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Portfolio Specialist Chris Adams:
If we think about the last 18 months or so there are a number of important pieces in play in the Asia region. There are questions about global supply chains, geopolitical tensions and a great diversity in terms of managing the human and economic consequences of Covid.
We’ve seen regulatory shifts in China that have dramatically altered the outlook for entire industries. All of this is driving heightened uncertainty, which drives the opportunity for active investors.
Today we want to share with you where we’re seeing the opportunity in Asia.
I’m joined by Samir Mehta, a senior fund manager at J O Hambro Capital Management. J O Hambro is part of Pendal Group. Samir has been investing in Asia for 31 years. He’s been with J O Hambro for since 2011 and he’s the manager of Pendal Asian Share Fund.
Samir, your funds had very strong relative performance over the last 12 months.
What are the key calls that you’ve made that have driven this?
Senior Fund Manager Samir Mehta:
Thank you, Chris. As you mentioned, there have been so many changes over the past two years or so.
When I look back at the last year of performance, two big things stand out in terms of the positioning of the fund.
First, I was reasonably early in taking cognisance of risks in China — particularly the regulatory risks — and therefore had a big underweight position in China.
If you go back in history even from 2018 onwards and look at the fund, I haven’t held any American-listed Chinese companies because the risks on ADRs was starting to come to the fore ever since the trade tensions between the US and the Chinese started to come in.
That prompted me to rethink the risks.
So there was the underweight position in China, particularly recognising the regulatory risks.
Second, in China valuations had gone to levels where I did find them to be a touch expensive.
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And there’s a possibility of the Chinese economy slowing, having gone into Covid first in 2020 and coming out of it first in 2021.
Combined with that was a relatively big overweight position in India.
It’s a country you could say hasn’t really handled the Covid situation well yet.
There has been significant consolidation among businesses, which has allowed the better-managed companies to generate supernormal profits in what has definitely been a challenging year.
And we’ve had some very good stocks in our portfolio.
So those two – a big underweight in China and a big overweight in India – have effectively been the difference.
Chris Adams: The Chinese underweight obviously has been a good call. A lot of international investors are increasingly wary of China, given the signs of slowing growth and then the recent regulatory crackdown. So are you maintaining your Chinese underweight?
Samir Mehta: For the moment yes, but I also have been taking advantage of the dips that have come in.
As you know in July we had a big sell-down. I added to our existing holdings a couple of names like Tencent which is one of the large companies in China you would have heard about. And Meituan, which is the largest food delivery company.
When we had the complete panic towards the end of the month I did add to it at valuations I thought were quite cheap.
Then I’ve been running my screens because, as many of my peers around the world are starting to become a lot more cautious, I want to ask: “what can go right?”
Because now the risks are well known. The government’s come down quite hard on several industries, regulatory risks have come to the fore and there is, for example, in the education sector an attempt by the Chinese government to make them non-profit.
So the natural question people are asking is: “should we even invest in China?”
I say valuations are now reasonable and risks are to the fore.
Therefore it is incumbent on someone like me – who’s been lucky enough to be underweight in China – to take advantage of the situation, to find opportunities.
It’s not going to be immediate, but I do find several companies that I want to add in the portfolio in China.
Chris Adams: Can you tell us what kind of sectors might be attractive to you in China?
Samir Mehta: Yes sure. I did mention a couple of our existing holdings [above], which have good growth prospects, high returns on capitals and good cashflows.
I’ve then added a lens to ensure they are unlikely to be in contradiction with what the Chinese Communist Party wants for its society.
Tencent and Meituan for me are the standouts.
I realise games might be a controversial topic. But I feel at some point businesses will adapt and Tencent is already doing that.
They have curbed the ability for kids to use games. They’re looking for identification, etc.
And Meituan creates a phenomenal service for society. Imagine in a period of Covid, not having the ability to order food at home.
So these services I think are going to be quite critical.
Another sector to be aligned with policy of the party and the government is energy.
China has been a large emitter of carbon and has suddenly put its foot down in terms of what they want to achieve for the economy by 2030 or 2050 or 2060.
Energy is going to be a very large part of that attempt to move towards a carbon neutrality.
So in the portfolio, we own a company called ENN Energy. It transports natural gas which is much better than burning coal.
They’ve also gone into a business in industrial estates. In China there are hundreds of industrial estates spread around the country which used to have coal as a primary energy source.
ENN goes into these industrial assets, converts them from coal into natural gas, and takes over other utility functions such as steam and water.
So that’s one company I have.
The other thing I’m looking at is investments in the State grid. As the Chinese government and industries use a lot more solar and wind power, you need to have a smarter grid.
These smarter grids require significant investment in better automation and better control of how these alternative sources of energy are used in that grid.
I’ve looked at a couple of companies, one which I’ve already started to buy.
I prefer not to mention the name because I’m just starting out. But these are examples where I’m trying to make sure a) they are reasonably good in terms of what they do for society and b) I’m trying to be aligned with what the Party and the government wants.
Chris Adams: India and China are large allocations in the portfolio but that’s obviously not all there is to Asia. Can you give us a flavour of where else you’re finding opportunities? And what are some of the risks you’re thinking about – whether Covid or otherwise – when it comes to Asian equities at the moment?
Samir Mehta: If you look at one of our top holdings in the fund is a company called Kakao, a South Korean company which is completely digital – native digital as they say – and have done a marvelous job in several aspects.
They have a business in developing games. They are into music. They have a vertical that is into payments. They started a bank. They’re in cartoons and media properties.
The key has been their instant messaging platform called Kakao, which has 46 million monthly active users out of a total population of about 51.5 million people in Korea.
It is as dominant as you can get. They have the ability to create verticals around those customers.
The founder is very good. His ability to bring on professionals to run these verticals and give them autonomy has worked out very well.
Just to give you a bit of flavour, Kakao Bank is an internet-only bank. They launched it in 2017. That’s just four years ago.
They did an IPO last month. And today it trades at a valuation of $US30 billion. Kakao, the company we own in our portfolio, owns about 27.5 per cent of the bank.
Similarly, they own minority stakes in several of these verticals I mentioned earlier.
So Korea has been a good hunting ground for us and this is one exmaple.
Then south-east Asia I’m doing a lot more work on. It’s been one part of the world that has taken a really big hit from Covid.
Infrastructure has been poor. Governance in many of these countries hasn’t been up to scratch. The challenges from Covid have been particularly bad for companies in these countries and Southeast Asia.
As valuations have come off, people have ignored these countries.
Now my screens are showing many companies that are cheap.
So I’ve started to buy a company in Indonesia as well as one in the Philippines.
Again, I won’t say the names because I’m just starting to buy them.
But I do find in Southeast Asia companies are trading at valuations that are reflective of the risks. And if we are able to find better management of Covid – which I hope will happen over time – you might find these opportunities will deliver performance for our fund.
Taiwan I’ve been a bit underweight. The reason is it’s a primarily a technology-oriented market.
I feel at some point in time this massive bull run we’ve had in tech stocks – particularly around hardware and semiconductors – may be a bit long in the tooth. I’m a little bit cautious on that.
So I’m underweight in Taiwan – there are good businesses, but valued highly. So I’ve stuck to Korea and Southeast Asia – that’s where I’m now looking for opportunities.
Chris Adams: One final thing I want to touch on – which is increasingly important to investors here in Australia – is the ESG (Environmental, Social and Governance) element. It would be good to get your thoughts on ESG factors in Asia and how that figures into your process.
Samir Mehta: You mention a very good point. We have clients who are based in the US or Europe and have been at the forefront of ESG – just like Australians have been.
I’ve benefited from my clients asking me to think about ESG much earlier than what regulations have forced many fund managers to do.
In Asia you have to accept that we have a spectrum – it’s neither black nor white.
These are countries that are quite poor. Many of them are focused on development. Coal for industrial use – not only for generating electricity – is a very big portion.
This is a real challenge that we face. Governments and companies want to get towards a better and cleaner future but it is a very expensive proposition.
So I lean on my colleagues at Regnan (Pendal Group’s responsible investing business). They have world-class resources and expertise. I use their research to find companies that meet some of the best adherence to ESG principles.
We engage a lot with many of these companies and the issues are quite wide ranging.
I am not here to say that I’m going to be successful at every single one that we take on.
But we do try our best. With our colleagues at Regnan who provide such great and fantastic back-up, I’m able to hopefully achieve for our clients a very good outcome on ESG as well.
Chris Adams: Thank you Samir and thank you very much to our viewers today.
If you have any more questions, please don’t hesitate to contact your Pendal account manager.
Thank you very much.
Samir manages Pendal’s Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia. Samir is a senior fund manager at UK-based J O Hambro, which is part of Pendal Group.
Pendal Asian Share Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI AC Asia ex Japan (Standard) Index (Net Dividends) in AUD over the medium-to-long term.
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