Another strong year for Pacific Horizon despite departure of long-standing manager – Pacific Horizon (PHI) has published its preliminary results for the year to 31 July 2021. The trust’s strong performance from the previous year has continued, with an exceptional NAV return of 61.3% and share price return of 59.2%. This compares with a 12.7% total return from the MSCI All Country Asia ex Japan index.
Meanwhile, the trust ended the period trading on a premium of 3.2%, slightly down from its 4.6% premium last year. The chair said the majority of the absolute performance was achieved in the first half of the financial year, though performance was possibly even more impressive in the second half, as the managers succeeded in avoiding the headwinds that caused a fall of 6.5% in the comparative index, instead generating a positive return of 11.2%. This reflected a significant, timely move in the portfolio weighting away from China, initially into commodities and subsequently towards India.
Towards the end of the period under review (10 June) long-standing manager Ewan Markson-Brown left Baillie Gifford but was immediately replaced with Roderick Snell, who has been the trust’s deputy manager since 2013. The chair said, “In appointing Roderick, we have been reassured by Baillie Gifford’s confidence that he will continue to deliver the high standard of investment management service we have benefited from, supported by Baillie Gifford’s strong team and investment culture.”
[These are once again stellar results for Pacific Horizon, against a backdrop of volatility from Covid-19; inflationary versus deflationary pressures; US/China political tensions; and the return to favour of value over growth investing, which is what manager Baillie Gifford is known for. While the period under review did indeed see the departure of Ewan Markson-Brown, this occurred in early June and so towards the end of the financial year. The impact of this change cannot therefore be assessed in these latest results and so we will have to wait for the next half-year report. That being said, new manager Roderick Snell has worked on the trust for almost a decade and so if anyone knows how PHI has created and maintained its success, it’s him.]
The trust’s annual general meeting for 2021 will take place on 17 November, where shareholders will vote on the life of the company being extended for a further five years until the date of the AGM in 2026, or 30 November 2026 if sooner. If the continuation vote is not approved, the directors will convene a meeting, to be held on or around 3 March 2022, at which a further resolution would be proposed to wind up the company voluntarily.
Manager’s review
Review
The portfolio is noticeably different from a few years ago when we were more cautious on large parts of South East Asia and were very concentrated in technology and consumer stocks. In the context of the growth inefficiencies we exploit, the Company had a large number of investments in the ‘duration’ and ‘pace’ buckets, but very little in ‘surprise’. This had been changing gradually as we found more opportunities in more cyclical, old economy companies, but accelerated dramatically over the course of the Covid-19 pandemic as the extreme dislocation in Asian markets provided us with extremely attractive opportunities in these more cyclical sectors.
The result is a portfolio today that may surprise some. In absolute terms our largest exposures remain focused on the key themes of the rising middle class, technology and innovation, however we now have significant exposures to more cyclical industries including materials, industrials and energy that respectively make up the three largest relative positions within the portfolio. There remains, however, one commonality among the companies held: growth.
Using Pacific Horizon’s largest relative sector position, Materials, as an example, holdings here are predominantly concentrated in companies exposed to two commodities, nickel and copper, both of which lie at the core of the green revolution. Copper, as the most cost-effective conductive material, sits at the heart of capturing, storing and transporting new energy sources, and demand from green sources could easily grow ten-fold by 2030. Nickel is a core material in electric vehicle batteries, where demand across Asia will be driven by China’s intention to have electric vehicles account for a quarter of all automotive sales within the next few years (from around 5% today).
By country, the most noticeable change to the portfolio has been the substantial increase to India, going from a 7% absolute position to 29%, and it is now the largest country overweight in the portfolio (+18 percentage points). Our purchases here can be divided into two parts. The first is ‘old’ India, where we have increased holdings in traditional sectors such as property, where we believe the Indian property market is at the cusp of a multi-year revival; since 2007, the market has fallen significantly in real terms, affordability is the highest it has been in a decade, and a number of regulatory changes and tightening liquidity requirements have consolidated the market into a handful of the largest and best developers.
The second part is arguably the more exciting, ‘new’ India. For many years India has had some of the most attractive companies across Asia, but often this has had more to do with the lack of competition they face, rather than any great innovation or technological edge. Catalysed by the rollout of the world’s second largest 4G mobile network, allowing many Indians to access the internet for the first time, things are changing fast. Just as we experienced in China more than a decade ago, a new breed of exciting and innovative technology-focused companies is emerging in the country.
Many of these prized businesses, however, remain private, and Pacific Horizon’s ability to invest into unlisted (private) companies has been extremely beneficial. Over the period we made three new investments into private Indian companies, Delhivery (leading delivery and ecommerce logistics), Dailyhunt (online short form video) and Star Health (India’s largest private health provider), while the trust also added to its existing position in Zomato which subsequently listed.
With around US$200-300 billion worth of technology-focused private companies likely to list in India over the next few years, the opportunity set for investors will be revolutionised. Having built meaningful stakes in a number of these businesses, developed strong relationships with management and gained early insights into these industries and companies ahead of their IPOs, we believe Pacific Horizon will be well placed to benefit.
A significant portion of funding for Indian companies came from the sale of our Chinese names, with China reducing from a 41% absolute weighting in the portfolio to 27%, and in relative terms it is the largest portfolio underweight position at minus 20 percentage points. Noticeable reductions took place to a number of the large technology companies where we had concerns over competition and increasing regulation; the position in Alibaba was reduced and the positions in Tencent and Meituan exited.
Our timing proved to be prescient; the demolition of the private education sector (where we had no exposure), a crackdown on the monopolistic practices of internet giants and enhanced rules on data ownership and security have displaced any confusion, if any existed, regarding who is in charge in China. For the internet companies specifically, it will be crucial going forwards to understand whether the Chinese regulators have simply imposed some sensible regulations to protect consumers, or whether this is the start of the Chinese government exerting ever greater control over these businesses.
Performance
Although our performance was exceptionally strong over the reporting period, we would hesitate to draw too much from such short-term numbers. We are long-term investors, running a high conviction growth portfolio that is index agnostic. Performance will be volatile and there will be short term periods when we underperform. Our investment time horizon is five years and beyond and it is on these time scales that our performance should be judged. Over the past five years, the Company’s NAV has outperformed the comparative index by 17.5 percentage points per annum. Such performance is pleasing to report, however it will almost certainly moderate from these exceptional levels.
Over the relatively short reporting period, markets have been volatile, sentiment see-sawed between growth and value, as investors grappled with the implications of enormous global fiscal stimulus, eye-popping monetary stimulus, surging GDP growth, and inflation, to name a few. We pay no attention to debates of growth versus value, however it is interesting to note that the portfolio has generally performed well in both market environments; the first half of the period when growth was generally in favour and the second half when it switched to value.
Such a favourable outcome has largely been the result of the broadening out of the portfolio into more cyclical growth companies, as previously discussed. Consequently, by sector, cyclical industries including materials, real estate and financials, were the second, fourth and fifth leading contributors to portfolio returns. Even within the largest contributor to absolute performance, consumer discretionary, a significant portion of performance came from some of the more traditional sectors such as automotive, where Tata Motors (owners of Jaguar Land Rover) was the third biggest stock contributor to performance.
By sector, only information technology detracted from performance (by a modest 0.6 percentage points), mainly due to underweight positions in some of the region’s manufacturing behemoths including Samsung Electronics.
We are of course indifferent as to what sectors our stocks are defined as by the market; we are stock pickers after growth companies, and as such it is no surprise that more than three quarters of the portfolio’s positive absolute return came solely from stock selection.
Towards the end of the reporting period, performance was also helped significantly by what was not held. This was especially so in China, where the government’s decimation of the listed education sector and increasing regulation of internet companies led to dramatic price falls in these sectors. In July 2021, when these changes occurred, the portfolio had no exposure to companies in the education sector, and more importantly was significantly underweight many of the large internet names, for example with a five percentage point underweight position in mega cap Alibaba, and no holdings in index heavyweights such as Tencent and Meituan.
The above, combined with strong stock performance from companies like Li Ning, the Chinese sportswear company that continued to benefit from a shift towards local brands by Chinese consumers, meant China was the top contributor to portfolio returns. This was closely followed by India, where a number of stocks performed very strongly including Tata Motors (up 177%) and Happiest Minds (IT outsourcer, purchased at IPO, up 677%), which were both among the top five stock contributors. In India it is also noteworthy that Zomato, a private company holding in the portfolio, listed and generated a total return of 171% over the reporting period.
The performance of the portfolio’s largest holding, Sea Limited (+113%), South East Asia’s leading ecommerce and gaming company meant that by country, Singapore was the third largest contributor to portfolio performance. The gaming division showed great strength, with Free Fire, the company’s in-house-developed game, becoming the world’s most downloaded game in 2020 and reaching more than 300 million monthly active users. The ecommerce business continued its impressive market share gains across much of ASEAN and, with its increasing scale, looks set to be the dominant online shopping platform across much of the region over the coming decade.
Despite the strong performance of a number of companies, including Sea, it is worth noting that performance was pleasingly broad-based, with the top ten contributors accounting for less than half of Pacific Horizon’s relative outperformance.
The portfolio underperformed in Taiwan, largely as a consequence of the portfolio’s underweight position in TSMC, arguably the world’s most important semiconductor manufacturer. TSMC continued to increase its technological lead over rivals, and we will be carefully considering the portfolio’s exposure to the company over the coming 12 months.
Other notable detractors to performance were a number of technology companies in China including Dada Nexus (logistics), Lufax holdings (Fintech) and HUYA (online game streaming). These were all impacted in the aforementioned Chinese regulatory clampdown on the internet sector.
Outlook
We remain extremely positive on the long-term outlook for the region. The rise of the Asian middle class, accelerated by technology and innovation, continues to be one of the most powerful investment opportunities of the coming decade. As active managers, with long-term time horizons, we are enthused by the number of exciting growth companies we can buy that should benefit from these economic, social and technological changes across the region.
All of this is against the backdrop of Covid-19 from which Asia ex Japan, to use an unfortunate phrase, could be a major beneficiary. The modest financial stimulus and monetary response observed across the region stands in stark contrast to the many trillions of dollars desperately being deployed by western economies as their interest rate structures collapse. For much of the developed world, such profligacy will be a major financial burden for years to come, leading to slower growth and potentially weaker currencies. The majority of Asia ex Japan, with decent growth rates, sensible interest rates and limited balance sheet expansion, looks attractively placed in comparison. It is time to look east.
PHI : Another strong year for Pacific Horizon despite departure of long-standing manager