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Edinburgh Dragon’s performance picks up

For the year to 31 August 2016, Edinburgh Dragon’s NAV rose by 31.9% on a total return basis. This was slightly less than the MSCI All Country Asia (ex Japan) Index ‘s increase of 33.0% in sterling terms. Most of these returns were generated in the second half of the year when Edinburgh Dragon’s performance picked up, its NAV rising by 32.7% over this period against 29% for the benchmark.

The share price rose by 29.7% to 302.0p, with the discount to NAV widening marginally, from 11.8% at the start of the period to 13.4% as at 31 August 2016. Since the year end this discount has tightened again slightly to 11.9% at 1 November 2016. The Board is recommending the payment of a final dividend of 3.2p per Ordinary share (2015 – 3.0p).

The manager says that, although the Trust marginally underperformed the benchmark, it thinks the double-digit return in absolute terms is encouraging. Good stock selection, notably in India, Taiwan and Korea, helped mitigate the Trust’s underperformance. At the stock level, several Indian holdings were among the top contributors to relative return.

HDFC continued to report healthy growth in loans and savings, while non-performing loans remained well below levels common among state-run lenders. Grasim Industries was buttressed by solid revenues and improved margins. Despite a muted demand outlook, Hero MotoCorp benefited from lower commodity prices and cost cuts. Piramal Enterprises’ share price soared on news that it was separating its financial services and healthcare divisions to create more focused businesses that should unlock shareholder value over the long term.

In Taiwan, a holding in Taiwan Mobile added to performance as the telco’s net income was bolstered by increasing contributions from the 4G network, lower handset subsidies and dividend income from its investment in Taiwan High Speed Rail.

Stock selection was also positive in Korea. Despite a sluggish IT sector, Samsung Electronics rallied after management announced that it was repurchasing 11.3 trillion won-worth of shares, while continuing to grow its dividends. This was the biggest buyback in the company’s history and the first cancellation of shares in 10 years, underscoring the increased focus on shareholders returns. After the review period, the share price took a hit when the highly anticipated Galaxy Note 7 smartphones were plagued by faulty batteries. The company has announced a discontinuation of the model. While unfortunate, taking this decision now and writing off the cost of the Note 7 range allows the company to focus on the development of the next generation of handsets. It should also lessen the impact on its brand over the long term. The rest of Samsung’s business remains strong, particularly in semiconductors, where the company is benefiting from its investments in leading-edged technology. In line with our due diligence process, they will continue to research its product design and quality-checking process. They will also continue to engage management on improving governance structure and capital management.

Conversely, the key reason for underperformance was the Trust’s significant exposure to financial companies. At the stock level, the holdings in HSBC and Standard Chartered detracted. The share prices were depressed as the lenders continued to restructure, while navigating a difficult operating environment. The Brexit vote also caused a sell-off in the UK-domiciled banks, despite both deriving the bulk of their earnings from well-established emerging-markets franchises. On a positive note, Standard Chartered returned to profitability as shown in its recent interim results. It delivered this via cost controls, lower impairments, reduced commodity exposure and an improved capital base. HSBC, too, streamlined operations and strengthened its capital position, which allowed it to maintain dividends and announce a share buyback. They say they are encouraged by the progress being made as the banks’ restructuring efforts are starting to bear fruit.

Given that financial stocks make up around half of the Singapore local index, the Trust’s substantial exposure to that market also hampered performance. The local-currency share prices of our holdings UOB, OCBC and DBS were pressured by the low interest-rate environment and rising NPLs (non performing loans), which contributed to tepid earnings. Concerns over the fallout from Swiber, a local offshore oil-and-gas contractor that filed for liquidation, also weighed on sentiment. However, the banks’ actual exposure to Swiber appears manageable. It is worth noting that Singapore lenders are in better shape than many of their regional peers, and we are encouraged by their robust liquidity positions and attractive valuations. Elsewhere, energy-related stock Keppel Corp was buffeted by commodity-price volatility. The rig builder was further hindered by major customer Sete Brasil, which filed for bankruptcy protection. Keppel responded swiftly by raising provisions, reducing costs and shutting less-utilised yards. Its non-oil businesses also continued to do well.

Meanwhile, property holdings were hampered by tightening measures in the sector. As a result, the Trust’s holdings in Hang Lung Group and Swire Properties in Hong Kong, as well as City Developments in Singapore, cost performance. Swire Properties, in turn, proved a drag on its parent Swire Pacific, another of the Trust’s Hong Kong holdings. However, they believe the companies’ underlying portfolios place them in good stead to capture rising demand over the longer term.

Stock selection in China detracted, albeit this was mainly due to the Trust’s lack of exposure to mainland internet companies Tencent and Alibaba, both of which continued to report good earnings growth. However, valuations remain relatively expensive in the sector and the still-evolving operating environment seems a shaky foundation. In addition, they are not sufficiently comfortable with Tencent’s corporate structure. As for Alibaba, they are wary of its aggressive move into financial services, where its lending activity may not be subject to the same level of scrutiny as occurs at other local financial services providers.

EFM : Edinburgh Dragon’s performance picks up

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