Views from Fidelity Asian Values following underwhelming half-year results

Over the six-month period ended 31 January 2020, the NAV of Fidelity Asian Values (FAS) fell by 13.2%, compared with a decline of 3.6% for the MSCI all countries Asia ex Japan index total return. Over the same period, the company’s share price decreased by 15.0%.

The company performed poorly before the covid-19 outbreak. Exposure to India’s PNB Housing Finance, was the biggest detractor to performance, owing to a  slowdown in the housing market in India. As at 31 March 2020, India was FAS’s largest market market, accounting for 23.1% of the portfolio.

Covid-19 views

FAS’s manager said the following:

“This is an unprecedented event for everyone, and investors are having to opine on a topic for which they are not trained. Even scientists and epidemiologists are not certain in terms of how things will unfold over the next few months. Having said that, undoubtedly the economic impact will be quite severe in the short-term on both demand and supply. Looking at current earnings forecasts is pointless given the fluidity of the situation. We can model scenarios but frankly the dispersion in outcomes makes them meaningless. There are a number of unknown factors. For example, as China emerges from its lockdown measures, could we have a second wave of infections? Factories cannot “work from home” so the risk of a resurgence in cases certainly exists. For the rest of the world, we do not know how long the lockdown must last and, once lockdowns are lifted, the degree of freedom of movement that will be allowed. It’s very difficult to forecast when the recovery will begin and whether it will be quick or long drawn.

My working assumptions are listed below. I would take these views with a pinch of salt as forecasting a pandemic is obviously beyond my core competence. I am by no means a trained epidemiologist.

• Short-term: The disease has now spread globally, and I would expect governments to be conservative in easing restrictions. I would expect a few waves or a continued (but controlled) flow of cases in most countries. This implies that the world economy will be on a hand brake until a medical remedy is found or nature takes a different course.
• Long-term: I think this will be contained – through natural causes or a vaccine. In two years’ time, it’s unlikely that there will be a significant impact on how the world functions. Some industries will change, some companies will fold; but on the whole the world should be able to return to normal.
• Economically, I expect earnings to get downgraded materially across most sectors. There will be disruption of both production and demand. Weak balance sheets should worsen, and we may see some bankruptcies of weak businesses.
• Unemployment rates will rise and will take time to bring back down. This will dampen the pace of recovery.
• Falling mortgage rates and low oil prices will boost consumer spending as we recover. However, overall I expect heightened volatility until such time as things start to improve. Markets will react (maybe overreact) to every data point as forecasting disease patterns is beyond our circle of competence and every data point gets extrapolated.

The new economic reality due to covid-19 has had an impact on our portfolio as well. Businesses we own will be impacted either due to lack of demand and/or due to lockdown of their facilities. Most businesses that we own have low levels of debt (actually most have net cash on their balance sheets) and will be able to weather the storm. They should come out in a stronger position (as weaker competitors either shut shop or are unable to invest in the business) as the economy stabilises. However, there are a few businesses which cannot endure zero revenues. As a result, I have made the following changes to the portfolio:

• Sold out businesses which, even though they had a reasonable balance sheets, will not be able to endure the fixed cost burden during a lockdown. These were a small part of the portfolio (at about 1-2% of total assets).
• Increased the average quality of businesses that we own. There are businesses which I have known and admired for a long time, but which were historically not available at attractive prices. During this sell down, they came to prices which made sense to me and I have decided to invest in them. I have funded some of these by selling some existing holdings where I felt the stock market had not reflected the damage caused by covid-19. I am taking this opportunity to increase the quality of the portfolio without sacrificing our value discipline.”

“The last time small cap value stocks were this cheap was in 1999!”

The manager went on to say:

“The company’s performance over the last nine months has been subdued and worse than the market returns. I am unable to explain market sentiment of many stocks – both in the portfolio and the market in general. There has been a dominance of growth companies, momentum strategy and stocks that fit a narrative (Technology, Bio-tech, Chinese Consumer, etc).

Stocks which are ignored or cheap, have become even more ignored. At times, the narrative of the stock market is different from the reality of business. This is true for value equities currently and cheap stocks have underperformed severely, with the valuation dispersion expanding further in the last few months. On a relative basis, the last time small cap value stocks were this cheap was in 1999!

My process of focusing on undiscovered stocks which have good underlying businesses, are well managed and available on cheap prices has been out of fashion and a headwind for performance. This is not an excuse but a reflection of how investment sentiment has worked over recent years.

Having said that, I have the utmost faith in my process. The most time-tested way of investing is to own good businesses, run by competent and honest managements and buy them at attractive prices. Avoiding bubbles and unsustainable valuations is key to long-term compounding, no matter how painful it is in the short-term.

Over time, the quality of business and valuations will matter.

The long-term value of any business will be driven by the cash flow it generates. Short-term market opinion on the value of a business should be meaningless except its impact on investor psychology (mine and yours) and unless we are forced to transact at these depressed valuations.

I am happy with the portfolio of companies we own – both the quality and price at which we own them. On average, we own vastly superior businesses versus the market and at significantly cheaper prices. This gives me confidence of robust returns in the future.

It has been a testing 9 months in terms of performance, but market fashions should not drive an investment philosophy. I look forward to what markets have to offer over the next three to five years and, in the meantime continue to work to find good businesses, run by good management teams and try to buy them at good prices.”

FAS’s geographical allocation, as at 31 March 2020

FAS: Views from Fidelity Asian Values following underwhelming half-year results