The near £700m market cap Asia fund, Schroder AsiaPacific (SDP) has reported interim results to 31 March 2020. Between them, China and Hong Kong account for nearly 80% of its allocation by geography and its three largest sectoral exposures are technology, financial services and consumer cyclical.
During the six month period ended 31 March 2020, SDP’s NAV and share price produced total returns of (10.8%) and (9.4%), respectively, compared to a total return of (9.3%) for the benchmark. The discount narrowed slightly from (11.4%) at the start of the period to (10.3%) as at 31 March 2020. The discount remained in a similar range in April. In May discounts widened throughout the sector and the company’s was (13.5%) as at 13 May 2020.
“In the seemingly now distant pre covid-19 months of the fiscal year, regional markets made steady, if unspectacular, upward progress. Although consensus earnings expectations for 2019 continued to fall, relatively loose global monetary conditions and some, admittedly fragmentary, signs of a stabilisation in economic indicators provided support to regional equities. More specifically, there seemed some genuinely valid grounds for a recovery in the crucial information technology sector based on a recovery in demand for data centres and Chinese ramping up of investment in 5G mobile infrastructure.
It took a while for investors, us included, to register the true implications of the covid-19 virus that emerged from the wet markets of Wuhan. A measure of complacency (partly engendered by the brevity of the far more lethal but less contagious example of SARS in 2003) soon changed from late February, although the most severe free fall took place when the waves lapped firmly at the shores of Europe, and subsequently the United States. This could no longer be consigned a peculiarly Asian problem; indeed it is a measure of the speed and decisiveness of action taken by many Asian governments that markets such as China, Korea and Taiwan have outperformed many western counter-parts. This is also true of Hong Kong which had its own domestic issues to contend with in the latter part of 2019.
Already facing a number of longer-term structural issues, and in some cases (Indonesia, the Philippines, Thailand, Malaysia) a fair measure of domestic political turmoil, the approach to the virus outbreak did not help emerging ASEAN markets, which have been notable underperformers over the period. Relative illiquidity has also undoubtedly been a factor, as even Vietnam (which has so far shown a degree of competence in addressing the covid-19 challenges) has been equally hard hit.
In India, an already slowing economy and some credit quality issues in the non bank financial sector weighed on the market, along with expensive valuations. A period of laissez faire in the face of the virus has been followed by somewhat arbitrary lock down measures which has further undermined rather than helped sentiment.”
Taking profit on China mainland stocks
“With the disparate performance between China and Hong Kong, despite the fact that many Hong Kong based companies have attractive and growing Mainland exposure, we have tended to take profits on our Chinese stocks to fund further additions to Hong Kong. We also made significant reductions in Thailand and more modestly in India and Korea. The increase in Australia was in the resource area where concern over global growth appeared well discounted given the solid cash generation at even relatively depressed commodity prices. The increase in exposure to markets outside the region reflected specific opportunities to pick up stocks with substantial exposure to the growth of the region.
It would have been difficult to imagine events that could leave the Global Financial Crisis (“GFC”) of a decade ago looking like a mild inconvenience to financial markets and economic activity. The key difference between then and now is, of course, the fundamental threat to human life covid-19 presents, necessitating actions that threaten to cause economic paralysis across the globe. We are seeing virtually unprecedented degrees of government control and targeted support for the most vulnerable; certainly measures difficult to imagine in peacetime. It is unsurprising that a wartime analogy is widely drawn, and depending on how long the current situation persists, the stock of public debt in many developed economies is likely to end up at levels akin to post war levels.
The speed, and extent, of the market correction as the crisis has escalated has reflected both the scale of the perceived economic shock, but also equity valuations generally towards the expensive end of historic ranges. In Asia’s case, valuations were not excessive at the end of 2019, but did reflect a measure of hope that there would be a meaningful recovery in regional earnings in 2020. Such hopes have been utterly extinguished.
Given the unique circumstances, current levels of volatility should be of little surprise and we will undoubtedly continue to see significant market movements in both directions over coming months. Recent market lows reflected the fear of the unknown as much as the deterioration in the economic environment which had seen the sharpest eight-week decline in growth expectations since the GFC. As a consequence, unprecedented monetary and fiscal stimulus is now being brought to bear to support economic activity. Besides concerted action by Central Banks we are seeing fiscal packages in major economies ranging between 3-6% of GDP. This has included a number of Asian countries, particularly those with enviable room to manoeuvre given years of relative fiscal conservatism such as Korea, Hong Kong and Singapore. Perhaps of note China’s response has thus far been more measured, including suspension of social security payments, reductions in VAT and support for lending to SMEs.
If the impacts of the virus can be “successfully” managed, or are less profound than some of the more extreme scenarios envisaged by some, global equity markets could see sharp recovery over coming months, more realistically towards the latter half of the year. If not, we will likely see a different path of recovery. One complication is that a number of countries/governments appear to be somewhat in denial as to the measures required, primarily among emerging markets. It is also evident that recovery is likely to be erratic, at best, as governments gradually relax and then tighten controls in response to case progression, while sentiment will be subject to traumatic headlines from the emerging countries that are inevitably less able to manage the crisis or afford the dramatic economic cost of lockdowns. So far the experience in India and populous emerging ASEAN has been fairly benign, but that could well change.
It is clearly positive that numbers of new cases in China have fallen to relatively low levels and industrial activity is almost back to pre-crisis capacity. We would expect a gradual pick-up in domestic consumption as day-to-day life is slowly normalised. With China taking the pain of its own lock-down ahead of the rest of the world, this leaves the country (and to a lesser extent the region) slightly “ahead of the curve”; however, the recovery is likely to remain patchy as some sectors, such as travel, tourism and leisure, are likely to take much longer to recover fully. Furthermore, there are still real risks of a secondary spike in infections if the lock-down is eased too quickly, as recent experience in Singapore has shown. The export sector, both in China and across the region, also faces a secondary demand shock given the collapse in demand as Western countries move into their own lock-downs, and this will have an impact on employment, income and investment spending if the downturn lasts for more than a few months.
In the shorter-term attempting to navigate recent volatility has been challenging both due to the speed and quantum of the share price movements over the past few weeks, and the degree of uncertainty regarding the near term growth outlook. But as long-term investors we have sought to take advantage of this volatility. We must work on the assumption that it is a matter of “when” not “if”, a degree of normality will be achieved, but the key uncertainty is timing. Consequently, while we are prepared to take a degree of operational risk at a holding level (we believe it is too late to be extremely defensive), balance sheet, cost flexibility and the ability to weather an extended downturn is key.
We would also note that this crisis is giving further impetus to a number of the longer-term disruptive structural trends that have been in progress such as the rise of e-commerce, flexible working patterns, digital payments, social media use, on-line procurement and services, and the automation of manufacturing and logistics. It is interesting that many asset-light platform models also enjoy more flexible cost structures and, in many cases, strong balance sheets. They can therefore afford to weather tough times while many of their legacy competition are facing major issues.”
Anti-globalisation tide to be strengthened by covid-19
“On a less welcome note, the tide against globalisation (trade, supply chains, people movement) will also draw strength from this epidemic. We do have exposure to a number of export oriented companies in Asia, but our focus has always been on market leaders and higher value-added businesses. These are not easily substitutable, and have already been subject to rigorous audit by their mainly blue-chip Western customers, themselves under increased scrutiny by regulators, consumers, NGOs and media. Furthermore, in general our investee companies, conscious of the cyclicality of their operations, have been conservative in terms of balance sheet structure. Meanwhile, many of the information technology holdings continue to benefit from the increased need for data storage and connectivity.
Conscious that we are in somewhat uncharted waters, we have been cautious about significant deployment of the gearing facility, particularly given the rapid recovery we have seen in markets over the last few weeks. However, we have tried to take advantage of often indiscriminate selling to position the portfolio towards companies well placed to exploit the longer term trends. Strong management, sustainable business models and resilient balance sheets seem more than ever crucial, along with retaining a focus on longer-term underlying fundamentals.”
SDP: Schroder AsiaPacific sees anti-globalisation tide drawing strength from the pandemic