Improved performance trends observed last quarter endured into 2021 as investors continue to position for a synchronised global recovery from COVID-19. Although absolute returns were more modest over the quarter, the return for the market remain very respectable over the rolling 12 months at 58.6%. The market has gained 78.9% from its COVID-19 induced low point on March 23 last year.
As profiled in the review and strategy section, the key issues confronting markets in recent months have centred on the pace of inoculations across the globe and the impact record stimulus (particularly in the major developed economies) are having on interest rates. The bellwether 10-year US Treasury note suffered its worst quarter in over four decades, with yields rising from 0.9% to 1.7% as at the end of March. Along with solid gains across much of the commodity complex, such reflationary signals continue to be positive for value strategies such as ours. Whilst such a reversal in sentiment is a most welcome development from the conditions confronting the portfolio barely a year ago, it remains our strong conviction that the current rotation towards value remains in its infancy.
Across the region returns were again disparate with Taiwan (+10.9%), Singapore (+8.9%) and Hong Kong (+7.3%) the best performing markets in USD terms. Taiwan extended its sharp outperformance over the rest of the region benefiting from its impressive management of COVID-19 and a swift economic recovery. Taiwan is also benefiting greatly from the record demand for semiconductors with the rise of 5G, high performance computing and electric vehicles as well as taking on greater strategic importance given the ongoing tension between China and the United States. Meanwhile, the Philippines (-10.6%), New Zealand (-10.6%) and Indonesia (-7.6%) were notable laggards, principally on account of renewed COVID-19 outbreaks and potential vulnerabilities to higher dollar cost funding.
On a sector basis, cyclical sectors remained among the best performing. Financials (+6.2%), Communication Services (+6.0%) and Industrials (+5.7%) outperformed (in USD terms), while Health Care (-4.6%), Consumer Staples (-3.0%) and Consumer Discretionary (-3.0%) were the weakest.
At a stock level, notable contributors included State Bank of India, China BlueChemical and Incitec Pivot. Banks performed strongly across most markets as they continue to regain the significant losses incurred last year. The Indian banking sector has staged a sharp recovery benefiting from robust margins and a better than expected experience in terms of asset quality. Although vulnerabilities towards the sector remain, State Bank of India remains an attractive investment on account of its resilient market share, improved management discipline and overly penal discount to its private sector peers.
The key detractors to performance were Ace Hardware, Tencent Holdings, Beijing Capital International Airport (BCIA). Ace Hardware is the leading home improvement and lifestyle retailer in Indonesia. It fell during the quarter as a number of stores were impacted by mall closures by authorities as they seek to control the spreak of COVID-19. BCIA reported a weak set of results in the quarter and did not pay a dividend. Although domestic air traffic is recovering rapidly, BCIA has more operational leverage to international traffic (and duty-free shopping). Longer term we continue to believe this will return and the company is well placed to ride out the current period of uncertainty.
Our Asia Pacific ex-Japan strategy’(1) largest active sector positions are overweight Financials (+4.8%), Energy (+4.8%) and Industrials (+3.4%), while underweight Consumer Discretionary (-5.8%), Information Technology (-4.6%) and Health Care (-3.6%). On a country basis, the fund remains overweight Hong Kong (+3.8%), Philippines (+2.5%) and South Korea (+1.8%) while key underweights are Taiwan (-6.7%), China (-2.9%) and Australia (-1.7%)
(1) Maple-Brown Abbott representative account.
The stocks that made the largest contribution (positive and negative) during the quarter to the strategy’s return relative to the Benchmark are shown below.
|Best contributing stocks||%||Worst contributing stocks||%|
|State Bank of India (overweight)||0.60||Ace Hardware Indonesia (overweight)||-0.26|
|China BlueChemical - H Share (overweight)||0.45||Tencent Holdings (underweight)||-0.19|
|Incitec Pivot (overweight)||0.42||Beijing Capital Int'l Airport - H Share (overweight)||-0.18|
|Kerry Logistics Network (overweight)||0.38||McMillan Shakespeare (overweight)||-0.15|
|Kunlun Energy (overweight)||0.31||Globe Telecom (overweight)||-0.15|
The main purchases and sales in the Portfolio during the quarter were as follows:
|Alumina||Samsung Electronics Co Pref GDR|
|Shinhan Financial Group||Samsung Electronics Co GDR|
|Want Want China Holdings||Taiwan Semiconductor Manufact. Co ADR|
|Ping An Insurance - H Share||Baidu ADR|
Commentary on selected portfolio
- WH Group is the largest pork producer in both the US (Smithfield) and China (Shuanghui). The integrated global nature of its operations from hog farming to packaged meats across two countries enables the company to mitigate rising prices, while its consumer-packaged meats business accounts for 90% of operating profits. The China business has been performing well, with packaged meats achieving record profit per unit in 2020. Profitability is expected to remain high as hog supply recovers from the African Swine Fever epidemic, keeping input costs at low levels. Meanwhile the US business was heavily impacted by COVID-19 in 2020, with a significant turnaround expected in 2021. Yet at present this opportunity is not reflected in the current share price. WH Group’s 73% stake in its A-share listed subsidiary Shuanghui is currently worth more than its entire market cap, implying a value of negative value of ~$3.0bn for the US business Smithfield. While the US business suffered last year, it has been profitable at an EBIT level every year since its acquisition by WH Group in 2013. The stock is attractively valued at 10.0x 2021 P/E, with a 6.0% forward dividend yield supported by 8.0%-9.0% FCF yield.
- Kunlun Energy is the dedicated downstream natural gas arm of PetroChina (~58% direct stake), consisting of the development and operation of city gas projects as well as LNG terminals. It recently disposed of its stake in a large gas pipeline asset and is due to receive ~CNY 37B in cash, 50% of which was committed to special dividends payable in 2020 (amounting to ~31% of its current market cap). Adjusting for this payment, its continuing operations trade at an unjustifiable discount to its pure play city gas operator peers. Going forward Kunlun are making further investments in city gas projects, a sector with favourable economics and a strong growth outlook. Natural gas will remain a fast growing and critical energy source as China seeks to meet its carbon neutrality pledges by 2060.
- Ping An is a leading Chinese life insurer and wealth management platform. China’s long-term life insurance outlook remains attractive in light of rising family wealth, greater demand for protection policies and aging population. Our analysis indicates Ping An is the best quality Chinese life insurer given its management and strategy, as well as its low liability cost and consistently high asset investment yield. It has been in the vanguard of China’s life insurance industry’s efforts to digitise its operations and has also invested in a number of technology ecosystems that centre on finance and health including Lufax, OneConnect and Ping An Health which enhance its core business. Additionally, its diversification into general insurance, bank and wealth management offer customers a one-stop wealth solution. Ping An’s share price has been under pressure since 2019 as growth slowed due to its agency channel reform and COVID-19 disruption. Much of this restructuring is now complete yet valuations have compressed such that the company now trades on 0.9× Price/Embedded Value, making the current risk-to-reward proposition attractive..
Analysis of portfolio
The value and balance sheet strength characteristics of the portfolio compared to the market overall at 31 March 2021 are as follows:
|Price:Cash Flow ratio||7.3||12.2|
|Price:Net Tangible Assets ratio||1.3||2.2|
|Dividend yield (% p.a.)||3.3||2.2|
|Balance sheet strength (Cash Flow/Total Liabilities)||0.49||0.43|
* Represents our quantitative data which includes 91.7% of the index weight of the stocks in the Benchmark, plus non-Benchmark stocks.
The figures are based on estimates for the next twelve months which include assumptions that may not hold true. Actual outcomes may vary in a materially positive or negative manner. Source: Data from Maple-Brown Abbott Ltd, UBS, Macquarie.
The asset allocation of the portfolio is:
|Asia Pacific Equities||99|
Country and sector weightings
The country and sector weightings (%) in the strategy are as follows:
Review and strategy
The MSCI AC World Index gained 4.6% in USD terms over the March quarter with major equity markets supported by resilient corporate earnings. The US, Japanese and UK markets gained 5.4%, 8.7% and 5.2%, respectively, in local currency terms, while China finished the quarter in line with December 2020. Bond markets softened amid expectations of strengthening inflation.
Global industrial production recovers from the depth of the pandemic, supporting elevated commodity prices
The International Monetary Fund (IMF) revised its 2021 world output growth projection to 5.5%, an increase of 0.3%, reflecting benefits from the vaccine rollout and additional policy support in the US and Japan. The growth rate of -3.5% for 2020 was revised upwards by 0.9%, assisted by a recovery in global industrial production. Stronger economic conditions were reported in the second half of the year across countries such as the US, Japan, India, Australia and Korea. The outlook remains uncertain with renewed lockdowns and virus mutations impacting various regions across the world.
US momentum continued with GDP(2) increasing by 4.3%. Exports, fixed investment and consumption were key growth drivers, while government expenditure fell by 1.2%. Personal savings remained high at 13.4%. President Joe Biden announced a $1.9 trillion COVID relief package consisting of individual cash payments, extended jobless benefits, local government support, business support and spending on health and education. At the end of the quarter, the president also detailed a potential $2 trillion plan to rejuvenate public infrastructure funded by an increase in corporate taxes. While inflationary pressures may increase from such significant stimulus packages, a sustained reduction in unemployment is a necessary precursor to material wage inflation. The Federal Reserve kept rates unchanged during the quarter and expects rates to remain close to zero during the next two years.
Economic activity across Europe was impacted by lockdown measures following renewed virus outbreaks. GDP grew by just 1.3% in the UK and 0.3% in Germany, while France declined by -1.4%. Business investment and net exports remained strong in France, yet a reduction in consumer spending by 5.4% hampered the economy. Despite holding two consecutive quarters of growth, GDP in the UK remains nearly 8% below 2019 levels. The Bank of England kept policy rates unchanged during the quarter. While monetary policy expectations do not foresee the need for negative interest rates, the Bank of England announced the intention of adding negative interest rates to its ‘policy toolkit’ (giving the banking system six months to update IT systems to cater for sub-zero interest rates). Meanwhile, the European Central Bank signalled an increase to its asset purchasing program for the coming quarter and highlighted that monetary policy will remain restrained in light of inflation volatility.
Conditions in China remained steady with GDP growth of 2.6%. Government stimulus and export growth continued to drive strong levels of industrial production, in turn supporting elevated commodity prices. However, consumption per capita was weak, falling 4.0% during 2020. Growth in Japan remained strong with GDP increasing by 2.8%, almost returning to pre-COVID levels. Government handouts and employment protection subsidies helped to keep unemployment low and consumer confidence robust. Economic activity in India also approached pre-pandemic levels with strong GDP growth of 7.9%. Private sector and manufacturing strength helped to offset some weakness in public administration spending.
GDP growth in Australia remained resilient, increasing by 3.1%. Household spending grew by 4.3% and favourable weather conditions led to a 27% increase in agricultural production values. Employment rebounded to around half a percent shy of pre-COVID levels, with the Reserve Bank of Australia (RBA) anticipating limited negative impact from the end of the ‘Job Keeper’ program in March. The RBA completed just over two-thirds of its initial $100b asset purchase program with another $100b to be purchased from mid-April. Weak net population migration is expected to provide headwinds for construction and the economy in coming years. The RBA noted unemployment would need to be materially lower than current rates to result in wage growth above 3% and, in turn, sustainable inflation in the targeted 2-3% range. Based on this outlook, the RBA reaffirmed the current 0.1% cash rate target was likely to be in place until 2024.
(2) GDP data is based on December quarter-on-quarter growth rates.
Asia Pacific equities
Value style responding well to these ‘interesting times’
May you live in interesting times ... This old saying may have been meant as a curse, but even though its true meaning and origins are hazy, it certainly captures the mood of the current times. Across the globe, ultra-loose financial conditions coupled with a sharp increase in risk appetite have created bubble-like conditions across a range of asset classes and markets. From the inexorable rise of Bitcoin, whose market value now exceeds that of the entire Hong Kong equity market, to the parabolic jump in retail trading activity fuelled by equally record levels of leverage and co-ordination via online social platforms, or the surge in Special Purpose Acquisition Companies (SPAC) or ‘blank cheque’ companies coming to market, we are indeed living in interesting times(3). Perhaps it will be the US$69m paid (reportedly in Bitcoin) for a JPEG file of digital images created by the US artist known as Beeple that will mark the ‘peak’ of easy money in this cycle. Amid all this, from a portfolio perspective, relative performance trends continued to improve in line with the change in sentiment observed towards value and cyclical stocks aligned to a post-COVID recovery
(3) According to FT data, the value of SPAC deals announced in q1 was $172bn in the US alone. Financial Times, April 1, 2021.
May you live interesting times ...
A year after the world entered its COVID-19 induced stupor, there are encouraging signs the worst is well behind us from both a humanitarian and economic perspective. It is easy to forget that barely 12 months ago the world was in the grip of panic and confronting the worst economic dislocation in the post war period. From its January peak to the lows reached in March last year, the MSCI AC Asia Pacific ex-Japan benchmark declined 32% (in USD), a familiar pattern to that observed elsewhere in the globe, representing one of the sharpest and most pronounced drawdowns in history (4). Following such a collapse, markets did what they normally do at the confluence of peak uncertainty, they rallied. While most markets have given up some ground in recent weeks drifting off record highs set in February, the Asia Pacific ex-Japan region has gained some 79% from its COVID lows of March last year, broadly in line with the rest of the world.
Although at a headline level the market return over the March quarter was quite modest at 2.7% (in USD), such returns belie the significant rotation underway since November last year following the positive COVID-19 vaccine announcements. In what was tantamount to a complete reversal of the trends witnessed in the first six months of last year (reflecting the peak COVID drawdowns), the last two quarters have seen the portfolio recapture much of the “lost alpha” experienced over that period as investors sought stocks aligned to reflation of the regional and global economies.
(4)Refers to MSCI AC Asia ex-Japan (net) between January 17 and March 23.
What a difference a vaccine makes
Major stock contributors / detractors
|Key Detractors - 6 months to June 2020||Key Contributors – 6 months to March 2021|
|Negative Contribution||Absolute* %||Relative^ %||Positive Contribution||Absolute* %||Relative^ %|
|State Bank of India||-49||-1.4||Alibaba (not held)||-23||+3.1|
|Tencent Holdings (underweight)||+34||-1.2||State Bank of India||+98||+1.1|
|Standard Chartered||-41||-1.0||Baidu ADR||+72||+1.0|
|Incitec Pivot||-42||-0.8||Samsung Electronics||+48||+0.7|
|Siam Commercial Bank||-39||-0.8||Haier Electronics Group (sold)||+52||+0.7|
|Beijing Capital Int'l Airport - H Share||-33||-0.8||Siam Commercial Bank||+74||+0.6|
|CK Hutchison Holdings||-30||-0.7||Apollo Tyres||+73||+0.5|
|PICC Property & Casualty - H Share||-27||-0.7||Kunlun Energy||+60||+0.5|
|China Resources Pharmaceutical Gp||-36||-0.6||Standard Chartered||+57||+0.5|
|Beijing Enterprises Holdings||-27||-0.6||Kerry Logistics Network||+68||+0.5|
|Contribution of key detractors %||-8.6||Contribution of key contributors %||+9.2|
|Relative portfolio performance %||-14.2||Relative portfolio performance %||+11.9|
*Stock absolute return in USD
^Stock contribution to the portfolio on relative basis
We have profiled in numerous previous reports just how dislocated valuation spreads within the market had become relative to their historical norms. As highlighted in our December report, the 12m forward PE premium between quality growth and value cohorts was approaching three standard deviations from its long-term average, a level not observed since the TMT bubble of 2000.
A notable catalyst supporting the rotation towards value and cyclicals more generally has been growing confidence that economies across Asia Pacific and indeed the world are on the path to recovery as populations are inoculated for COVID and life progressively returns to ‘normal’. The continued record fiscal and monetary stimulus applied by governments and central banks across the globe and their resultant impact on interest rates and inflationary expectations is also underpinning the rotation. While Asia Pacific has proven relatively austere in this regard, region is far from immune from this dynamic given its critical US dollar linkage and the concomitant impact such stimulus has had on inflationary expectations and bond yields, particularly the all-important US 10-year Treasury bond. For many years, the common riposte heard from growth investors was that lower interest rates justified higher multiples on account of their compressing the cost of equity applied to discounted future cash flows. This long-standing narrative is being increasingly challenged by markets and came under close scrutiny during the quarter as the yield on US 10-year Treasury bonds (the global risk-free proxy) almost doubled from 0.9% to 1.75% making it the worst quarter for the securities since 1980.
Such a short-term move is indeed significant, but it is worth remembering this type of move only leaves bond yields at the same level they were barely a year ago in January 2020, suggesting the ‘normalisation’ of interest rates potentially has a long way to go. In a role reversal to the post-GFC narrative, it is now the central banks led by the US Federal Reserve who are sanguine on the prospects for rising inflation, flagging no intention to adjust interest rates before at least 2023. This potentially sets the scene for further market gyrations should they be forced to ‘catch up’ with market expectations. As measured by the 10-Year Breakeven Inflation Rate shown below, the implied outlook for US inflation is now at its highest level in over five years.
The Market vs the Fed
It may be the view of major central banks to remain dovish on interest rates, but it is not necessarily the view of all central bankers. Recent papers from the Bank of England and Hong Kong Monetary Authority are just two examples of research highlighting the significant dispersion in potential outcomes from current policy settings(5). With additional cost burdens emanating from recent rises in commodity prices and various supply chain dislocations, it would suggest exercising caution with regards to the scope for inflationary pressures and interest rates to rise further. Such a scenario would obviously bode well for value strategies such as ours.
While ultra-aggressive policy reaction may be de rigueur among the major developed economies such as the US, Europe, Australia and Japan, the same cannot be said for all of Asia Pacific. Indeed, China surprised many during the quarter when Premier Li Keqiang outlined a relatively ‘modest’ GDP target of above 6% for this year (well below the IMF’s forecast) and failed to provide a specific GDP growth target as has been the custom in outlining its latest five-year plan to 2025. Cognisant of its already high debt burden, Chinese authorities appear to be taking a more conservative approach in following more ‘orthodox’ policies of managing its economy. China’s plan to reach the status of a ‘moderately developed nation’ by 2035 does invoke a reasonably ambitious growth target, however, implying GDP per capita would need to double over that period from its current level around US$11,000. We must not lose sight of the long-term opportunities in Asia Pacific, a region that within the next decade is expected to be home to two-thirds of the world’s middle-class population.
(5) A Tiger by the Tail?, Andy Haldane Band of England Chief Economist 26 February 2021. An Assessment of Inflation-At-Risk in the US, Hong Kong Monetary Authority, Research Memorandum 4 February 2021.
Chinese GDP per capita (USD)
In addition to a range of measures aimed at furthering the development of domestic consumption, China also announced a plan to target carbon neutrality by 2060 and to reach peak consumption by 2030. We continue to see a number of investment opportunities aligned to China’s maturing economic profile and have used its recent underperformance to add to several such holdings.
With the reporting season across Asia Pacific recently concluded, it is increasingly clear that but for a few sectors namely in the travel and hospitality sectors, conditions are showing clear signs of improvement. Based on reported data, earnings per share for Asia Pacific declined a relatively modest 6% over the year to December and are forecast to grow 31% in the current year and 14% in 2022, leaving the market on 15 times next year’s earnings. Although market multiples can no longer be considered ‘cheap’, our portfolios continue to trade at a deeper discount to the market recognising the bifurcation that persists between the perceived high growth stocks (including many loss-making companies) and the broader market, especially among the value cohort. On that basis, we continue to see meaningful upside from our current portfolio at current levels.
In conclusion, it is pleasing to be able to report on a more prospective period for the strategy. Value as a style has responded positively to the improving prospects for the global economy. This is a good start, but if history is a guide, then the normalisation of valuation multiples has a long way to go. In cricket parlance, we are still in the first session on the first day of a five-day test match.
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