Asia ex-Japan investment trust discounts widen

Matthew Read QuotedDataThe economic slowdown in China is impacting other countries in Asia and the developed world, and hopes of growth in consumer spending and the services sector coming to the rescue are fading. Rebalancing the economy away from infrastructure investment and traditional industrial drivers, while cushioning the services sector and allowing new industries to develop, is a challenge facing policymakers trying to save the faltering economy.

Earlier actions seem to have encouraged reckless borrowing by many companies and some of the policies aimed at shoring up the economy have instead boosted the Chinese stockmarket, creating a challenge for managers.

The long-term consumer story in Asia is still a convincing one however. Trusts investing in the Asia ex Japan region have experienced a widening in discounts in recent times, meaning these trusts represent better value, and taking a look at the sector there are some standout offerings.

The new manager of Fidelity Asian Values, Nitin Bajaj, who took over the trust in September, is one. He favours companies exposed to the structural growth story of the emerging middle class in Asia and therefore the company has a large allocation to the consumer discretionary sector.

There are other factors working in the region’s favour. Bajaj notes that many countries have accumulated healthy foreign exchange reserves so that their financial systems are more robust than before, and currencies are no longer pegged to the dollar but float relatively freely. Businesses are in better shape, with cost cutting progressing, and companies outside the commodity sector are generally enjoying margin expansion.

Bajaj typically looks for companies that can return 50 per cent over three years. He is also willing to deviate from the fund’s benchmark. While that might add more risk to the portfolio the number of holdings has increased from 60 to 100 over the past three months, boosting diversification.

The emphasis on fundamental deep dive research is clear in the increased focus of the trust on smaller companies, where the new manager believes this less well researched area of the market will allow him to find hidden value. Exposure to companies with a market cap in excess of $10bn (£6.6bn) has been reduced heavily in favour of companies with market caps up to $1bn.

The manager, alongside others in the sector, reduced the weighting to China prior to the August correction to protect the portfolio. He had valuation concerns and thinks it’s difficult to get reliable information for many companies in China.

Exposure to South Korea has been reduced, while the largest increase has been to India, where the manager has past experience of running pure Indian portfolios. As a primarily domestic economy, Indian equities and the rupee have held up better in the recent sell-off than countries that have staked their growth on supplying China with commodities. India has also been a beneficiary of weaker oil prices.

Also in the Asia ex Japan sector is Edinburgh Dragon, one of the largest investment trusts. It buys high quality companies principally through investment in larger stocks. The trust is more narrowly focused with a lower turnover than Fidelity Asian Values, but has a similar outlook on China.

In its annual results for the year to 31st August, Edinburgh Dragon’s underweight exposure to China was among the biggest detractors from performance. The Chinese market outperformed other regional markets during the period with initial gains exceeding the losses from the late sell-off. The manager, Adrian Lim, has been selective about investing in China because of what he sees as a dearth of quality companies as well as the impact of heavy state intervention.

The low interest rate environment in China and elsewhere in the developed world has, according to Edinburgh Dragon’s manager, provided support for otherwise challenged companies. In China, this is a particular issue where it is believed overcapacity exists in a number of sectors, resulting in inflated valuations of companies that could suffer a correction over the long term as true fundamentals come to the fore.

In a similar vein to Fidelity Asian Values, Edinburgh Dragon’s portfolio resilience came from its exposure to India. Improving fundamentals and India’s relative insensitivity to China’s slowdown, meant shares held up in the recent sell-off. Further boosting return was the limited exposure to Korea, where share prices have corrected amid concerns over the Chinese market, its largest trading partner.

The current discounts in trusts arguably reflects concerns over rising interest rates in the US and what impact this could have on emerging markets, alongside the additional uncertainty created by the market setback in China.

However, it seems if you look under enough stones in Asia, you can find hidden treasure when you’re a bottom-up stock picker. Investing over the longer term in companies with strong fundamentals will eventually bear fruit, despite the macro headwinds. While most investors fret about the situation in China, the long-term benefits of investing in the Asia ex Japan region, with an emerging middle class and many potential value opportunities to consider should not be overlooked.

Matthew Read is a senior analyst at QuotedData.