Pacific Horizon (PHI) has announced its annual results for the year ended 31 July 2019; it has benefited from a better second half performance. During the year as a whole, PHI saw its fall by 1.9% on a total return basis, compared to a 4.2% rise in the MSCI All Country Asia ex Japan Index in sterling terms. The share price declined by 11.8% in total return terms, and the shares ending the period at a 7.1% discount having been at a 3.3% premium a year earlier. Most of the NAV underperformance occurred in the first half of PHI’s financial year (caused by cyclical macro-economic headwinds driving valuations and near-term earnings lower as well several stocks in the portfolio whose specific business models were challenged and disrupted faster than the managers expected, or where the threat of greater competition came sooner than the managers originally anticipated).
Following the difficult first half, PHI outperformed in the second half. Its provided NAV and share price total returns of 15.4% and 10.0% respectively, compared to a 9.1% total return from the MSCI All Country Asia ex Japan Index in sterling terms. PHI says that its share price failed to keep pace with the rise in the NAV mainly as a result of a large institution placing a sell order close to the its year end.
Tender offer not triggered
At PHI’s 2018 AGM, approval was given to PHI allowing it to hold a performance-based tender for up to 25 percent of its issued share capital if its NAV total return failed to exceed the total return of the Company’s comparative index by at least 1% per annum over a three year period to 31 July 2019 on a cumulative basis. PHI says that it outperformed the comparative index by 3.1 percentage points on an annualised basis and the tender offer will therefore not take place.
Manager’s commentary on portfolio developments and performance
“We actively seek out the big winners, the stocks that can give us asymmetric returns. Over the last year this approach has largely played out as intended, with a few of our chosen stocks making enormous gains. Interestingly, the top five positive contributors to relative returns versus the comparative index in the year were all stocks we had either bought (SEA Limited, Li Ning, Accton Technology, Ping An Bank) or sold (Baidu) in the prior financial year, supporting our view of 2018 as a year of change.”
“Over the year we reduced exposure to some of our larger positions in the Information Technology sector. Our sector exposure here now accounts for 19.6% of the portfolio, down from a restated 31.5% a year ago – restated to reflect the reclassification by MSCI of some stocks into different commercial sectors, mainly Communication Services. Despite this, Information Technology continues to be our largest absolute sector position. Over the course of the financial year, it had an average return of minus 7.5%, significantly underperforming the broader index return of a 4.2% gain and the sector return of 3.7%. SEA Limited, the Singapore-based e-commerce and gaming company, rose 167% and become our largest holding following a re-rating sparked by its new hit game Free Fire, which is likely to deliver close to a U$1 billion of revenue for it in 2019. This was one of the holdings reclassified to the Communication Services sector, resulting in our exposure here returning 67.5% versus 14.0% for the sector. We further reduced our holding in Tencent, reflecting our concern that the company’s previous leadership in the WeChat social platform is being threatened by ByteDance. We sold Sunny Optical Technology, our biggest performance detractor of the year, over concerns that new AI algorithms were reducing its leadership advantage in high-precision lenses and threatening margins. We also sold Macronix and reduced SK Hynix as the global semiconductor memory market looked set for an extended downturn.”
“The Consumer Discretionary sector is our second largest sector exposure at 16.6%, down from 20.5% in the previous year. As economic growth within the region recovers, the focus on the Asian consumer and the consequent growth opportunities has the potential to generate increased investor interest. Li-Ning, a domestic Chinese online footwear brand performed very well, rising 146% on the back of a recovery in sportswear sales. We reduced our holding in Geely Automobile as the Chinese car maker is undergoing a prolonged restructuring. Despite significant share price volatility, we have broadly maintained our holdings in JD.com and Alibaba.”
“The Financial sector represents the third largest sector weighting in the portfolio at 16.4%. We sold Mumbai-based IndusInd Bank after it had performed well over several years. We remain concerned that rapid credit growth may lead to an increase in non-performing loans, and we decided to sell before a management transition next year.”
“On the negative side, South Korea was our worst performing market, falling 20% and detracting 450 basis points from the portfolio’s overall performance. A combination of factors, including trade disputes with China and Japan, weak semiconductor and smartphone sales and negative sentiment towards biotech companies all affected our diverse range of holdings in the country. We had only two contributors to positive performance: software company Douzone Bizon and Samsung battery power subsidiary Samsung SDI. We have maintained most of our holdings and we are confident of their potential for future growth despite the poor short-term stock performance.”
“Our Vietnamese exposure hurt as this frontier market suffered from liquidity outflows and reduced investor appetite for risk in this market. We continue to be attracted to the long-term outlook for the country and believe that its economic prospects have been bolstered by the US trade conflict with China. Our Vietnam holdings fell 6.4% on average during the year. We see the Vietnamese economy as an under-appreciated growth story.”
“In terms of the countries where we invest, our Hong Kong and China weighting decreased from 40.2% to 34.4%. It remains the largest country weighting in the portfolio, followed by South Korea at 19.0%.”
Manager’s commentary on outlook
“There is significant potential for positive returns from the Asia Pacific region in the coming years. Our focus remains on investment in individual stocks which will benefit from the economic, social and technological changes in evidence across the region. In the near term, the recent market noise over trade wars, slowing global growth and a rising US dollar are obscuring the underlying reality of strong, consistent economic growth and social opportunity within the region. When the market looks again at fundamentals in Asia, we expect it to see healthy growing economies, with attractively priced companies and undervalued currencies, all creating significant investment opportunities for the Company, and all to the benefit of our shareholders.”
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