Liontrust Asia Income Fund

Q1 2020 review

Summary

 

  • While Asia was first into the coronavirus crisis, it is now showing some signs that it may be the first to emerge from it. As the spread of virus in China has slowed, economic activity has begun to recover. By early April Baidu’s tracking app showed that 90% of shopping malls have re-opened nationwide, as have 80-90% of restaurants.
  • Much will depend on the extent of any reintroductions of the virus. The risk of infections still exists, so the path to recovery is likely to be bumpy.
  • The extent of recovery is now also likely to be constrained on the demand-side. Production capacity is being re-opened but domestic demand will take some time to recover and international demand remains significantly affected by lockdowns.
  • In China and Asia more widely, there is plenty of scope for demand recovery to be significantly supported by government stimulus.
  • In terms of portfolio positioning, we are not turning defensive but instead are looking to play into the region’s expected economic recovery.
  • There are lots of investment opportunities in the region – most prominently in China as it is first to stage a recovery – but also in other countries such as Australia, which has fallen the most in US dollar terms. From a sector perspective, technology is throwing up some interesting opportunities as we expect supply chains and demand to recovery relatively quickly.

 


 

Performance Q1 Since launch
Liontrust Asia Income Fund, institutional class -18.8% 56.8%
MSCI AC Asia Pacific ex-Japan Index -15.3% 57.5%
MSCI AC Asia ex-Japan Index -12.8% 64.5%
IA Asia Pacific ex-Japan sector average -16.4% 54.3%

 

The Fund has an income Target Benchmark of 110% the yield on the MSCI AC Asia Pacific ex-Japan Index. The Fund’s most recent income distribution was announced on 31 March 2020. Its distributions over the 12 months to 31 March 2020 – expressed relative to the Fund’s price on 31 March 2019 – give a 12 month yield of 4.8%. The MSCI AC Asia Pacific ex-Japan Index yield on the same basis was 2.8%.

Source: Financial Express, as at 31.03.20, total return (net of fees and income reinvested), bid-to-bid. Fund launched on 05.03.12.



Asian equities fell heavily alongside global equities in a quarter dominated by the emergence and escalation of the coronavirus (Covid-19) crisis. While Asia was first into the crisis, it is now showing some signs that it may be the first to emerge from it. China reported its earliest cases in January, although the virus was probably present from at least November. The number of new cases peaked during February (with the mid-month spike being driven by a change in diagnosis technique) and fell sharply in March.


Asia Income Q1 2020 reiew - daily new cases


By this point the virus had spread beyond China and its surrounding regions to become a global crisis with cases accelerating through February and March.


Asia Income Q1 2020 reiew - daily new cases worldwide

 

 China and other Asian countries such as Hong Kong, South Korea, Taiwan and Singapore have managed the virus relatively well in terms of containment. This seems in part due to their past experience with SARS in 2003 which led to swift testing and contact tracing, as well as behavioural and cultural acceptances of strong government control. Governments have taken different approaches to business restrictions and are at different stages of the crisis.


As the spread of coronavirus in China has slowed, its economy is now beginning to show signs of recovery.
The lockdown of Wuhan (the city where the virus first took hold) is scheduled to end soon, almost 11 weeks from its start on 23rd January. Baidu’s tracking app shows that 90% of shopping malls have re-opened nationwide, as have 80-90% of restaurants. Chongqing is resuming dine-in restaurant service and businesses have re-opened. Around 85% of people who left Tier 1 and Tier 2 cities for the Chinese New Year celebrations have now returned, but that is obviously still 15% short of normal levels. Evidence also shows that their behaviours are yet to return to normal; subway traffic is currently only just over 50% of normal levels. PMI data shows that the services side of the economy hasn’t quite returned to pre-crisis levels (the data also fails to capture the SMEs that are likely to have been harder hit).

The impact of the lockdown will be brutal, however. We are expecting Chinese GDP to fall by about 5% in Q1, taking 2020 growth expectations to around 3.5%. While the deputy governor of China’s Central Bank has predicted that potential economic output levels will be regained “rather swiftly”, we think this tone may prove too optimistic. Much will depend on the extent of any reintroductions of the virus. The risk of infections still exists, so the path to recovery is likely to be bumpy. China announced on 31st March that it would re-impose a lockdown in Jia, a county in the province next to Hubei, after an asymptomatic doctor infected patients.

 

What is important is that China is now sending a clear message that it is open for business, although the extent of recovery is now likely to be constrained on the demand side for a period. Production capacity is being re-opened but domestic demand will take some time to recover, while the c.20% of Chinese output that is exported will be hampered by the coronavirus battle other countries currently face.

 

Asia Income Q1 2020 reiew - China's recovering PMI

In China and Asia more widely, there is plenty of scope for demand recovery to be significantly supported by government stimulus. Debt-to-GDP ratios show that Asia is generally well-placed to embark on stimulus packages.


Asia Income Q1 2020 reiew - debt to gdp ratios


The United States’ unprecedented fiscal ‘bazooka’ – equivalent to 10% of GDP – is at the time of writing being matched by some Asian countries: Japan, Australia and Singapore have all made spending pledges of over 10% of GDP while South Korea planned measures account for around 7%. Monetary easing has been widespread across the region, as it has worldwide.

 

China hasn’t come out with its own version of the fiscal bazooka; its measures account for around 3% of GDP but it is engaging in management of its state-owned enterprises to ease the crisis. Banks have been told they can’t recognise any non-performing loans in the next six months or so and policy banks have been instructed to set up credit support guarantee schemes for hard-hit SMEs.

 

China will also target spending at areas of the economy it would like to encourage. At its most recent politburo meetings (February and March) it mentioned accelerated investment in new infrastructure such as 5G base stations, the internet-of-things, data centres, ultra-high voltage networks, inter-city high-speed rail connections and electric vehicle charging stations. The aim is to create smart super-cities and increase the rate of urbanisation, which stands at around 60%. It is targeting 75% within a decade, meaning an extra 220m people will be brought into urban areas. This underpins the structural growth in domestic consumption that we are trying to position the portfolio to benefit from.

 

The quarter’s fall in oil prices is also a positive for the region, which should help consumption. Malaysia is the only net exporter of oil in Asia. Due to the price war between Russia and Saudi Arabia, Brent crude oil prices dropped to finish March at US$22.70 a barrel – around a third of the level at which they started the quarter.

 

In terms of portfolio positioning, we are not turning defensive but instead are looking to play into the region’s expected economic recovery. The experience of the SARS outbreak suggests that a peak in new cases could be associated with a turning point for financial markets. Globally it seems we are not far from a peak in new cases, but this should be caveated by the fact that a lot of cases are not being reported and there is risk of a resurgence in infections if any countries suffer from reintroductions of the virus.

Asia Income Q1 2020 reiew - MSCI

Overall, we stand ready to make selective changes as opportunities present themselves. We will look to increase exposure to companies that:

 

  1. are not reliant on exports to the developed world
  2. are less exposed to the areas of the economy likely to be hardest hit (tourism, hospitality and consumer discretionary are dependent on a physical presence, especially restaurants/entertainment/retail).
  3. will not be hurt be low interest rates 

The areas that may provide most opportunity are:


  • China, as it is likely to recover first, having been affected by the virus first and having greater capabilities to manage its domestic economy.
  • Australia, as it has fallen most in US dollar terms, much of which is due to currency weakness.
  • Technology, as any supply or demand disruption should recover swiftly when normality returns.
  • Those that are oversold.

The first portfolio change we made during the quarter were the addition of two stocks which seemed to have been excessively punished in the initial sell-off after Chinese New Year: Huaxin Cement and Cifi.

 

As its name suggests, Huaxin Cement, forms part of a Chinese cement industry that we think offers a broad play on infrastructure investment in China. Local governments had already raised money through bonds with such spending in mind, but it is now also likely to be brought forward as a vehicle to kick-start the economy following the sharp drop in activity levels caused by coronavirus containment efforts.

Huaxin Cement is based in Wuhan and has, along with swathes of China’s industrial landscape, been hit heavily by the lockdowns enforced to battle the spread of coronavirus. However, we think that cement production is more likely to have been postponed rather than cancelled. Following the sell-off in Chinese (and global) equities, we bought Huaxin’s A shares – the first to be included in the Fund – because their valuation looked compelling at a price/earnings ratio of 7x. The company is cash generative and offers a prospective dividend yield of 5%.

Cifi also stands to benefit from accelerating government stimulus targeted at encouraging a recovery in the property market after the effects of the coronavirus have diminished. It is a property developer focusing on Tier 1 and Tier 2 cities in China. Larger developers such as Cifi are gaining market share and sales are expected to be strong driven by increasing urbanisation, rising affordability and Hukou reforms. Inventories are also at a healthy level. Cifi was bought on an attractive valuation of around 5x forward price/earnings, with over 20% forecast earnings growth, and offers more than 5% dividend yield.

 

We then switched back from Cimic into Downer. A few months ago we had switched from Downer to Cimic as Downer was looking expensive. Since then, Downer has fallen more than 50%. Year-to-date, Downer has underperformed Cimic by around 13%. So we reversed the switch. Downer derives ~60% of its revenues from long-term Australian government contracts, has significant liquidity and has minimal refinancing due over the next 12 months. It should benefit from the transport infrastructure spending of the Australian federal and state governments. Downer trades at 7x price/earnings for 8-10% expected growth and a 7.5% dividend yield.

 

We also sold BOC Aviation, DGB Financial and JNBY.

 

BOC is a company that provides operating leases of aircrafts to airlines. Given a lot of airlines are cutting capacity and idling planes, BOC Aviation may have issues collecting lease payments if travel is disrupted for more than a few months. The balance sheet is strong as it has US$5bn of available liquidity and up to 14 months of security deposits and has exposure to the top 20% of the airlines. Recently it completed a purchase and leaseback deal with Cathay worth US$700m at attractive rates. However, the risks seem higher in the near term as air travel is unlikely to return to normalcy soon, thus impacting the profitability of the whole airline industry.

 

DGB Financial is the largest bank in Daegu and Gyeongbuk, in the south east of the Korean peninsular. Daegu city recently recorded largest number of Covid-19 cases in Korea, and with 80% of loans on variable rates DGB’s net interest margin will be impacted in a falling interest rate environment. Banks are also likely to see a rise in non-performing loans in the aftermath of the current crisis.

JNBY is a niche-branded apparel company in China. It has been overly ambitious in its expansion from three core brands to 10 brands in the last 15 months. The development of these new brands has been below expectations and management has now stated no new brand launches in 2020, and that two of new brands will cease operations.  We believe that consolidation is necessary and that net store closures and restructuring will be a drag on performance. There is high risk to earnings downgrades given market projections for 15% profit growth. 

Finally, on 31st March we added BHP to the portfolio. The company is one of the world’s largest mining companies with a diversified exposure, expected to benefit from the increase in infrastructure investment by China and other countries. BHP has a strong balance sheet and generates significant free cashflows through the cycle and currently trades on a dividend yield of over 9%. From peak to trough, the share price halved during this year’s sell-off but has recovered slightly and we think there should be more to come.

Turning to look at portfolio income, dividends paid in 2020 are based on 2019’s profit, which means that any reduction will be due to companies hoarding cash to protect themselves during the current downturn. So far it is too early to tell how many companies will take this approach but there is no evidence yet of companies being compelled to do so in the manner of the UK banks.

 

We have one company, Downer, that is delaying payment of a dividend previously announced, although it has not cancelled it and there is no final decision on dividends going forward. But we have others (China Communication Services and Cifi) that have announced special dividends (i.e. paying at levels higher than they deem to be the longer-term base level).

Our initial impression is that Asian companies will tend towards protecting their payout ratios, which means dividends paid in 2021 (based earnings generated in 2020) are more vulnerable than those paid this year. We should have some time to adjust the portfolio should needs be.

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

 

 

Mar-20

Mar-19

Mar-18

Mar-17

Mar-16

Liontrust Asia Income I Inc

-14.7

3.7

2.8

36.8

-6.9

MSCI AC Asia Pacific ex Japan

-10.9

3.9

7.6

35.9

-8.7

MSCI AC Asia ex Japan

-9.0

2.0

12.2

35.0

-9.0

IA Asia Pacific Excluding Japan

-11.3

3.1

7.3

35.1

-8.1

Quartile

3

2

3

2

3

 

Source: Financial Express, as at 31.03.20, 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, April 15, 2020, 10:23 AM