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Growth and large-cap tide working against Fidelity Asian Values

Fidelity Asian Values FAS

Over its full-year, to 31 July 2020, Fidelity Asian Values (FAS) delivered a total NAV return of (16.7%) and a share price total return of (24.8%). In doing so, FAS underperformed the 2.7% delivered by its comparative index, the MSCI all countries Asia ex-Japan small-cap index.

FAS’s manager, Nitin Bajaj, deploys a value approach geared around holding businesses with strong management that are judged to be mispriced. The approach lends itself to significant weight in small and medium-sized companies. The value style, particularly within the smaller-cap segment, has underperformed over the course of the rally in global stocks since April and in the periods preceding this too.

Stock picking review – Indian mortgage companies a major detractor

Nitin had this to say on stock-specific performance over the year: “There are two kinds of errors that an investor can make: errors of omission and errors of commission. Errors of omission are stocks that we don’t own that go up. Errors of commission are stocks we own that go down.

Errors of omission are inevitable. There will always be stocks that we do not own that go up a lot. This year these were concentrated in technology and health care – but more generally, in categories of stocks which can be broadly labelled as ‘momentum’. These are stocks which we are very unlikely to own as they are expensive, with high expectations and very little margin of error. When they are appreciating, no one questions them.

Unfortunately, we also made a few errors of commission this year – most notably, our investment in mortgage companies in India. The country has been in a housing downcycle for almost eight years resulting in significantly improved housing affordability (house prices compared to household income) – its best level in the last 25 years. Our analysis showed that we should be on the cusp of a turn in the cycle for the better. In a weak economy, the recovery was delayed, and it got worse due to COVID-19, which led to unprecedented economic hardship and liquidity stress on households, property developers and the financial system. I feel our analysis was sound and the risk-reward was in our favour when we made the investment – but our bet size was not. At 6% of the Company’s NAV, it was too big a position.

Position sizing is tricky – when you get it right, you always feel you should have had more, and when you get it wrong, it’s the opposite.

In addition, there have been a few other stock-specific detractors like Cebu Air. Cebu Air is a low-cost airline with 55% market share in the Philippines. It has an almost insurmountable lead on its competition in terms of its cost structure. The management team is best in class and it has a well-funded balance sheet. The business has been hit hard by COVID-19, and like most airlines, its stock price has declined. I continue to own my position in Cebu Air as they should be able to get through this period given the balance sheet strength and emerge in a stronger competitive position.

In terms of positive stock contribution, our investment in e-bike battery company Tianneng Power International performed exceptionally well as the stock was discovered by mainstream investors. Also, our investment in rubber glove company Riverstone has performed well during COVID-19 due to the huge demand for medical-grade gloves. I continue to own shares in both these businesses.

Our objective is to not lose money when we are wrong so that our correct decisions can add up. It did not happen this year. In fact, this was the first year since I have managed Asian portfolios that I have had a negative contribution from stock selection. This was partly due to 1) stock picking, and 2) due to the number of business we own being currently unloved in the stock market. This meant that our bucket of positive contributors was smaller.”

India, Indonesia and the Philippines have been relatively more affected than the wider region

“Country allocation for us is an outcome of stock selection rather than a top-down view. Going into COVID-19 we had a significant portion of our assets invested in India, Indonesia and Philippines (38.7% at the end of February 2020; and 30% at the end of July 2020 as we adjusted some of our positions). We have historically found exceptional businesses, with significant growth opportunities at attractive valuations in these countries.

However, all three are densely populated countries and have had to impose stringent lockdowns. This was essential and does not change the long-term dynamics of these economies. However, it has led to a significant stock market sell-off in these three countries – more than the rest of Asia. Some of this stock market correction is justified but I would argue that quite a few stocks in these countries have been sold off irrespective of fundamentals.

An example would be Power Grid Corporation of India, our 2nd largest holding. Power Grid is a high-quality regulated monopoly for electricity transmission in India and has an enviable track record of growth, stability and return on equity. Irrespective of the strong fundamentals, the stock has been sold off due to COVID-19 and now looks very compelling from a valuation perspective.”

‘We are seeing extreme valuations which approximate to what we witnessed during the tech bubble in 1999-2000’

On the outperformance of growth companies, Nitin highlighted two reasons: “Firstly, fundamentally ‘growth’ companies have delivered reasonably good operating results during the economic downturn as a lot of them are in the technology and health care sectors. These businesses benefited during lockdown due to an accelerated shift towards online services as well as the trend towards “working from home”, which has led to an increase in demand for computers and peripherals.

Secondly, the valuations of these businesses have expanded even further. We are seeing extreme valuations which approximate to what we witnessed during the tech bubble in 1999-2000. In my opinion, this multiple expansion is not supported by facts, as on average, there is a big difference in perception of growth and actual earnings delivery.

Growth has significantly outperformed value as a style in almost all markets. We are looking at a value drawdown which is the most extreme in 200 years. Even though data going this far back is bound to have some errors, it is indicative of where we stand versus history. These cycles have always levelled out over time. It would take a brave man to say that “this time it’s different”.

This has been primarily driven by huge appreciation in large-cap growth stocks. If you look at the earnings of small-cap value stocks over time, they have easily outperformed large-cap stocks. Even in the last five years, the earnings of small-cap value stocks have outperformed the large growth companies despite COVID-19.

So fundamentally, I find it hard to justify, based on earnings or cash flows, why small-cap value stocks in Asia (or small caps in general) have lagged materially in the last three years (and particularly in the last 12 months). It basically comes down to the price-earnings ratio expansion of large growth companies.

As a fundamental investor, the primary anchor for valuing any business must be earnings and cash flows. This has always been the case and I do not think it is different now. I have no doubt, therefore, that this situation will reverse. The catalyst for and timing of that change is, however, difficult to forecast.”

FAS: Growth and large-cap tide working against Fidelity Asian Values

 

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