Pacific Horizon reports on positive year – Pacific Horizon Investment Trust reports that, in the year to 31 July 2018, its NAV total return was 13.6%. During the same period the MSCI All Country Asia ex Japan Index total return was 6.0% in sterling terms. The share price total return was 26.9% and the shares ended the period at a 3.3% premium to NAV. The chairman says that the relative and absolute performance over the course of the year was largely as a consequence of good stock selection, particularly in Korea, Hong Kong and China where exposure to certain healthcare and information technology names proved beneficial. 4m new shares were issued which helped push the company’s ongoing charges lower – to 1.02%.
Increased unlisted exposure
“Our portfolio managers anticipate being shown an increasing number of interesting unlisted investment opportunities, particularly Chinese companies, over the coming years and we believe it is in the interest of shareholders for them to consider these opportunities for investment. The Pacific Horizon portfolio currently has four unlisted investments accounting for 1.6% of total assets: Philtown Properties (0.0%), a holding inherited following its spin-out from RFM Corp of the Philippines in 2009; JHL Biotech (0.3%), a Taiwanese biotech which was taken private with a view to listing in Hong Kong; JHL Biotech Convertible Bond (0.5%) issued as part of the de-listing; and NIO (0.8%).
Given the increasing quantum of potentially attractive unlisted investment opportunities that Baillie Gifford is beginning to see, in particular some very interesting Chinese names, the Board believes that the portfolio managers should have the opportunity to invest up to a maximum of 10% of total assets, at the time of initial investment, in unlisted equity opportunities in the Asia-Pacific region and Indian Sub-continent. The Board is therefore seeking shareholder authority to permit this increase in their investment remit at the AGM.”
Extract from the manager’s statement
“Technology companies now account for 48.7% of the portfolio , down slightly from 48.9% a year ago as we reduced some of our holdings when the market was strong. Over the year, Technology was our largest sector exposure from both an absolute and a relative weight perspective, and the top contributor to returns, with an average return of 24.5% significantly outperforming the broader comparative index return of 6.0% and the sector return of 8.7%. We reduced our holding in Tencent, reflecting our enthusiasm for other holdings. We sold Baidu and Ctrip.com as we believe that the future growth potential may be lower than our prior expectations. We sold Advanced Semiconductor Engineering, Advantech and Hon Hai Precision Instruments in Taiwan and bought Global Wafers, Accton Technology and Kingpak Technology.
The Financial sector is the second largest sector weight in the portfolio at 16.3%, down from 17.2%. We took a new holding in HDBank, a well-run and rapidly growing private bank in Vietnam that is attractively valued.
The Consumer Discretionary sector is our third largest sector exposure at 14.1%, down from 19.8%. As economic growth within the region recovers, the focus on the Asian consumer, and the consequent growth opportunities, should generate increased Investor interest. We established a new position in Li Ning, a domestic footwear brand, which we believe is undergoing a significant restructuring and moving its business online, where it will have new growth opportunities. JD.com and Geely Automobile are our two top holdings in this sector.
In the Technology sector, Kingdee International Software and Sunny Optical Technology were the two best contributing stocks. Koh Young Technology, a small South Korean manufacturer of 3D optical inspection equipment, rose 72% and is now among our top 10 holdings. It is the world leader in 3D solder paste inspection equipment and is currently growing its market share rapidly in the 3D automated optical inspection market. As global automation rises and the size of components shrinks, greater precision is necessary. We believe this will lead to more companies seeking Koh Young’s solutions and this company, now capitalised at US$1.3 billion, has the potential for rapid expansion as it takes its key technology from one niche market to another.
We believe that the global transportation market is currently undergoing rapid change, which in ten to twenty years is likely to make it a fundamentally different industry. China is likely to have a scale advantage in the new global electric vehicle industry due to the need to address environmental issues. It currently is the leading producer of electric vehicles (EV) globally. We own two Chinese automotive companies, Geely and NIO, both of which are investing heavily in EVs. If even some of the more pessimistic EV penetration rates are to be reached by the mid 2020s, then the world needs significantly more batteries and their respective components. We therefore own Samsung SDI, currently one of the top five global makers of electric batteries. The stock rose 37% as a result of rising demand and margins from its energy storage solutions business. We also initiated a new holding in PT Vale Indonesia, a nickel producer. Nickel is a key component in electric batteries and, as technology improves, is likely to become increasingly so. The world is not currently producing enough nickel to meet current global demand. In due course, total demand for nickel from EV could equal the whole of the global nickel market today. To this end, it appears that there should be a significant and sustained rise in the price of nickel to meet the additional supply that the market will demand and we believe that Vale Indonesia has the ability to increase production to meet this need.
On the negative side, JD.com, was our biggest detractor, falling 20% over the year. The company’s revenue growth slowed and margins disappointed as competition from Alibaba increased and the company focused on investments in its logistics arm. We feel the shares are materially undervalued and will re-rate when the current investment phase starts to produce tangible results. China Rapid Finance (CRF), a peer-to-peer (P2P) credit lender in China, fell 75% hurt by tightening regulatory standards and a dramatic consumer credit crunch orchestrated by the authorities. We think that CRF has a strong history of credit scoring, an innovative management team and a model which has the potential for scale. We continue to hold the company, despite these short term significant losses, as we think it may emerge from this episode significantly stronger with less competition.
Sunny Optical is up almost 800% over the last five years and up another 40% over the last year, making it the best performer and highest contributor to our performance over five years and the second largest contributor over the year. Looking back, Sunny Optical was bought in April 2015 for a number of reasons. First and foremost, we believe that the importance of vision in the way that humans interact with their devices and how computers interact with the world will increase. This is evidenced by the rise of smartphone photography and the need for cameras on cars and other machines. At the time of investment, Sunny was a distant seventh in the smartphone camera lense market. However, we believed that not only would the market grow rapidly, but that Sunny had a distinct competitive advantage, allowing it to take market share. It had acquired significant technological know-how and patents from Konica Minolta, it was the leading domestic player in China, and had the potential to be a cost leader when the company scaled up to meet demand. It also had a 30% share of the auto camera market; at 0.8 cameras per car, we believed this market could reach 10+ cameras per car over a 10-year period. The company was privately founded and the founder had, via a share trust, given a significant portion of the equity to his employees, demonstrating vision, ability and integrity. We hoped to make two to three times our money if our thesis proved to be correct. We still believe that Sunny has significant upside to come and it remains one of our top 10 holdings, despite expectations for future performance being much higher today, with the stock trading on a forward multiple of 24.8x versus 18.5x when we first purchased it.
Geely Automobile is the second best performing stock over the last five years, up 558%, and is also our second highest contributor to performance. Both Japan and South Korea developed a significant and dominant domestic car industry which then became world leading: Toyota, Honda, Nissan and others from Japan, together with Hyundai from Korea are now deeply respected global brands. China five years ago was dominated by foreign brands via joint ventures with thousands of very poor quality local manufacturers. We believed that one or two of these local companies would eventually become the domestic (and then a global) champion in what is the world’s largest automotive market. Geely’s founder demonstrated the vision to take Geely to being a leading brand within China, and potentially globally when the company acquired Volvo in 2009, giving it the technology to leapfrog its domestic peers. In 2015, its first car based on Volvo’s design was released. In the long run, we believe Geely will improve its domestic market share from 5% today towards 20% and eventually sell cars overseas. At year-end, it represented 3.1% of the portfolio.
Although Kingdee International Software has risen 177% over the last five years, the majority of this gain has been very recent, returning 168% over the last year, making it the best performer over the year. We purchased Kingdee in April 2015; it is one of China’s leading developers of enterprise resource planning (ERP) software for small and medium-sized businesses (SMEs). As the world digitalises, the competitive nature of many industries change, and there are significant network effects and economies of scale to the online digitalised industry compared to the offline world. Our view was that the market share gained by the online winner in SME Enterprise Resource Planning would be significantly higher than in the offline world. Kingdee was the leader in moving towards a cloud-based solution for its offline customers and at the same time attempting to win larger companies via its new data processing solutions. Management here definitely has a strong vision and ambition to grow. As a result of frequent changes to the company’s business model, the stock has fallen more than 50% from its 2015 high. We believe, however, that Kingdee has a good chance of being the leading provider of software for ERP in China and we anticipate significantly improving cash flow and profit generation in the coming years.
Our holdings in South Korea performed very well, contributing significantly to performance over the year, rising on average 24.3% versus the country index which was down 0.4%. Our notable country overweight position also helped these returns. Some of our South Korean biotech stocks did very well: Genexine was up 89% – it is a leader in innovative technology for longacting therapeutics; Bioneer rose 107% after it undertook a discounted rights issue to fund research and development; and Theragen Etex rose 106% on expectations of a licensing out deal. Our worst performing stock was Finetex EnE, the maker of nanofiber material for the garment industry. The stock was suspended after the auditor resigned. We subsequently wrote down our holding. The company has seemingly been unable to scale its technology profitably, but we remain confident that it has a unique product which serves a new unmet need.
Our Vietnamese exposure contributed meaningfully to the overall performance of the portfolio. Our Vietnam holdings rose 25% on average during the year. Vingroup, the leading real estate developer in the country, was the standout performer, rising 184% as the company realised significant value by listing its two subsidiaries, property malls and real estate development. We continue to see the Vietnamese economy as a whole as an underappreciated growth story.
We made two unlisted equity investments during the year. NIO is one of China’s leading new energy vehicle start-ups, which aims at the upper end EV market in China and claims the world’s first in-car AI system and the world’s fastest electric car among its products. We expect the stock to list in 2018. Our second unlisted investment was comprised of two components. We helped JHL Biotech to delist from the stock market in Taiwan with the intention of relisting on another exchange which would give the company access to a larger pool of more sophisticated investors. As part of the delisting process, we participated in a convertible bond which gives extra security and return over the pure equity holding. We expect the stock to relist by the end of 2019. The investment trust structure lends itself well to having some unlisted exposure where we believe there to be the potential for significant returns.”
PHI : Pacific Horizon reports on positive year