Liontrust Asia Income Fund

Q3 2018 review

Summary

 

  • Political statements have replaced central banking decisions as the key short-term drivers to equity market performance.
  • Markets have reacted to a deterioration in the trade spat between the US and China by shunning risk assets.
  • The Fund’s relatively high exposure to mid-caps and low allocation towards more defensive areas held back relative performance in this environment.
  • A full line-by-line review of portfolio exposure to trade tariffs triggered only one sale – Kingboard Laminates. By and large, reduced valuations have more than discounted the increase in trade frictions.   

 Performance      Q3 YTD  Since launch 
 Liontrust Asia Income Fund, institutional class  -1.9%  -4.6%  77.1%
 Liontrust Asia Income Fund, retail class            -2.0%  -5.1%  68.7%
 MSCI AC Asia Pacific ex-Japan Index  -0.2% -2.0%   74.0%
 MSCI AC Asia ex-Japan Index  -0.4%  -2.8%  77.5%

Source: Financial Express, as at 30.09.18, total return (net of fees and income reinvested), bid-to-bid. Fund launched on 05.03.12.

 

The third quarter ended in a distinctly millennial tone, as the US president verbally defriended Xi Jingping, leader of the world's second largest economy. “He may not be a friend of mine any more” said Trump, after accusing China of undermining his prospects in the upcoming American elections.

 

Childish in content, it belittles the importance of the ongoing trade spat between China and the US. Equity markets however, have reacted swiftly. Recently, political statements have overtaken central banking decisions as the key short-term drivers to performance.

 

The trade dispute between China and the US started earlier in 2018, and things have deteriorated further this quarter. At the end of June, the US had already placed 25% tariffs on US$50bn of Chinese imports. This compares to a total US$505bn imports from China, which in turn form a significant part of China’s total US$2.09tn exports. China had retaliated with similar tariffs in both scale and size of US exports to China. So far so good, as such tariffs accounted for only 2.3% of China’s total exports and 3.5% of the US’s total exports. Equally China appeared to make some pacifying concessions, pledging further opening up of the economy through easing market access and better intellectual property rights protection.

 

We had hoped this would lead to a declaration of victory by Trump, but instead things escalated further. Trump imposed tariffs on US$200bn of Chinese imports, effective from 24 September at 10%, due to rise to 25% in January 2019. China responded with tariffs on a further US$60bn of US goods, at levels varying from 5% to 10%. Trump also came out with yet another list of US$267bn further goods he might target, effectively including all Chinese exports to the US.

 

Markets have reacted to events by swiftly shunning risk assets. As a region comprised primarily of emerging markets, Asia has underperformed the rest of the world in this environment. Within the Asia Pacific region, we see further signs of risk aversion in the pattern of returns: Australian equities and energy companies (driven by the rising oil price) were the most obvious outperformers, while large capitalisation companies have proved more defensive.

 

Given its relatively high exposure to mid-caps – which in our view provide the best opportunity to access the region’s long-term development via companies with good earnings and dividend growth prospects and compelling valuations – and its low allocation towards more defensive areas, the Fund underperformed the index in this environment.

 

We have undergone an exercise to estimate the impact of trade tariffs on each of the portfolio’s holdings, taking full absorption of 25% tariffs on exports to the US – an unlikely scenario – as our bear case. The actual impact of tariffs is likely to also be lessened by some Chinese production being shifted to other countries, while in the long-term global demand might fall as prices rise. Our analysis also excluded the likely reaction from China to ameliorate the overall economic impact.

 

This exercise led us to identify one holding which we felt failed to reflect its direct vulnerability to broader tariff rises – Kingboard Laminates – as well as facing concurrent pricing pressures. The sale of this position was one of a handful of portfolio changes implemented during the quarter.

 

In reality, the Chinese government is already taking action to reduce the impact of the trade dispute. It has, among other measures, reduced reserve requirements, injected capital into the banking system, and increased export rebates on almost 400 products by lowering VAT. It has also allowed the yuan to depreciate to a level which offsets about half of the imposed US tariffs.

 

This should soften any blows to the Chinese economy, but there is also the chance that things escalate beyond just trade into a prolonged attempt by the US to contain China’s ascendance as a world power. While we obviously entertain such a theory, it is impossible to predict how such events would unfold.

 

Turning away from the influence of politics and refocusing on the region’s macroeconomic backdrop, we see a mild deceleration of growth. This alone is not a concern but it has coincided with a general aversion to emerging markets which was triggered by an economic crisis in Turkey that hit the Lira heavily. Any country in Asia with a current account deficit has been dragged down by contagion concerns, despite the absence of any other similarity with Turkey’s situation. Indonesia, India and the Philippines saw their currencies fall 11%, 14% and 8% respectively. The Fund is underweight in India and the Philippines, and bought its only holding in Indonesia, a coal exporter, this year.

 

Investor concerns are understandable as the US raises rates, heralding the end of a period of cheap money, and the effects of likely repatriation of the carry trade funds is yet to become clear. The funding crunch has taken a particular toll in India, with Infrastructure Leasing & Financial Services (ILFS) the hardest hit. Some cost overruns and late government payments threatened the company's short term debt funding, which needed to be continuously rolled over under its operating model (in a scenario reminiscent of the UK’s Northern Rock a decade ago). The company’s size prompted swift government intervention, to reduce contagion on other non-banking financial companies using short-term borrowing to fund longer-term projects.

 

We own one company that was caught in the storm, Indiabulls Housing. It predominantly lends to individuals for mortgages, and is the best capitalised of the Indian shadow banking companies. If bond markets were to close immediately, then Indiabulls still has enough cash at hand to continue disbursing loans and paying all its liabilities for the next six months. In its own words, it would be the last man standing, which means that they would only fail if most of corporate India was being engulfed at the same time. Its borrowing costs will no doubt rise as a result, but not to the extent suggested by its 32% share price fall in September. We viewed this weakness as an opportunity to top up the Fund’s position in the stock.

 

The trade war has escalated beyond our initial expectation, but this has been swiftly factored into equity valuations so there is no case to be made for a knee-jerk portfolio changes. Although negative sentiment towards emerging markets and Asian equities may persist in the short-term, we are seeing increasing opportunities thrown up by the sell-off.

 

Discrete years' performance (%), to previous quarter-end:

 

 

Sep-18

Sep-17

Sep-16

Sep-15

Sep-14

Liontrust Asia Income I Inc

-0.1

13.1

40.9

-4.7

3.4

IA Asia Pacific Excluding Japan

3.8

15.7

36.9

-7.9

6.8

Quartile

4

4

2

2

3

Source: Financial Express, as at 30.09.18, total return (net of fees and income reinvested), bid-to-bid, institutional class.

For a comprehensive list of common financial words and terms, see our glossary here.

 

Key Risks

 

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Asia team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Fund’s expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation. 

 

Disclaimer

 

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Wednesday, October 17, 2018, 4:43 PM