In August the fund returned +0.6%.
This positive return contrasts with weak underlying markets and was driven at the position level by notable performance from Kaspi in Kazakhstan, Air Arabia in UAE and King Yuan in Taiwan.
At the sector level we had positive returns from real estate, energy, industrials and information technology which led the pack, also making Taiwan the strongest country contribution. Whilst there’s been plenty of enthusiasm for ‘AI’ over recent months we have very little that’s directly linked, but combined with increasing optimism on the inventory cycle it does appear to have prompted a more general revaluation of Taiwanese companies.
Although August is considered a slow month, there’s typically an avalanche of earnings and corporate actions to keep one busy. Most of our holdings reported in-line or better than consensus earnings with only two positions that disappointed (RHB and Hello). One of the more notable reports came from Swire Pacific, which as a holding company with significant operations in real-estate, airlines and beverages, provides an interesting cross-sectional view of what’s going on in China and Hong Kong.
The first-half result beat consensus by 36%, driven by their shopping malls, hotels, and a very strong recovery at Cathay Pacific Airways. As mentioned before, the Chinese consumer (especially at the higher end) is still spending and travelling. Hong Kong office remains challenged, but occupancy remains high as they have high quality assets in good locations. If they were on a Monopoly board, they’d all be blue or green squares.
Unsurprisingly shareholders approved the sale of their American Coca-Cola bottling business, with half the proceeds bolstering an already strong balance sheet and the other half paid-out as a special dividend. This equates to a 15% yield, and is on top of the regular dividend of around 6%. Holding companies typically trade at a discount to their underlying asset value, but it’s currently double what one might consider reasonable at around 65%. Whilst we wait for this to normalize it pays dividends in Hong Kong Dollars (which is pegged to the US Dollar) and with no withholding tax.
Whilst Swire is a top-quality asset, we are increasingly drawn to this combination of exceptionally low asset valuations, strong balance sheets, defensive earnings and attractive dividends. There’s a good universe of such companies in China and other parts of Asia so we’re looking to increase exposure, recycling positions that have performed well particularly in Central and Eastern Europe.
Economically China remains challenged, but the second derivative is beginning to turn more positive. For example, retail sales surprised positively in August, whilst new car sales have not deteriorated in volume. Consumption of refined oil products also remains strong. These point to an economy that’s slowly recovering as policy makers continue to make incremental stimulative policy measures.
Besides the geo-politics, the consensus push-back has been the risk of credit defaults. So far these have been largely confined to real-estate developers and have failed to trigger any ‘Lehman-moments’. Whilst defaults could broaden to municipal debts, these risks are known within policy circles and likely to be ‘managed’, whilst most corporates (and certainly in our portfolio) have low leverage.
On a relative basis, the risk of such defaults is probably increasing more in the US and Europe where interest rates have increased rather than decreased. Data shows the number of defaults in the first six months of the year has clearly risen and could easily exceed 2020 full year numbers. The sovereign credit default swap market (CDS) also shows how the world has changed. These contracts represent the cost of insuring against default and are a good smoke signal.
Historically the strongest credits would be in the G7 with the lowest spread typically the USA. However, with a spread of 50 basis points the US is now in-line with Hong Kong and there are no fewer than 8 other emerging market countries, mostly in the Middle East and Asia, that have similar or lower spreads. It’s yet another example of how the emerging world has changed.
