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Asia Pacific All Cap: Thoughts
Analyst and Senior Portfolio Manager David Gait gives his thoughts on the Asia Pacific All Cap strategy highlighting investment ideas and portfolio activity.
Plenty of new investment ideas
Current investment emotions are mixed. We are generating a significant number of new investment ideas in Asia. We have bought 15 new companies across our Asian strategies in the past six months, including four from China, three from the Philippines and four from India1. This is unlike us. Our turnover is usually low. And it’s becoming much harder to find room in the portfolios - perhaps as hard as it’s ever been - as we are reluctant to let go of any of our existing holdings. We find this is usually a good sign that strong, absolute returns are just ahead!
But significant lagging of the index due to low China weighting
However, recent performance of our Asian strategies is a long way behind the MSCI AC Asia Pacific ex Japan Net Index. While there are always many reasons for lagging performance, the simplest and most important explanation is the exceptionally strong recent bounce in China from oversold levels and the healthy correction of Indian share prices from elevated levels. The MSCI China Index is +18% year-to-date, while India is -10% year-to-date2. Over the last 6 months to 15 March 2025, MSCI China is +40% and MSCI India is -16%3. A 56% performance differential. While we generate plenty of ideas in China, we currently have a much bigger weighting in India, although this is slowly changing as our conviction in new Chinese companies grows and the corporate backdrop there becomes clearer.
China weighting is growing slowly but steadily
Our China weighting continues to grow for three main reasons. First, our investable universe of quality China ideas is expanding as companies navigate more difficult economic times, often for the first time in their corporate histories. This has allowed us to take a hard look at the fundamental resilience of many Chinese businesses and the foundational attitude to risk and mindset of their management teams and owners. While many Chinese franchises have struggled, cut corners and diminished, a decent number have come through the other side much stronger and better positioned for growth. Second, valuations have become much more attractive. This has allowed us better entry points into companies we have been waiting for on the sidelines. Third, and perhaps most importantly, the changing geopolitical landscape and US Government policy has brought increasing clarity to the new Chinese approach to shareholder capitalism.
China requires four rather than three golden rules
We have four golden rules when investing in China, compared with our normal three. First, the company must meet our quality requirements of management, franchise and financials. A growing number of listed Chinese companies are meeting these requirements Second, they must be well positioned to contribute to China’s sustainable development. On this, we are particularly well aligned with the Chinese Government in almost all aspects of sustainable development. Sustainability talk is cheap, but we believe very few countries have walked the walk as purposefully or far as China in terms of reorientating development toward a genuine sustainable path. Human rights risk is the clear and present exception and challenge that we continue to try and navigate with a bottom-up approach. Third, valuations must be attractive. The prolonged sell-off in Chinese assets has brought many companies back to attractive levels. Despite the recent bounce-from-the-bottom, valuations are still reasonable, particularly when factoring in a recovery in earnings.
Our fourth “China-specific” golden rule is the need to form a view on the Chinese Government’s “allowable return” for a particular company. This tries to capture the idea that in China, returns can erode not just with new capital and competition entering a market, but with a change of strategic view by the Chinese Government. In other words, all Chinese companies are actively regulated by the Chinese Government, whether they sell soy sauce, build toll roads or connect small businesses with consumers via online shopping platforms. Over the past decade or so, the Chinese Government appears to have taken a much more proactive approach to allowable return, built on national purpose. Great companies are not just tolerated by Beijing but embraced and encouraged as part of the development solution, but excess returns are only acceptable to the extent required by national development. In order to earn extended supernormal returns in China, not only must companies have sound business fundamentals, they must also be operating in the “build-out” phase of industries of national importance. The Chinese Government has been notably transparent in spelling out just what these industries are, with clear long-term development plans reaching out to 2035 and beyond.
Allowable Returns as a development model
It's an interesting development model and there are shades of it elsewhere. In South Korea, companies who are unable to generate export earnings often struggle to earn the necessary social license to maintain supernormal returns. Elsewhere, many national banking systems entered this unwritten, unspoken but clear arrangement post the “Global Financial Crisis”. Very few banking regulators or societies are comfortable with allowing 20% plus return on equity for their banks these days, whereas pre 2008 it was often the norm in many countries.
Investing in a world of “allowable” or “capped” returns comes with challenges of its own and we are still learning. Long-term sustainable development alignment is a critical first step, but looking through a “toll-road” lens is also helpful. So long as new roads need to be built, toll -road companies are usually allowed to generate attractive returns well in excess of their cost of capital in order to reinvest in new roads. This virtuous cycle usually comes to an abrupt end once the last roadbuilding project is in sight. We are trying to apply this lens not just to our Chinese companies but more broadly. Where China leads, other countries often follow.
A few comments on recent portfolio activity across Asian strategies
We have been busier than usual for three reasons.
1. Trimming expensive Indian holdings
Some, if not many, of our favourite Indian companies became very fully priced and we were left with no choice but to trim and sell, reducing our large India exposure. Examples include our favourite Indian consumer and industrial companies, Mahindra and Mahindra, Tube Investments, Godrej Consumer, Dabur Consumer, Marico Consumer and Tata Consumer. In hindsight we should have sold a little more a lot quicker! Having trimmed, we are now comfortable with our Indian holdings at current levels and retain high conviction over their future return potential from here.
2. Trimming companies whose cashflows are at risk from new US Government policy
Across Asia Pacific strategies, we own several high quality medical and pharmaceutical companies, but all of them have significant US sales, and often little or no US manufacturing capability. Given the unpredictable risk of tariffs hitting their cashflows and the relatively full valuations they trade on currently, we have taken the opportunity to move quickly and trim the weightings in these companies significantly. Companies trimmed include Cochlear, CSL, Fisher & Paykel Healthcare and Dr Reddys. We have also sold out completely of Resmed.
Elsewhere, we have also trimmed Taiwanese technology holdings and in particular Taiwan Semiconductor (TSMC). Whilst geopolitics has always been a constant for these companies, it feels as though, for the first time, Taiwanese companies are at risk of losing control over their own capex plans. This is particularly so for TSMC. Given the size of TSMC’s capex this is a significant short-term risk.
3. Picking up attractively valued companies in China, Philippines and India
We have purchased three new holdings in the Philippines: Ayala Corp, BDO Unibank and Bank of the Philippines. All three are high quality businesses on extremely attractive valuations in a country with strong economic fundamentals. For example, the excellently stewarded conglomerate Ayala Corp currently trades at 7x earnings, with earnings expected to grow around 15% per annum for the next few years4.
Likewise, we have picked up four favourite Indian companies across Asian strategies: Bajaj Auto, Triveni Turbine, Bajaj Holdings and Investment and Sundaram Finance. Bajaj Auto and Triveni have both almost halved from their peaks, and valuations are of all four are extremely reasonable for their long-term growth prospects5.
And in China, we have purchased four new companies. Dongguan Yiheda Automation, Shenzhen Mindray, Alibaba and SF Holdings. In all four cases, share prices more than halved from their peak to our entry points, valuations are extremely attractive, and growth prospects are solid6. Similar to Misumi of Japan, Yiheda is a one-stop supply chain solution for factory automation across China. We like the power of the franchise – returns to scale, efficiency and professionalism are significant, while it is “hot-spot” agnostic, meaning neither the Company or ourselves need to chase the short-term capex trends of any particular company or industry. Mindray is a global leader in affordable medical devices and has been successful in using cashflows to drive its offering further up the value chain. A recent glowing reference from the CEO of one of our favourite portfolio holdings helped persuade us that Mindray’s healthy margins can be durable over time. It is well positioned to displace foreign medical device companies such as GE and Siemens across the Chinese hospital network for both advanced and basic medical devices as well as offering price-competitive, quality solutions to Emerging Markets healthcare systems. SF Holdings is the number one logistics service provider in China and particularly well placed to benefit from the growth in time-definite efficient logistics across Asia more broadly. Like Yiheda, SF’s chosen business is hard to get right, with thin margins and no room for short-cuts. Such industries tend to attract hard-working, professional founders and managers who are not prepared to cut corners, and SF’s success can be attributed to the culture and professionalism of the company.
Alibaba, why now?
In the case of Alibaba, this the first time we have dipped our toes into any Chinese internet company for Asian strategies. Ultimately we approach these companies just as we would any other. In Alibaba’s case, governance risks have substantially reduced over time as the company has effectively become a very-well run Government State-Owned Enterprise (SOE), with strategy determined by the Government and implementation left to a highly capable, private-sector-mindset management team and board. Our long-held concerns about the vulnerability of the retail business have been assuaged to some extent and replaced by an appreciation for the relatively mature stream of retail cashflows which are being used to build a new cloud business. And although their financials remain relatively opaque, a US$70bn net cash balance sheet7 combined with a new and minority shareholder-friendly share buyback programme makes it easier to get comfortable. Meanwhile we like their long-term positioning from an allowable returns perspective as they set out to deliver technology solutions to development challenges across the Chinese economy. Despite a strong bounce from very oversold levels, valuations are still attractive, trading on around 13x 12-months forward price-to-earnings with a very healthy balance sheet8.
Exciting times
Given the number of attractively valued companies in Asia at present it’s hard not to get excited about future returns. As always, there are plenty of things that could go wrong at any time. Political risk is rising in almost every Asian country, with impeachments, International Criminal Court arrest and attempted coups a growing feature in the region. If the US economy falters and global demand falls, Asian economies will all be impacted, to differing degrees. Asia’s technology complex, built around Taiwan, South Korea and China, is particularly vulnerable. Elsewhere, India remains a domestic growth story, largely isolated from the global economy, while the Philippines would receive a significant economic boost from falling oil prices. Predicting these events is beyond us though. Fortunately, most of our Asian companies have very long memories and the scar tissue from multiple previous crises from which to learn and adapt. As a result, they are set up not just to sail in fair weather but to navigate safely through unpredictable political and economic storms which could appear at any time. Ultimately, it is the opportunity to invest in such companies that is the key attraction of bottom-up investing in Asia.
David Gait
March 2025
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