Schroder Oriental Income has announced its annual results for the year ended 31 August 2020, during which it provided an NAV total return of -0.9% and a share price total return of -3.9% (reflecting a widening of the discount during the period) both of which suggest it has missed the mark a little, underperforming its Asian equity benchmark, which it says provided a positive return during the period. However, the chairman says that in an environment where the rise in regional markets was driven by lower yielding growth stocks, which do not produce the income SOI is targeting, the board believe this is a good result. The board is also reassured by the subsequent recovery in NAV, which has risen by 6% since the year end.
Revenue, dividends and performance
SOI has increased its dividend, drawing modestly on its revenue reserve to cover the 7% fall in revenue earnings per share during the year. SOI’s chairman says that Asian economies have shown remarkable resilience to date and the reduction in income has been much more modest than that of the United Kingdom, demonstrating the Company’s value as a diversifier away from UK income. Dividends declared by SOI over the year totalled 10.30 pence, and remaining revenue reserves are equivalent to nearly eight months of the dividend at current levels.
Change of portfolio manager
SOI’s portfolio manager, Matthew Dobbs, will be retiring in early 2021. Matthew was instrumental in the launch of SOI in 2005 and has been the fund manager of the portfolio since then. Richard Sennitt, a close colleague of Matthew’s over the last 13 years, will be taking over as portfolio manager of the Company. Richard joined Schroders in 1993 and SOI’s board says that he has become well known to it for some time and it is confident that Richard will be an excellent successor to Matthew. Richard will take on the role of portfolio manager from 31 December 2020.
Investment manager’s comments on positioning and performance
Over the life of the Company, actively-managed Asian income stocks have been able not only to keep pace, but outperform the reference benchmark. There have been two notable recent periods when this has not been the case; calendar year 2017, and the last twelve months. In both cases, markets have been narrowly focused on a relatively small number of large-cap growth stocks (particularly in China) which offer little in the way of dividend return. Indeed, over the review period, two thirds of the performance shortfall can be ascribed to not owning just two stocks – Tencent and Alibaba. The balance is largely accounted for by the Company’s exposure to real estate which has been out of favour given concern over the long term potential for disruption from changed work habits and the challenge to off-line retail.
There have been some bright spots. Stock selection in Taiwan, Australia and Korea has been strong (partly reflecting exposure to information technology), and the correct underweighting in financials which have suffered due to lower interest rates and fears over credit quality.
The geographic exposures in the Company’s portfolio have remained well spread between Hong Kong, Australia, China, Singapore, Taiwan and Korea. It is notable that over the last few years, more income opportunities have emerged in China although we remain relatively underweight. The major move during the period has been to reduce the bank exposure in favour of information technology (particularly in Taiwan) and insurance which remains relatively under-penetrated in the region. Real estate remains an important exposure, but we have taken a very selective approach both in terms of the nature of the underlying asset and also balance sheet strength.
Investment manager’s comments on outlook
The rate of earnings downgrades across the region has slowed recently, but there is still a lack of visibility on the timing of an end to global lockdowns and travel restrictions, and the likely path of the subsequent recovery in activity. This is especially the case now given secondary spikes in infections in several countries. It is, therefore, no surprise that companies are providing limited guidance on their shorter-term outlooks and continue to plan conservatively. In our interaction with management teams, our focus has been on understanding what measures they are taking to deal with the crisis and how well placed they are to ride out the downturn – operationally and financially. For many companies, this year’s earnings are likely to be something of a write-off, so it is important to focus on the longer-term prospects for our investee companies. As performance in the past few months has demonstrated, markets by and large are willing to look beyond this crisis, as long as there is scope for a healthy recovery next year to a more ‘normalised’ level of profitability.
Consequently, aggregate valuations for the region have risen to slightly above historic average levels. This is clearly already pricing in a measure of the recovery in earnings expected into 2021 and the upside for the ‘lockdown winners’. There is scope for disappointment, but the ultra-low level of interest rates and bond yields around the world provides support to valuations. It also makes the dividend streams from those companies able to sustain pay-outs particularly attractive.
Behind the aggregate valuation measures, there is a very wide spread of multiples. This means that valuations in some of the sectors with strong momentum this year – notably selected healthcare, e-commerce, online gaming, 5G equipment, electric vehicle-related and other popular China A-listed shares – are much more stretched. We are also seeing some signs of ‘froth’ emerging in the very strong flows and performance of new initial public offerings in Hong Kong and South Korea. This froth is also evident in the high levels of retail participation in these deals and in market trading more generally. Although not yet at worrying levels, this sort of optimism does leave markets more vulnerable to disappointment.
The obverse of this is that many companies with solid dividend prospects are offering great value. Clearly, we must be very selective as some industries are facing severe disruption. Consequently, the Company’s portfolio has relatively little exposure to hydro-carbon energy and autos, and taking a very selective approach in banks and real estate; but across all sectors we are sensitive to the long-term sustainability of company business models, working closely with our local analysts and the Environmental, Social and Governance (ESG) team.
When the Company was launched fifteen years ago, we contended that actively-managed higher yield Asian equities could provide attractive long-term returns, and enable income sensitive clients to access an exciting and high growth region. However, we also warned that dividend yield is both an opportunity and a constraint; there may be attractive areas of the market that we are constrained from accessing due to lack of adequate yields. We have experienced just such a period in recent years, but on a longer term time horizon the Company has generated attractive and competitive returns. This writer signs off with great conviction that the longer-term pattern will be restored over the coming years under the capable stewardship of Richard Sennitt and the team at Schroders.