abrdn Asia Focus (AAS) has released its annual results for the year ended 31 July 2023. There are a number of key highlights from the report but we think that the most interesting of these is the announcement that veteran Fund Manager, Hugh Young, chairman of abrdn, Asia Pacific, who has headed up abrdn’s Asia Pacific division for nearly 32 years, has confirmed he will be retiring on 31 December 2023. However, AAS’s portfolio will remain in the capable hands of Flavia Cheong, abrdn’s Head of Equities, Asia Pacific, Gabriel Sacks and Xin-Yao Ng. It is worth noting that Gabriel Sacks and now Xin-Yao Ng have worked alongside Hugh for 15 and 5 years respectively.
During the year under review, AAS provided NAV and share price total returns of 7.6% and 7.3% respectively, modestly underperforming its benchmark, the MSCI AC Asia ex-Japan Small Cap Index, which returned 8.0%. It is worth noting that, since its inception in 1995, which covers much of Hugh Young’s tenure (he has been in place since 1992), AAS has provided NAV and share price total returns of 2,283.6% and 2,158.4% respectively, outperforming the benchmark, which has returned 261.3%, by close to 9x. This performance reflects the staggering growth seen during Asian markets during the period, which Hugh and team were able to capitalise on. AAS is one of the top 5 companies that would have made investors £1,000,000 if they had invested their full ISA allowance from 1999 to 2023 – making it an AIC ISA millionaire. For the year under review, AAS has paid dividends totalling 6.41p (2022 – ordinary dividend 6.4p), with a further special dividend of 2.25p, bringing the total distribution for the year to 8.66p (2022 – 8.0p).
Performance
Although the weaker global economic environment has continued to be challenging for investors, the outperformance of smaller companies in Asia against their large cap peers now stretches several years, with the small cap index outperforming large cap by more than 10% annually over the past 3 years. AAS’s chairman, Krishna Shanmuganathan, says that this is a testament to the benefits of investing in this overlooked segment of the equity market. He also notes that, in the two-year period from 1 August 2021 (the date that the board set AAS’s new benchmark against the new investment policy), the NAV total return has been 6.1%, the share price total return has been 5.5% and the benchmark return was 2.5%.
The sort of high-quality, cash-generative small companies favoured by AAS’s manager have fared well, particularly in countries like India and Indonesia, where structural growth, huge consumer markets and rising adoption of technology led to strong performance from businesses in a variety of sectors, including banking, industrials, IT, and branded consumer products. China has been one of the weaker countries in terms of its performance, but AAS’s manager has been able to take advantage of volatility and attractive valuations of certain high-quality smaller companies to add exposure, from a relatively low base (this was aided by the change of mandate approved by shareholders last year that saw the removal of the limit on company size at initiation). Stock selection was strong in Korea and Taiwan – companies involved in cutting-edge technologies and digital services benefited from a recovery in sentiment towards the IT sector globally, supported by a wave of interest in Artificial Intelligence. Frontier markets such as Vietnam and Sri Lanka also had a pretty volatile ride due to political and economic pressures although ended the period on a much stronger footing, with some of the companies there among the portfolio’s strongest performers.
Dividend and reserves
AAS’s ordinary dividend has been maintained or raised every year since 1998, and the board says that it is firmly committed to the new enhanced and progressive dividend policy approved by shareholders in 2022. Three interim dividends of 1.6p and a fourth interim of 1.61p have been paid in March, June, September and December 2023, totalling 6.41p (2022 – ordinary dividend 6.4p). However, reflecting the continuing strength of dividend generation from the portfolio, AAS’s board is able to declare a further special interim dividend in respect of the year ended 31 July 2023 of 2.25p per ordinary share. This will be paid on 20 December 2023 to shareholders on the register on the record date of 24 November 2023 (ex-dividend 23 November 2023). The special dividend will bring the total distribution for the year to 8.66p (2022 – 8.0p).
The board’s strategy is to maintain the progressive dividend policy of the last 25 years (including with the flexibility to pay dividends out of capital reserves where merited in the future). Following payment of the four interims and special dividend for the year to 31 July 2023, there remains well over a year’s worth of reserves to cover the ordinary dividend.
Share capital and gearing
AAS’s board says that one of the disappointing aspects of its performance is the continuing discount to NAV. During the period the shares have traded at an average discount of -12.5%, which is higher than its long-term average, although in line with AAS’s immediate peers, at a time when investment trust discounts have moved to historically wide levels. Reflecting this, the board has started to buy back ordinary shares in the market for treasury. In total 500,000 shares have been purchased in the company’s financial year (2022: nil), 0.3% of the company’s issued shares (excluding treasury shares). A further 595,000 shares have been purchased since the end of the reporting to date and the board intends to continue with the share repurchase activity. The shares bought back during the last financial year were at a weighted average discount to NAV of -13.5%.
The company’s net gearing at 31 July 2023 was 12.1% with the debt provided by the £30m loan notes and the £36.6 million convertible unsecured loan stock redeemable in 2025. As at 18 October 2023, the latest practicable date, the net gearing stood at 10.2%.
Investment manager’s performance review
“Asian small caps demonstrated strong performance over the 12-month review period to 31 July 2023, despite the volatility across global markets. The benchmark MSCI AC Asia Ex Japan Small Cap Index returned +8.0% in sterling terms over the review period. The Company’s net asset value (“NAV”) and share price, both in total return terms, increased by 7.6% and 7.3%, respectively.
“As your Chair has highlighted earlier in this report, global markets have faced numerous challenges over the review period, including increasing inflation and interest rates (especially in developed markets), concerns regarding a potential global recession and a slower-than-expected China recovery. Nevertheless, Asian small caps have demonstrated remarkable resilience, outperforming their larger counterparts by a significant margin. Over the past three years, the cumulative outperformance of smaller companies in Asia against the large cap index has amounted to a meaningful 38 percentage points (the MSCI Asia ex Japan Small Cap gained 43% in the three years to 31 July 2023, compared with 4.2% for the MSCI Asia ex Japan). Heightened market volatility and macroeconomic uncertainty means our investment process gains even greater significance and we believe the unwavering rigour in seeking out quality has proven particularly advantageous over the 12-month period.
“Our stock selection in India and Indonesia contributed to the positive performance, as both countries enjoyed resilient domestic spending during the review period. India-based engineering and technology solutions company Cyient, has seen a strong recovery in earnings as demand for engineering software and design services bounced-back in the aerospace industry, while margins benefited from management’s restructuring efforts over the past few years. Prestige Estates, a property developer, released robust presales figures thanks to new projects and continued industry consolidation as they look to accelerate growth and become a national player. Similarly, Syngene, a contract research organisation working in pharmaceuticals, biotech and other industries, also benefited from a series of positive earnings reports.
“The company’s strategic investments to expand capacity in biologics manufacturing and discovery services, as well as its solid balance sheet and a low debt profile, contributed to its success over the review period. Shares of Indian downstream oil and gas company Aegis Logistics were especially strong in the last month of the period, as the company released good quarterly results. In Indonesia, Bank OCBC NISP announced robust first-quarter performance, buoyed by asset growth due to an improving economic climate. Other standout performers in Indonesia included Ultrajaya Milk Industry, a more consumer-driven business focused on household dairy products, and fuel distributor AKR Corporindo.
“At a sector level, technology, industrials and financials were positives for the portfolio. A stabilising tech sector and rising enthusiasm for generative artificial intelligence (AI) saw strong performance in both Taiwan and Korea. Positive stock selection in both countries aided performance over the 12 months. In Korea, Park Systems, manufacturer of atomic force microscopy (AFM) systems, was the leading contributor to relative results over the year. AFM has diverse applications in advanced science and technology labs, and the size of the addressable market should grow over time given it is still a relatively new field. Leeno Industrial also generated strong returns, with an anticipated recovery in demand driven by AI and testing initiatives. Meanwhile, in Taiwan, Sunonwealth Electric Machine Industry, which manufactures industrial fans and Taiwan Union Technology, which distributes copper-clad laminate, also contributed to relative performance given an improved outlook for growth. In addition, Vietnam’s leading IT group FPT Corporation advanced over the review period on continued strong results with the company reporting a 21% profit jump in the second quarter, driven by a 29% surge in IT service revenues.
“Elsewhere, our positioning in several other companies also proved advantageous. Shares of Thailand-based TISCO Financial Group performed well as its conservative lending practices over the past few years proved prescient. Sri Lankan conglomerate John Keells Holdings, which operates in sectors including transportation, consumer goods, retail, leisure, property, and financial services, also advanced as a beneficiary of a recovery in tourism and the overall domestic economy in Sri Lanka following the implementation of significant structural reforms.
“On the other side, your Company’s exposure to China and Hong Kong, both among the worst-performing markets, dragged on performance. Consumer-related sectors bore the brunt of the selling and the property sector continued to languish. Key detractors in China included JOINN Laboratories., a drug testing business, and Sinoma Science & Technology, an advanced materials company focused on green energy solutions. Hong Kong-listed banking group Dah Sing Financial Holdings Limited and dry-bulk shipper Pacific Basin Shipping were also weak.
“Our stock selection and overweight positioning in Singapore also weighed on overall performance. Among the main detractors in this market were investment holding company Yoma Strategic Holdings, a conglomerate operating in Myanmar, property developer Bukit Sembawang Estates and nanotechnology solutions provider Nanofilm. The latter reported weak semi-annual results due to slowing demand and high operating expenses.
“Other detractors of note mainly included companies in the consumer discretionary, materials and health care sectors. Malaysian hotel operator Shangri-La Hotels Malaysia Bhd., Indonesia-focused M.P. Evans, which produces palm oil, and Thailand-based Mega Lifesciences PCL came under pressure. In addition, Taiwan-headquartered e-commerce operator momo.com underperformed, in part due to disappointing sales growth and broader concerns about the lacklustre pace of digital sales expansion following the easing of lockdown measures.”
Investment manager’s comments on portfolio activity
“Much the same as we have said in previous reports, market volatility creates price disconnects, which require managers to focus on fundamentals. We have a long-term approach to investing and favour businesses with clearer earnings visibility and stronger fundamentals, focusing on quality companies that are well placed in structurally growing areas, such as healthcare and technology. This approach also helps us mitigate downside risks to growth from inflationary pressures. As such, over the period we have reduced or exited positions where we felt there was less certainty in a company’s earnings trajectory or where those earnings could be less resilient to current macro headwinds.
“Keeping in line with the Company’s focus on quality, we purchased shares in Taiwan’s Sinbon Electronics, which makes cables and connectors for niche markets. The company supplies products and applications to sectors including green energy, industrial applications, automotive, medical equipment as well as communication and electronic peripherals. In a highly fragmented industry, its competitive edge lies in its capabilities to manufacture highly customised products for its diversified customer base, as well as its well-entrenched partnerships with its suppliers and clients. Although its shares were under pressure after the release of its 2023 first half results, we view it as a beneficiary of long-term structural trends such as the Internet of Things, 5G applications and electric vehicles, as well as growing demand for renewable energy, supported by solid order visibility over the next two to three years. The company operates a cost pass-through model which ensures healthy margins and cash-flow.
“Another key purchase was Autohome, a dominant Chinese auto platform with more than 60 million daily active users. It trades at attractive valuations, with just the cash on its balance sheet representing more than 75% of the Group’s total market value, and we see latent potential for consumer spending to pick up in China as the economy re-opens. Autohome has an asset-light business model, delivering comprehensive, independent and interactive content to automobile buyers and owners. Its core business benefits from the powerful network-effect characteristics of a classifieds business and it is the number one player in the market. Its original generated content drives high-quality user traffic, which in turn results in advertising and lead generation. It is also expanding into new areas of business, such as auto-related financing for example and used car sales.
“As covered in our interim report, we added other Chinese companies to the portfolio including seeds & nuts producer ChaCha Food. With well-established brands, the company has high potential for growth as the largely fragmented snacks industry in China presents a consolidation opportunity. As an aside, we engaged with the company over the period to gain visibility on its risk management policies on key environmental, social and governance (ESG) topics, and to encourage the company to issue its first ESG report. We came away with a positive impression given ChaCha’s comprehensive ESG practices in its daily operations, as well as its efforts to improve disclosure and business integration. We also added Kerry Logistics, one of Asia’s largest integrated logistics providers. With its diversified customer base, we believe it is well placed to benefit from supply-chain relocation, e-commerce growth and intra-regional trade in Asia.
“Against these purchases, we exited Pacific Basin Shipping, given the lack of visibility and momentum on shipping rates (despite the compelling supply and demand dynamic). The industry is likely to enter a significant capex cycle, which could also affect shareholder returns. Elsewhere, we sold Douzone Bizon, due to concerns over execution and an uncertain growth outlook, and divested from eCloudvalley Digital Technology, owing to poor disclosure and a slowdown in growth. Other sales included Absolute Clean Energy, IPH, Nazara Technologies and Tatva Chintan Pharma; small positions that we didn’t feel compelled to scale up.”