Edinburgh Dragon Trust has announced its final results for the year ended 31 August 2015. During the year the trust’s NAV fell 12.4%, in total return terms, underperforming its MSCI All Country Asia (ex Japan) benchmark which fell 9.1% (all in sterling terms). During the period, the share price fell by 12.8% to 235.8p, as the discount widened marginally, from 11.3% to 11.8% at 31 August 2015. The trusts underweight exposure to China was among the biggest detractors from performance. The Chinese market outperformed other regional markets during the period with initial gains exceeding the losses from the late sell-off. The trust’s manager has been selective about investing in China because of what he sees as a dearth of quality companies as well as the impact of heavy state intervention. The board also believe that the manager`s focus on quality ‘lends itself to an innately defensive portfolio which tends to outperform in times of market weakness’.
Stock selection was not the primary cause of underperformance. However, in terms of individual names, Standard Chartered was the most notable underperformer, given its emerging-market exposure. As profits came under pressure, it undertook a major restructuring that included senior-level management changes. The market responded positively but the recovery in the share price was insufficient to offset earlier losses. The manager remains confident of Standard Chartered’s prospects, citing the company’s ‘almost unique footprint and expertise in the developing world’.
Elsewhere in China, not holding internet company Tencent and several Chinese banks that performed strongly during the rally also detracted from the company’s performance. With regards to Tencent, the manager has concerns over its valuations, opaque corporate structure and the impact of the transition from a PC-based business to a mobile one, where competition is more intense. For the Chinese mainland-listed banks, the lack of exposure is due to concerns over the sector’s ability to operate commercially in a heavily-regulated environment. The manager believes that many lenders are facing weakening asset quality and falling provision coverage for loans.
Jardine Strategic was another detractor. The manager says retail business Dairy Farm de-rated on the back of higher operating costs and slower top-line growth, while Astra International, one of Jardine’s core businesses, continued to face a difficult macroeconomic environment in Indonesia and increased competition in the auto distribution segment. However, the manager considers that Indonesia remains attractive and Astra appears well-placed to tap this potential. As such, the manager took the opportunity provided by market weakness to establish a position in Astra.
Hong Kong real estate developer Hang Lung Group was also a detractor. Weakening luxury spending amid Beijing’s anti-corruption campaign has hurt business on the mainland, which accounts for more than half its rental income. However the manager says that it has a robust balance sheet and is well positioned to capture any rebound.
The Trust’s heavy exposure to Singapore also hampered performance. Growth seems to have stagnated and China’s unexpected devaluation of the yuan sparked concerns over financial institutions with mainland exposure.
India, by comparison, contributed positively. Indian equities and the rupee held up better in the recent sell-off than countries that have staked their growth on supplying China with commodities. The manager believes this resilience was partly due to its improving fundamentals. At the stock level, Indian holdings also held up well. Further boosting return was the limited exposure to Korea. Share prices there have corrected amid concerns over the Chinese market, its largest trading partner.
In term of portfolio activity, several new holdings have been introduced to the portfolio. These include China Resources Enterprises, MTR Corp, Piramal Enterprises (consumer finance and pharmaceutical services), Yoma Strategic (Myanmar real estate). The manager says that both Yoma and Piramal trade at notable discounts to their net asset values. The market correction was also used to add to long term positions in Oriental Holdings, Batu Kawan, China Conch Venture, BAT, CIMB Group, and ITC. Profits were taken from several holdings after strong share price rises, including HDFC, AIA, China Mobile, Samsung Electronics, Venture Corp, Ayala Land and Ultratech.
In terms of outlook, the manager considers that Asia still presents compelling opportunities for investors despite the downturn. The manager considers that region is also in a better shape today than in previous crises and that many countries have accumulated healthy foreign exchange reserves so that their financial systems are more robust than before, and currencies are no longer pegged to the dollar but float relatively freely. They say that cost cuts are progressing, and companies outside the commodity sector are generally enjoying margin expansion.
Edinburgh Dragon’s China underweight impacts performance : EFM