Schroder Asian Total Return has published what it describes as a disappointing set of results for the year ended 31 December 2022. The NAV total return was -12.7%, underperforming its performance benchmark which fell by 7.1%. The share price total return was -17.4%, as the shares moved from trading at a premium to NAV at the start of the year to a discount. Having started the year issuing stock, the board switched tack as the discount widened and 3,851,448 shares, amounting to 3.5% of the issued share capital, were repurchased, at an average discount of 5.1%, for a total consideration of £15.7m.
The revenue return from the portfolio for the year increased by 34.8% to 12.47p and the board has recommended a final dividend of 11.0p, an increase of 29.4% over last year.
Extracts from the managers’ report
Detractor #1: Taiwanese and Korean semiconductors
Perhaps unsurprisingly, the company’s large positions in Taiwanese and Korean semiconductor (foundry and fabless) companies top the year’s list of negative contributors. Stellar contributors to the Company’s outperformance in 2020 and 2021, the last year has seen a reversal of fortunes as these very same holdings handed back a third of the combined alpha that they had generated in the previous two years. For your portfolio managers, the investment thesis here has always been clear. We are bullish on the longer-term trends of automation, electric vehicles (“EVs”), Internet of Things (“IoT”), artificial intelligence (“AI”), cloud migration and digitalisation; we see a structural uplift in semiconductor demand that underpins the long-term earnings of these companies and engenders their future shareholder value creation. Being world leaders in a fast-consolidating industry, the continued investments into R&D by these firms, as well as the reasonable valuations they trade on, further boost our conviction in them.
Unfortunately, short term share price performance was not to be. The global slowdown, particularly in the consumer technology space (computers, smartphones, televisions etc), has led to a large build up in inventories and downgrades to earnings forecasts for the Asian technology sector. However, even after the humbling share price experience of these names, we have seen little that has fundamentally shaken our confidence in our long term investment thesis. With hindsight, and being more critical of ourselves, the lesson learnt here is that we should have been more cognisant that nothing goes up in a straight line and that even in a structural uptrend, there will still be mini-booms and busts along the way. This means that we should have been more ruthless in trimming the company’s positions when the upsides to the fair values of our names narrowed, particularly at the end of 2021 when an element of froth entered the market. Lesson here is do not get too caught up in hubris and be disciplined about trimming stocks as they approach our fair values.
Detractor #2: Indian stock selection
The second drag to the company’s performance last year was the stock selection in India. This detraction stems not just from the stocks that were held in the company, but also the ones that we did not hold. The company holds a long-term position in the Indian IT consulting industry, a traditional Indian stronghold that benefits from the rapidly-unfolding trends of corporate digital transformation and IT modernisation. Unfortunately a lull in IT spend by Western clients last year has put a temporary dent in the project pipelines of these Indian IT companies. Worried about the Ukraine war and concerned about an impending recession, some customers have slowed their digital transformation plans. Given that for most companies these projects are essential for long-term competitiveness we believe it is only a matter of time before these projects resume. Even before COVID hit, 92%1 of companies surveyed by McKinsey already thought that their business models were in need of an overhaul given how disruptive an economic force digitalisation had become. We therefore do not see this near-term cyclical weakness derailing customers’ longer-term technology ambitions and we believe Indian IT companies are well placed to take market share given their substantial labour cost advantage and the huge pool of young, well-educated engineers they can draw from.
What was perplexing to your portfolio managers were the parts of the Indian market that performed strongly in 2022. The Indian consumer sector, where stocks often trade at bubble like levels, continue to do well despite muted, and in some cases contracting, earnings. The other perplexing sector was the Adani group companies, which over the last two years have been on a massive acquisition spree across industries as diverse as cement and media. This not only propelled corporate debt to giddying levels but also drove share prices for the various group companies to stratospheric heights on the back of a retail driven investor frenzy. At the time of writing (February 2023), accusations of accounting fraud and share price manipulation have been raised and this has caused an overdue collapse of this bubble at least.
Detractor #3: US housing-related plays
The last major drag on the company’s performance last year was our holdings in a few US housing-related plays, particularly power tool giant Techtronic, window blinds manufacturer Nien Made, fibre cement siding leader James Hardie and plumbing fittings expert Reliance Worldwide. The poor near term performance was perhaps not surprising. After all, the average 30-year mortgage rate in US was only about 3% in mid-December 2021. By December 2022 though, the average rate has already more than doubled to 6.3%. A swing in interest rates of this magnitude will always cool some demand in the market. Long-term we remain bullish on the sector. A significant lack of housing inventory in the country persists, and this means that long-term demand for US housing remains well-supported. More importantly, our original investment rationale of these companies being intangible giants who are building ever-widening economic moats via continual investments into R&D remains intact. As such, we view the loss of performance here as more of a cyclical blip than a structural concern.
Hedges, debt and net exposure management
It has not been all bad news for the company. On the brighter side, our hedging strategy and net exposure management yielded a positive contribution of c.20 basis points last year. That said, in a year like the last where the market has fallen by double-digits, we would normally have expected a better outcome. This is particularly frustrating as the calls by our hedging and proprietary valuation models were, by and large, correct over the course of 2022. Unfortunately in this instance we were constrained by the exorbitant prices demanded on put options through much of the year, which meant that we were only able to buy hedges cheaply on a few rare days. Put options are contracts that the company uses for hedging purposes in order to try and provide some capital protection if our models indicate that markets could correct.
The company was approximately 5% to 10% geared throughout 2022. However until early October 2022, with the company’s proprietary valuation and hedging models cautious or neutral on Asian stockmarkets, we sold index futures to bring the company’s net exposure back to a neutral (100% invested) position. In October 2022 with Asian stock markets very weak, around the time of the Party Congress in China, the proprietary gearing indicators flashed BUY so we took the company to a 10% geared position by removing all hedges and adding to stock positions. The company then remained at c.10% debt from October to the end of 2022.
ATR : Disappointing results from Schroder Asian Total Return