Asia Dragon (DGN) has published its annual results for the year ended 31 August 2024, during which the MSCI AC Asia ex Japan Index rose 12.0% in sterling total return terms, while DGN’s net asset value (NAV) increased 9.3% on the same total return basis. The share price rose from 353p to 404p over the year, which, with dividends added back, yielded a total return of 16.7%. This reflected a narrowing of the discount to NAV to 10.8% as at the year end, from 16.2% as at the previous financial year end. DGN admits that it posted mixed returns over the reporting year, with initial weakness in late 2023 but with performance stabilising by August 2024. It says that the stabilisation followed a portfolio “reset” after the merger with abrdn New Dawn Investment Trust plc in November 2023, allowing the larger portfolio to invest in Australasia and up to 30% in non-benchmark holdings.
This broadened investment universe flexibility enabled the manager to invest in quality stocks that had previously been inaccessible, positively impacting performance. Key contributors over the year included non-benchmark stocks like ASML and ASM International in the semiconductor and technology hardware segments. As AI-related apps and chips start to proliferate, rising demand in terms of usage and complexity is boosting the semiconductor and consumer electronics segments. Other key contributors included Taiwan Semiconductor Manufacturing Co, power testing services provider Chroma ATE and passive component supplier Yageo in Taiwan, as well as Indian real estate group Godrej Properties.
China was the biggest detractor from performance over the first half of the financial year and remained a key detractor for the full financial year. DGN’s manager has undertaken a thorough review of the company’s Chinese holdings, and resized exposures where appropriate. This was implemented in view of the near-term headwinds in China, namely, a slower than expected consumer recovery and a still-weak property sector, amid a broader soft macro backdrop.
Strategic review
In May, DGN’s board announced its intention to undertake a strategic review of the trust, including its ongoing investment management arrangements, the conclusion of which was published on 28 October 2024. Following the strategic review, DGN’s board recommended that it should combine with Invesco Asia Trust (IAT), an investment trust managed by Invesco Fund Managers Limited (IFML), with the enlarged Invesco Asia continuing to be managed by IFML under IAT’s existing investment objective and investment policy. The intention is to offer a partial capital return alongside the rollover into IAT. DGN’s board says that, if approved, the combination will create a vehicle of scale with a diversified shareholder base, a significant increase in dividend for Asia Dragon shareholders who roll over into Invesco Asia and a more competitive management fee. There is also an intention to introduce a triennial unconditional 100 per cent. tender offer alongside ongoing buyback activity by the enlarged Invesco Asia that is expected to help manage the discount [QD comment: we think that 100% tenders leave a trust hostage to fortune as these can fall due at a time where markets are challenging forcing trusts to dispose of assets at depressed valuations, causing them to shrink rapidly at a time when investors should perhaps be increasing their positions. This can be against shareholders’ best interests and can effectively negate one of the key benefits of the closed ended structure in that disciplined investment managers can take a long term view and look through and take advantage of depressed markets.] The proposal is subject to shareholder approval at general meetings to be held in early 2025.
Investment manager’s comments on performance
“As the Chairman notes in his statement, we continued to see macro factors play an outsized role in influencing investor sentiment and equity markets across Asia and globally over the review period. These included a slowing China amid a slower than expected consumer recovery post-Covid and property downturn, US monetary policy trajectory and geopolitical uncertainty. At the same time, we saw optimism over potential US rate cuts, signs of resilience in corporate earnings and strength in the technology sector. Over the 12 months to 31 August 2024, the MSCI AC Asia ex Japan benchmark index rose 12.0% in sterling total return terms, while the Company’s net asset value (“NAV”) increased 9.3% on the same total return basis after accounting for dividends.
“Over the financial year, we witnessed mixed market fortunes across the Asia Pacific ex Japan region (see chart 1 below). Within the China market, we saw a meaningful style rotation out of quality into value, and a chase for thematic names with AI and state-owned enterprise (SOE) reform in vogue. The Hong Kong market bore the brunt of the spillover impact, which was also exacerbated by heavy foreign capital outflows. In contrast, Taiwan and India were the best performing markets. Taiwan benefitted from a big uplift in optimism around a semiconductor sector turnaround and positive demand trends in AI applications. India’s strength was supported by a resilient macro backdrop, including a property boom, strong urban consumer sentiment, and robust infrastructure capex.
“Against this backdrop, the portfolio posted mixed returns with a weak start but stabilising performance towards the end of the financial year. We highlight three key areas of performance drivers: China and Hong Kong, technology and finally India.
China and Hong Kong
“Together, China and Hong Kong were the biggest detractors, where our still significant exposure to the Chinese consumer weighed on performance (see Chart 2 below). We do like many of the domestic consumption-oriented companies in China. They have been largely insulated from the geopolitical headwinds buffeting the country for years now. They have also been broadly aligned with domestic policy and the multi-year effort to shift China’s economic growth model away from a reliance on exports and investment to one that is domestic consumption-driven. Most importantly, many of these companies are evidently high-quality stocks with great brands, superior margins and return metrics, healthy cash flow and balance sheets. They still offer huge long-term growth potential tied to the rise of the Chinese middle class. However, over the past 18 months, this has not been a rewarding part of the market to be invested in. The Chinese consumer emerged from the pandemic with massive pent-up savings, but this did not convert into spending as China failed to follow the re-opening playbook seen in most other countries around the world. Instead, the gloom around the all-important property sector, in which so much of China’s household wealth is tied up, weighed heavily on consumer sentiment. This was compounded by slowing economic growth and rising job insecurity.
“Policymakers attempted to stimulate consumption and support the property sector, but these moves proved insufficient and consumer stocks and their proxies continued to get punished despite sometimes resilient underlying fundamentals. For example, our holding in Hong Kong-listed life insurer AIA Group was amongst the largest performance detractors despite the fact that it delivered solid earnings growth. Baijiu maker Kweichow Moutai was another such example. Other consumer holdings saw some deterioration in underlying growth given the challenging macro backdrop, for example, quick service restaurant operator Yum China and brewer Budweiser APAC, but this was not commensurate with their declines in share prices, which signalled to us that these stocks had been oversold. As detailed in the Portfolio Activity section below, we tightened up our exposure to the Chinese consumer over the period in light of the headwinds, but retained core holdings given their quality and value. Encouragingly, towards the financial year end, we saw stabilising performance from China and Hong Kong, leading to improved overall performance of the portfolio over the final quarter.
Technology
“We had proactively built up the portfolio’s exposure to the technology hardware sector in anticipation of a rebound in the semiconductor cycle. Our overweight position to the sector significantly contributed to performance, as the sector rallied on a cyclical upturn in semiconductor pricing and strong demand linked to AI. Contributors included several of the Company’s Taiwanese holdings, namely leading passive components maker Yageo Corp and semiconductor chip manufacturer Taiwan Semiconductor Manufacturing Co (TSMC). Both companies posted better than expected results in the first quarter of 2024 and TSMC raised its medium term guidance thanks to the rapidly growing contribution from AI-related demand. Elsewhere, our non-benchmark Netherlands-based holdings in ASML and ASM International also benefited from improved prospects in the advanced semiconductor industry.
India
“Our Indian holdings were a key driver of positive performance, accounting for 4 out of the top 10 biggest contributors. These were residential real estate developer Godrej Properties, which has been capitalising on the boom in the housing cycle in India; leading life insurer SBI Life Insurance; online insurance aggregator PB Fintech, and Power Grid Corporation of India which operates the majority of the electricity transmission network across the country. All four names have seen robust earnings growth tied to structural growth stories and themes within India that we believe have many years still to run. Rising affluence in India, for instance, is leading to fast-growing premium consumption patterns in areas like financial services, automobiles, food, and personal care, while urbanisation and the current boom in infrastructure development is benefiting property developers, materials producers such as in cement, and industrial and utility plays.”
Investment manager’s comments on portfolio activity
“Throughout this turbulent macro-economic and political period, we have continued to focus on quality companies for both their resilience and long term structural growth potential. Four key areas we wish to highlight are as follows:
China: Scaling back the consumer exposure and focusing on nearer-term cash flow generation and earnings visibility
“China presented us with a dilemma. On the one hand, the headwinds buffeting the Chinese consumer were strong, making life hard-going for even the best-run companies (see Chart 4 below). On the other hand, investor sentiment towards the consumer sector and its proxies was so poor that it was also clear that many of the stocks had been oversold and were trading at very attractive valuations. Whilst we were confident that our companies would weather the storm given their superior quality, it was also difficult to pinpoint any obvious catalyst on the horizon that would trigger a re-rating in the stocks. Balancing these two opposing forces, we chose to reposition the portfolio in China, re-evaluating more carefully our exposure to the Chinese consumer given the obvious headwinds, whilst also retaining positions in high-quality holdings with strong cash flow generation and solid near-term earnings visibility that were trading at deeply discounted valuations. In some cases, this involved completely exiting certain names where visibility was less clear, including China Tourism Group Duty Free, GDS, Glodon and Wuxi Biologics. However, we also introduced a new name, Asia’s leading online travel agency Trip.com, which was benefiting from the recovery in both domestic and international travel and has a long runway for growth. Overall, our decisions resulted in a reduced exposure to China.
India: increased exposure with new initiations across broad swathe of sectors
“India stands in stark contrast to China, being perhaps the most attractive macro-economic story in the region currently, with accelerating economic growth and sound macro-economic indicators (see Chart 5 below). The dilemma for us in this market is that much of that positive story has seemingly already been priced into the market, with few quality stocks trading at attractive valuations. We have been highly cognisant of the valuation challenge, but selectively we were still able to find multiple new ideas centred on companies benefitting from the economic tailwinds and delivering robust earnings growth that underpin and support the valuations.
“One good example is Bharti Airtel, a leading telecom service provider with a pan-India reach and sophisticated customer base with higher than average mobile spending. The domestic telecom market has rapidly consolidated and Bharti is now capitalising on the improved economics and rising tariffs in the sector. Another example is Indian Hotels (IHCL), India’s largest hospitality company, which is well placed to tap into the industry’s multi-year upcycle with improving occupancy rates and rising average room rates. We also introduced conglomerate Mahindra & Mahindra, which has been delivering healthy growth in its autos business, with market share gains in the passenger vehicle business, especially within the sports utility vehicle segment. Pidilite Industries was another addition. This is a quality consumer and specialty chemicals business with leading brands in the home improvement category that will benefit from the robust recovery in the housing cycle. Conversely, we exited Kotak Mahindra Bank and Maruti Suzuki.
Technology: Broadening exposure to the AI supply chain with a focus on Taiwan and Korea
“We broadened our exposure to the AI supply chain and cyclical laggards, given the positive structural growth outlook for Asia’s technology sector (see chart 6 below). We focused on Taiwan and South Korea, which are key players in the global tech supply chain and benefiting from increased demand for semiconductors, AI and other advanced technologies. We invested in Taiwan’s GlobalWafers, a silicon wafer manufacturer that ranks as one of the global leaders in a consolidating industry. We introduced Yageo Corp, Taiwan’s leading supplier of passive components and the world’s third largest provider. We also added South Korea’s SK Hynix, the second largest DRAM and NAND manufacturer globally by revenues. We view it as well positioned and benefiting from growing demand for high bandwidth memory (HBM) for AI processing, such as machine learning and neural network AI. This reflects our rising conviction in the structural growth memory demand backed by AI.
Vietnam: increased exposure to this attractive non-benchmark growth market
“Finally, we increased our exposure to Vietnam, a non-benchmark market with tremendous long-term growth potential given its young demographics, rising wealth levels and entrepreneurial spirit. More broadly, the liquidity of the stock market has improved through the years, along with market capitalisation, and this has enhanced its eligibility for the Company from a liquidity and risk perspective. The country is also emerging as an alternative supply chain option amid geopolitical uncertainties, attracting foreign direct investment in high-tech sectors, especially automotive and electronics (see chart 7 below). At the time of writing, we have invested in Joint Stock Commercial Bank For Foreign Trade Of Vietnam (Vietcombank), which we rate as among the highest quality banks in the country, with scale, a strong deposit franchise and a good long-term track record. The bank has been able to manage through multiple cycles and deliver growth over time, too. As for fundamentals, it leads its peers in profitability and efficiency, with a higher return on equity, lower cost-to-income ratio and lower cost of funding versus its domestic rivals. This is our second stock holding in Vietnam after FPT Corp.”
Investment manager’s comments on outlook
“The US has elected Donald Trump as its next president, and he has also secured control of both Houses of Congress. Asset prices have moved along with a focus on the reflationary aspects of Trump’s pre-election pledges and promises. We expect tax cuts and deregulation, but also higher tariffs. This could mean higher nominal GDP, mainly via inflation, and potentially higher for longer interest rates. We continue to monitor Trump developments closely, and higher nominal GDP growth and higher-than-otherwise interest rates are the macro implications that we are most confident about for now.
“As for the implications for Asia, it is a complex picture. Trump is likely to drive uncertainty and volatility, but this could also create opportunities for long-term investors. Higher tariffs and barriers to trade are bad news, and this seems likely under Trump. China could be affected, and this might prompt the Chinese government to ramp up domestic economic growth efforts with aggressive stimulus measures. It is also possible that with a more transactional US President, the US and China could arrive at some mutually beneficiary agreement; we should remember the first Trump presidency did see the Chinese equity market outperform. We should not ignore the risks though as unmitigated; the imposition of huge tariff hikes would have a significant impact on China’s economy. Similarly, export markets, too, with trade-oriented countries potentially facing pressure from higher tariffs and limited rate cuts in the US.
“Geopolitical tensions remain difficult to navigate and whilst the world’s focus is on Ukraine and the Middle East, Asia could also see shifts if Trump follows a similar playbook to his first term. So, we are likely to be in for a period of change, uncertainty, and volatility across multiple fronts.
“Asia, however, is a diverse region and it is wrong to paint it with the same broad brush. Largely domestic driven economies like India will be insulated and may even benefit from continued supply diversification away from China. Intra-regional trade continues unhindered. Asia also does not have the macro imbalances that the West is saddled with, so economies should be resilient. And there is still growth. All of which means quality companies should remain structurally well positioned.
“From a portfolio perspective, we believe we are well-prepared for a Trump victory due to our quality-focused stock picking approach. We have tightened quality characteristics, adding names with greater near-term earnings visibility and steady cash flow generation, while reducing and exiting names with less visible earnings. We have managed down our exposure to tariff-related risks. For our China exposure, we have focused on each holding’s ability to defend and grow market share, expand overseas with limited tariff risks, and deliver shareholder returns through dividends and buybacks. We have also reduced our technology exposure. We maintain our conviction in our holdings and their ability to navigate market crosswinds, given their quality and fundamentals.
“Finally, Asia remains home to some of the highest quality and most dynamic companies in the world. The region continues to offer rich pickings, underpinned by long-term structural growth trends such as the rising middle classes, rapid adoption of emerging technologies and continued urbanisation, enabling bottom-up stock pickers like us to deliver sustainable returns over the long term.”ed stock picking approach. We have tightened quality characteristics, adding names with greater near-term earnings visibility and steady cash flow generation, while reducing and exiting names with less visible earnings. We have managed down our exposure to tariff-related risks. For our China exposure, we have focused on each holding’s ability to defend and grow market share, expand overseas with limited tariff risks, and deliver shareholder returns through dividends and buybacks. We have also reduced our technology exposure. We maintain our conviction in our holdings and their ability to navigate market crosswinds, given their quality and fundamentals.
“Finally, Asia remains home to some of the highest quality and most dynamic companies in the world. The region continues to offer rich pickings, underpinned by long-term structural growth trends such as the rising middle classes, rapid adoption of emerging technologies and continued urbanisation, enabling bottom-up stock pickers like us to deliver sustainable returns over the long term.”
