight.
As mentioned, we have narrowed some of the underweights in those areas of the market typically perceived as more defensive, including consumer staples, health care and utilities. Given underperformance, relative valuations here are starting to look more interesting.
Korea has recently benefitted from an expectation that we might see an improvement in shareholder returns, similar to that which has been seen in Japan over the last few years. Korea has always looked cheap versus the region, and this in part has been due to perceived poor corporate governance and low shareholder returns. The government’s ‘Corporate Value-up’ programme is meant to improve that, and companies that could benefit from that have performed better. We do have exposure to several companies that have already started to demonstrate improvement in shareholder returns, but have increased exposure to this theme through a holding in automaker Kia.
Turning to the wider region, the dividend yield looks relatively attractive at the moment versus a global benchmark. In the medium to long term, dividends tend to follow earnings and earnings have recovered materially from the Covid lows. However, earnings growth during 2023 has faced some ongoing pressures, as has been seen in earnings revisions trends, particularly in some of the more cyclical areas (areas where earnings follow the cycles of the economy) such as amongst the energy and resource names. This year, if consensus earnings are anything to go by, earnings growth should recover which should be a positive, albeit we would caution that there is risk to these earnings numbers. Still, we believe overall payout ratios in Asia do not look extended in an absolute sense and corporates in Asia remain relatively lowly geared (a relatively low rate of debt) which should be supportive of dividends. The arguably more significant impact on dividends received comes from the performance of Sterling, which was quite strong over the past 12 months, thus impacting the progression of dividend growth.
Overall, aggregate valuations for the region are now trading at around long-term averages. However, this masks a large variation across individual markets where Singapore, China and Hong Kong, amongst others, look relatively cheap versus history. Historically, easing global interest rates and a weaker US dollar have been positive for Asia given the knock-on impact to domestic monetary conditions. Therefore, if rates do start to fall later this year, and it should be said that recent expectations have seen the timings for cuts shift further out, it could be a potential catalyst for the markets given where starting valuations are.
So in conclusion, although uncertainties remain around China’s outlook, the region’s inexpensive aggregate valuations, alongside potentially easing global interest rates, a weaker US dollar and a recovering goods export cycle does set up a more constructive backdrop for Asian markets in 2024, barring a global hard landing, or a more extreme geopolitical risk event.