Over the 12 months ended 31 August 2023, Henderson Far East Income delievered an NAV return of -13.0% and a share price return of -14.8% as compared to a -7.2% return on the FTSE All-Word asia Pacific ex Japan Index and a +0.1% return on the MSCI AC Asia Pacific ex Japan High Dividend Yield Index (which is perhaps the better benchmark). That means that over 10 years, the trust has delieved less than half the return of the FTSE Index in NAV terms (41.7% versus 96.2%) and about half the return of the MSCI Index in share price terms (37.4% versus 72.3%).
In addition, the company’s revenue per share slumped by 14% to 20.92p and it paid an uncovered dividend of 24.2p, up 1.7% on the previous year.
The chairman’s statement seeks to explain what happened and looks again at the company’s strategy for answers:
What happened?
- Investment styles go through periods of being both in and out of fashion. In the low interest rate environment, valuation tended to matter less, and our fund managers valuation-focused investment style has therefore been out of favour.
- China weightings, China stock selection and the timing of our exposure to this important economy and market have been the most significant contributing factors. Since the lifting of Covid restrictions, the pace of China’s recovery fell short of expectations and the negative impact of global supply chain shifts on how Chinese companies would prosper has been more severe. An over allocation to China was exacerbated by our exposure to Hong Kong which has increasingly moved in lockstep with the mainland over the Covid period and beyond.
- The low combined weighting in India, Japan and Taiwan in our portfolio has also had a negative influence.
- Our strong income bias has historically justified this absence but these markets have performed strongly over the period.
- Our overweight exposures to the energy and materials sectors, the latter including investments in copper and lithium which will be in demand to meet ‘green’ targets, have been held back by questions about the rate of economic recovery.
Strategy review
The board holds a formal review of the investment strategy at least annually. It has several points to make:
First, that the strategy to provide an attractive, growing dividend without giving up the potential for a degree of long-term capital growth remains both appropriate and achievable. As in the past, the aim is to achieve this objective by identifying a combination of companies with high and sustainable cash flow generation and dividends, and those achieving growth that are predicted to be the high yielding companies of the future. As dividend growth in the region slowly returns to its historic trend next year, the board believes that prospects for the future will be much improved.
Second, while it believes the broader strategy remains correct, it has sought to refine the process used to achieve the objectives. Income returns from stocks have been significantly undermined by the strength of sterling, especially over the last year. The manager had sought to enhance income and offset sterling strength through portfolio rebalancing but this had a negative impact on capital growth. The board’s analysis has now led it to revise the way in which the trust captures dividends, an approach that has too often led to diminished capital growth. The manager has now largely restructured the portfolio with the aim of allowing the renewed growth in portfolio company dividends to come through along with better capital growth returns. Through this transition period, the board will use distributable reserves to supplement the dividend.
The manager’s report comments on how to re-establish a long-term record of capital growth in more detail.
Third, strong sentiment around China’s reopening prospects in the fourth quarter of 2022 reinforced the manager’s long-term investment case for the market and supported a significant position. While the economic power and potential of many Chinese sectors remains compelling, macroeconomic influences have ultimately overwhelmed some robust fundamentals, with broader market sentiment now muted on the market. Further, there is increasing homogeneity between the markets of Hong Kong and China. With this in mind, and with the dividend culture in other markets including India improving rapidly, the trust is broadening its scope to include more companies from elsewhere in the region.
Change of manager
The board has agreed that now is the right time to pass the fund management leadership role to Sat Duhra. It has full confidence in Sat’s ability to manage the portfolio going forward, and he has been part of a long-standing succession plan having been co-manager since 2019. Mike Kerley will be retiring from the asset management industry in June 2024 and will support Sat to ensure a smooth transition process. Mike has played a critical role in the company’s historical development and the board would like to thank him for his many contributions over the years and wish him well in all his future endeavours.
Board refresh
Susie Rippingall and Carole Ferguson will join as members of the board with effect from 1 December 2023. Susie is an investment professional with more than 25 years of fund management experience in Asian markets. Carole has extensive experience in the financial services sector in research, finance and sustainability. David Mashiter will be retiring at the conclusion of the forthcoming annual general meeting.
Extracts from the manager’s report
The scars of the Covid-19 pandemic continued to be uncovered as evidenced by the magnitude of the shock to supply chains, which was unanticipated by investors and contributed to the initial rise in inflation data. However, it was manner of the response to Covid-19 in China and the subsequent weak recovery once restrictions had been lifted that produced the greatest impact on our performance. We had expected to capitalise on a strong recovery in China once the economy re-opened after a period of strictly enforced restrictions, however, this failed to materialise and our China consumer holdings suffered as a result. In addition to that, a steady flow of negative macroeconomic data, property sector defaults and concerning levels of leverage at local governments impacted sentiment towards our other holdings in the country. Our performance in China in recent years has been unsatisfactory and we are in the process of re-positioning this part of our portfolio towards higher quality growth names, which are now attractive on valuation, and come with a genuine domestic advantage and growing dividends.
Our investment style aims to take advantage of market mis-pricings where we believe the Net Present Value of future cashflows is not reflected in the current share price. However, this style has been distinctly out of favour in recent times as demonstrated by the outperformance of growth over value in most markets. Despite interest rates rising and therefore the cost of capital increasing in equity valuations, the emergence of themes such as Artificial Intelligence (‘AI’) have supported the thesis of higher growth into the future boosting the valuation of many expensive stocks. We expect this to reverse as rates remain higher for longer, pressuring the high valuation of many growth names. However, this may not transpire to the same degree in China where value names are more intrinsically tied to the fortunes of the economy versus underlying operational trends given that much of the high dividend universe are State Owned Enterprises (‘SOEs’). The structural issues faced by China, amplified by the collapse of the heavily indebted China Evergrande Group and subsequent defaults, combined with the collapse in property volumes and the ensuing impact on local government fiscal positions, have dampened our enthusiasm for high yield value names in China. We have begun the process of adding more attractive growth and yield names in other markets such as Indonesia and India where there is less regulatory risk and a much clearer path to growth without the structural impediments currently faced by China. Notwithstanding this we expect to continue uncovering opportunities in China, especially at the current depressed valuations.
More generally the rapid rise in interest rates has, unsurprisingly, created problems most notably in the regional banks in the US and the UK pension industry where the belief that interest rates would remain low indefinitely, were brutally exposed by the dramatic central bank moves. Consumer spending has slowed but remained more resilient than many expected as savings accumulated during the pandemic have offset the higher cost of food, energy and mortgages. This, though, has probably delayed the economic slowdown rather than postponed it. The World Bank expects global growth to be 2.4% in 2024 with the contribution from developed economies only 1.2%. The US is expected to grow by 0.8% and the EU, by 1.3%. All recent revisions have seen 2023 adjusted upwards and 2024 downwards, reflecting the lagging nature of this cycle’s monetary tightening.
The inflationary impact in Asia has been less pronounced. Most countries in the region did not receive the same fiscal support as the western world during the pandemic and, as a result, excess liquidity did not push up asset prices and wages in the same way as elsewhere. Labour shortages and supply disruptions were also less pronounced. As a result, the rise in inflation was caused mostly by rising food and energy prices and, as these have fallen, central banks in the region have started to ease rates. In short, Asian economies have had to raise rates less than their western peers and will be reducing them sooner. However, there are exceptions. Australia, New Zealand and Japan are three as they share greater similarities with advanced economies, compared to developing Asia.
Despite superior fundamentals, the performance of the region has been disappointing with Asian markets significantly lagging the 5.3% positive return from the S&P 500 and 7.9% return from the FTSE 100 over the Company’s financial year. The weakness of China is partly to blame, but the strength of the US dollar and a tightening of liquidity from higher interest rates has prompted flows away from equities as there are now attractive returns to be achieved on cash and lower risk bonds. The other phenomenon that has distracted growth investors is the rise to prominence of AI. A large proportion of positive returns, especially in 2023, have been derived in this area as borne out by the strong performance of the ‘Big 7’ US technology stocks (Microsoft, Apple, Google, Meta, Amazon, Nvidia and Tesla) compared to the rest of the market. Although Asia has some beneficiaries of this trend, most notably in Korea and Taiwan, the region as a whole could be seen as a net loser from AI as funds flow to more attractive, if less quantifiable, growth alternatives.
China was the weakest market in the region, although it rallied over 40% in local currency terms following the removal of the Covid restrictions at the end of October 2022. It has subsequently fallen almost 15% by the end of August. Although there are clearly headwinds associated with slower global trade and US sanctions/ geo-political risk, a number of problems within the China economy are self-imposed. The clampdown on the property and education sectors, in a valiant attempt to address wealth inequality, together with regulatory probes on private enterprises in the technology sector, have sapped confidence. After being locked-down for almost three years during the pandemic, while their largest asset (property) decreased in value, the Chinese consumer is reluctant to spend and, unlike their counterparts in the west, have continued to save. The Chinese government has begun introducing various measures to stimulate demand and to shore-up the finances of property developers, local governments and households. All the while cutting interest rates and bank reserve requirements to ensure the system is sufficiently liquid. As yet, there are no meaningful improvements. Having said that, the industrial production, manufacturing PMI (purchasing managers index) and industrial profits data in September suggest a mild improvement while anecdotal evidence of travel expenditure and consumer trends during the Golden Week holiday at the beginning of October, are somewhat encouraging.
The biggest positive contributions over the period were Bank Mandiri in Indonesia, Lenovo and Samsonite in China and Hong Kong, NTPC in India and Goodman Group in Australia. Detractors from performance were predominantly China based consumer discretionary stocks; JD.com (e-commerce) and Li Ning (sports goods) fell over 50%, while China Yongda (passenger vehicles) over 40%, China buildings material company CNBM also fell over 50% while Digital Telecommunications in Thailand fell more than 30%.
HFEL : Woeful results from Henderson Far East Income spell change of manager