Redmayne Bentley Publications Podcast May 2024

We are pleased to present the audio version of our May 2024 edition of Market Insight.


 

TRANSCRIPT

Welcome to the audible version of Redmayne Bentely’s Market Insight publication. Our May 2024 edition of Market Insight focuses on the Asia Pacific region, and two investment trusts which invest within it.

Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance. There is an extra risk of losing money when shares are bought in some smaller companies. Redmayne Bentley has taken steps to ensure the accuracy of the information provided. Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares and investments mentioned.
 
Our Leader Article, Asia Focus, was written by Alastair Power, Investment Research Manager.

On a quarterly basis, investment managers across the Redmayne Bentley network come together for a session led by our research team to look at specific areas of the financial markets. Each session focuses on an asset class or region, discussing both perceived opportunities and pain points within portfolios. For the most recent quarter, Asian equities were under the spotlight given lagging performance of the broader region, concerns around economic issues in China, and the recent strong performance of the Indian market.
 
Allocations to the Asian markets are most likely achieved through a broad regional strategy, via either an open or closed-end fund. These Asia Pacific ex-Japan strategies provide high levels of diversification across countries, with the frequently used benchmark MSCI Asia ex-Japan offering exposure to China, India, Taiwan, Australia, and South Korea, amongst others. Within the allocation, the choice between China and India remains a frequent discussion point, with either overweight or underweight allocations to the two countries scrutinised closely.
 
Going back to late 2020 and early 2021, Chinese and Indian equities, represented by the MSCI China and MSCI India indices, were showing somewhat similar performance in local currency terms. More recently, however, these markets have diverged, forming something akin to a crocodile jaw chart with India moving higher and China lower.
 
While the Chinese market has been struggling, India’s has been hitting new highs, with the MSCI India index up approximately 67% in the three years to the end of April, easily outpacing the near 20% of the S&P 500. Strong demographic tailwinds and a rising middle class consumption story are key drivers of Indian equity performance along with an urbanisation trend and government reforms to areas such as infrastructure spending and foreign direct investment. With current discussions seemingly focused on either China or India, it’s important to remember that opportunities in the Asia region are greater than these two nations alone. Taiwan remains a key player in the global semiconductor industry. South Korea hosts some of the world’s largest companies such as Samsung and Hyundai and is currently undergoing a new ‘Value-Up’ program implemented by the nation’s Financial Services Commission. Countries such as Thailand and Indonesia have leaders in both transport and financial services.
 
The Asia Pacific region is extremely diverse, both geographically and in terms of investable companies. Purchasing shares of companies in the likes of South Korea, China, and India can be best described as challenging, prompting some to focus on investment funds. In our Stock Focus article, we shine a light on two: Pacific Assets Trust and JP Morgan Asia Growth & Income. Each approach investing in the region in an entirely different manner, with distinctly opposing portfolio allocations. While the way investors gain exposure to the Asia Pacific region will differ, there is still optimism for the region. Top-down country specific stories are likely to hold the attention of many, and for good reason, but with such a variety of opportunities, focusing on the companies over the countries may be sage advice.
 
Asia Pacific And Emerging Market Outlook was written by Greg Lodge, Performance and Risk Analyst.
 
The Asia Pacific region is one that investors may be ill-advised to ignore. The region contains some of the wealthiest and most populous nations on the planet. Giants of the East, India and China lead the pack in terms of population, while Japan and South Korea are among the wealthiest in the region. When we also consider the growth potential of developing nations such as Thailand, the picture becomes more complex and interesting. Their respective governments, alliances, economies and prospects differ widely.
 
Notionally communist, China is also the world’s second largest economy. Relations with the West have waned in recent years. In 2023, it lost its crown as largest country by population to India, a developing democracy with a younger demographic. Japan is uniquely stable with strong ties to the West and increasing cultural power. South Korea is the home of family-run conglomerates, or ‘chaebols’, some of which have become global household names, such as Samsung, Hyundai and LG, and yet it must be wary of its neighbours north of the border. In southeast Asia, Thailand has seen a tourism boom and a growing middle class. While the geopolitics can be tricky to navigate, the Asia Pacific region has an enormous impact on every market sector, from shipping to advanced electronics to luxury goods. There may be opportunities aplenty, and how we position our portfolios to take advantage of this needs careful attention. Let’s take a look at some of the factors in play.
 
The big question in wealth management currently is: India or China? These emerging market giants have seen their paths diverge so far this year, evident by India’s S&P BSE 100 index surging ahead of the China CSI 300 index. The results of the 2024 Indian general election are due in June, with incumbent Narendra Modi expected to win a third term. In his campaign, Modi has been keen to highlight his plans to transform India into a fully developed economy by 2047, the centenary of India’s independence, with a range of reforms and business-friendly policies. He has pointed to India’s infrastructure development over the last decade and increasing interest from multinational companies such as iPhone manufacturer Foxconn as an alternative manufacturing hub to China. The Indian government has set a target to expand the country’s electronics output to US$300bn by the middle of 2026.
 
With such growth-oriented policies and potential, it comes as no surprise that the Indian stock market has seen a strong upward trend in recent years. The MSCI India index has grown by 141% in ten years. Corporate earnings have been strong, and the total value of the equity market now exceeds that of Hong Kong. There is concern in some quarters, however, that valuations are becoming too high. Consider Hindustan Unilever, which is trading at 50 times earnings per share. An expensive stock can be justified if the underlying sales growth is strong, but here it is flat. As an investment, you are not getting a lot for your money. In addition, some large caps have a very low free float – i.e. shares that can be publicly traded and are not held by insiders - which could be exacerbating this effect, with many shares still held by controlling founders and families.
 
Between India and China there is also something of a divergence in demographics. While China’s infamous ‘one child’ policy was revised in 2016, the country is now seeing a declining birth rate and the population is starting to decrease. In 2023, deaths in China exceeded births by two million. As the pool of working age people decreases, this results in lower tax revenue for the state combined with increased spending on pensions and social care. While China is by no means alone in experiencing this phenomenon – Japan, Italy and indeed the UK all face the same problem – such demographic changes are not conducive to GDP growth. By contrast, India has a growing population, and one which is increasingly moving to urban centres. The large pool of workers in India’s growing cities is a sign of growth and is contributing to positive investor sentiment.
 
There is of course more to Pacific Asia than China and India. Once an impoverished rural society, South Korea has grown at an average of 6.4% between 1970-2022, driven by family-run conglomerates and manufacturing. In 2018, South Korea’s GDP per capita overtook that of long-time rival Japan. This longstanding economic boom looks at risk, however, as the Bank of Korea has warned that annual growth is on track to reach 2.1% in the current decade before beginning to shrink into the 2040s.
 
While there has been some resistance to reforming a model that has worked so well for so long, reforms have been introduced. As part of the drive to maintain growth, in February of this year the Financial Services Commission announced support for the three pillars to help listed companies enhance value. These are: disclosure on ‘Corporate Value-Up’ plans, supporting investors to assess company initiatives and performance, and a dedicated support system to implement the ‘Value-Up’ plans over the medium to long term. In addition to these market reforms, to capitalise on the global demand for microchips, a US$471bn mega site is under construction near the capital, Seoul. Wary of being overtaken by rivals, the South Korean government has supported the initiative in what President Yoon Suk Yeol as described as a ‘semiconductor war.’ The 1,000-acre site has had financial backing from several chip manufacturers including Samsung Electronics, which has invested US$220bn into the project.
 
Investors should also consider the emerging markets in the region. Indonesia, made up of over 17,000 islands and which has the world’s fourth largest population, is benefitting from some favourable tailwinds. Similar to India, it has a large, young and increasingly urbanised workforce. It is also politically stable and has relatively stable inflation. As such, it has seen strong and consistent GDP growth in recent years. One case study is PT Bank Rakyat, one of Indonesia’s largest financial services providers. It operates through four sectors, but the most interesting to investors is its micro segment. Under this business division, it has over 35 million small borrowers, which gives it an extensive network and access to customer data. It has successfully rolled out a recent app which has reached over 31 million users so far. The non-performing loan ratio is low, at only 3.12%. Earnings per share has grown steadily over the past decade, and currently sits around 342 Indonesian Rupia (Rp).
 
The sheer size and complexity of the Asia Pacific region means it can be difficult to monitor, but investors should nevertheless pay attention as it is these same factors that bring the opportunities.

Our Stock Focus article, Investment Trusts and the Asia Pacific, was written by Konrad Pietka and Samantha Cory of the Investment Research Team.

Over the past three decades, the Asia Pacific (APAC) region has been home to many of the world’s great growth stories: China, India, and the Asian Tigers, to name a few. They all played their part in transforming the region into a global manufacturing and trade hub, pulling the epicentre of the global economy eastwards. This is evidenced by the rise in the region’s share of world GDP from 27% to 37% between 2000-2021. Despite this swift ascent up the global rankings, Asia Pacific (APAC) continues to sit outside the investment world’s top flight, accounting for approximately 17% of the MSCI All Country World Index. For this reason, we thought it would be worth highlighting two investment trusts which can provide exposure to the region, namely Pacific Assets Trust (PAC) and JPMorgan Asia Growth and Income (JAGI).
 
Pacific Assets Trust is a UK listed investment company seeking to deliver long-term capital growth for shareholders. Stewart Investors, investment manager of the company’s assets, seeks to invest in high-quality companies within the Asia Pacific region. Sustainability and quality are the two pillars underpinning the fund’s strategy, along with a focus on companies managed by long-term stewards of capital.

The trust remains highly differentiated from its peers, adopting an absolute return focus with performance benchmarked against UK Consumer Price Inflation (CPI) +6% per annum as opposed to the relevant equity index. In terms of geographic exposure, PAC holds a noticeable bias towards India, with just under half the company’s assets invested in the country. Even though India has benefitted from demographic and economic tailwinds, it is bottom-up stock selection which has resulted in this sizeable portfolio position, instead of a top-down macroeconomic analysis. The fund’s management believes that sustainability is the main determinant of a company’s long-term performance, being both a driver of returns and mitigator of risk. When assessing sustainability, a firm’s environmental, social and governance (ESG) credentials are considered, alongside balance sheet strength, franchise quality and stewardship.
 
Given the trust’s ten-year investment time horizon, stewardship quality is of vital importance, with effective stewardship perceived to aid in limiting capital loss and downside risk during drawdown periods. PAC’s underlying holdings lean towards those with an economic steward, be that family, foundation, or an entrepreneur. These stewards have a long-term vested interest in the business; their reputation is on the line, and they have an aspiration to grow their franchise for decades to come. Take Mahindra & Mahindra, a farming equipment and automotive conglomerate run by the third generation of the founding family with a market cap of US$36bn. It is a dominant player in India’s tractor market, driving the country’s agricultural sustainability and productivity push. Moreover, it seeks to diversify its revenue stream by investing in a range of sectors, from clean energy to IT outsourcing.
 
While the portfolio remains diversified and quality focused, there is clearly a large exposure to India, a factor likely to put some investors off given the higher valuation multiples currently showing for the MSCI India index, especially when compared to the broader Asia Pacific Index. With so many opportunities available across Asia, opting for a more geographically diversified portfolio is entirely understandable.
 
In contrast to Pacific Assets Trust, JPMorgan Asia Growth and Income investment trust offers a broader exposure to Asian equity markets, alongside an income stream through an enhanced dividend policy. Capital growth remains the focus and the enhanced dividend policy offers additional income for shareholders, by paying dividends equating to 4% of last year’s final net asset value (NAV) in quarterly instalments.
 
Looking at the specifics, the portfolio managers of the trust’s assets seek to invest in a mixture of quality growth companies, core franchises and restructuring stories. Its biggest holding is a name which you may have heard a lot of in the past year: Taiwan Semiconductor Manufacturing Company (TSMC). With the current economic landscape so heavily focused towards artificial intelligence, it makes sense that the company has 9.8% of its portfolio invested into this area.
 
Taking a high-level snapshot of the portfolio, regional allocations show small deviations from the benchmark. Having held a recent overweight allocation in China, the trust has been gradually reducing this exposure and is currently underweight to the benchmark. The reasoning behind this is the downturn experienced in the Chinese property market, a key pillar of the Chinese economy which, since 2021, has experienced a slump in prices and demand. The gloomy sentiment has been exacerbated by recent geopolitical and regulatory developments, dissuading many from investing in the region. That said, there are many quality companies remaining in this space, such as the Chinese video game company, Tencent. Despite the growing China anxiety, Tencent has materially outperformed the Hang Seng index for several years and demonstrated strong growth, doubling its earnings per share from HK$10 to HK$21 since 2019.
 
Instead, the trust is allocating into South Korea, where it remains optimistic about the ‘Corporate Value-Up’ initiative from the Financial Services Commission, implemented to incentivise family-owned conglomerates (chaebols) like LG and Hyundai to become more committed to corporate governance, sustainability and social responsibility standards. Traditionally, the chaebols have prioritised control over minority shareholder interests, but investors hope this will change and help to narrow the long-term valuation discount of the Korean market to other Asian markets.
 
Looking to the future, the trust holds an optimistic outlook for Asian equity markets, as falling global inflation could allow Asian central banks to cut interest rates, supporting economic growth and a possible increase in domestic equity investments.
 
To conclude, both PAC and JAGI offer exposure to high quality Asia Pacific companies, but with distinct flavours. PAC’s emphasis on stock quality and sustainability renders it sector apathetic, resulting in a heavy weighting in India due to the amount of attractive investment opportunities there. Small and mid-cap companies also form a significant chunk of the portfolio. In contrast, JAGI’s broader requirements for investable companies enables more flexibility of exposures within the region, aided by a quarterly dividend distribution for shareholders. However, these differences make both investment vehicles quite complementary. They can be used jointly to provide access to a range of high-quality and ESG conscious businesses across the world’s fastest growing equity markets. Alternatively, they can also act as standalone vehicles, helping to reap the benefits of the economic transformation in the APAC region, with both funds outperforming their benchmarks over a 10-year period.
 
Pacific Assets Trust and JPMorgan Asia Growth and Income are just two of a wide variety of investment trusts which can hold a focus on the Asian market. The extreme diversity of countries, industries and individual companies undoubtedly makes Asia an interesting region, however, readers should always conduct their own research regarding the topics highlighted within Market Insight to assess if a particular investment is right for them.
 
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