NESTOR Fare East - Quarterly Report 2/2020

Nestor Fernost fund is up +8.1% in Q2, underperforming even stronger benchmark recoveries

Market Review
The benchmark MSCI AC Asia Pacific ex-Japan rose +15.4% during the second quarter of the year, making a strong comeback following the March lows.

As we enter the second half of 2020, Mr. Market has – for now – decided that the severe headwinds to the global economy posed by Covid-19 and – maybe more important: the economy – are outweighed by fiscal policy (supporting corporate earnings and households in the short-run) and most of all monetary expansion across the globe.  

China’s outstanding performance in managing Covid-19 is doubted by the naysayers, but well confirmed by sources on the ground such as hospitals.  For the rest of the region where there is more data available, the positivity of Covid-19 tests (i.e. the proportion of all tests that return positive) is a good measure of Covid-19 spread that somewhat allows comparisons across countries with variants levels of testing.  On this metric, only Indonesia (11% positivity, indicative of under-testing and high levels of spread) and the Philippines (5%) are still at elevated levels within Southeast Asia, and it is fair to say the region has done a rather good job in managing the pandemic all things considered.  Surprisingly, other than China, it is Vietnam, not Singapore, leading performance in containment and mitigation.   Malaysia, Thailand and Vietnam have largely re-opened their economies mid-quarter, while Singapore, Indonesia and the Philippines did wait until early June for the first major relaxation of their respective lock-down regimes.  We should thus expect some regional earnings divergence once companies report on their second quarters by August.  South Asia’s governments appear to have surrendered in their Covid management strategy to the political-economic realities of day labourer economies in countries such as India, Pakistan and Bangladesh that leave no choice but to reopen.

Performance Review
After outperforming throughout the market downturn, the fund was too conservatively positioned into the upturn, which was both stronger and faster than anticipated.  As a result, while performance was positive for the quarter, the relative performance was below the benchmark.  China technology names and the Southeast Asian infrastructure theme contributed positively, with primarily smaller companies detracting from performance.  

Outlook and Strategy
The global outperformance of growth over value, led by the technology sector, is well known, with e.g. the Russell growth-to-value ratio up almost 80% in the past four years, and at levels last seen at the height of the dot-com bubble in October of 2000!  

It is worth highlighting that this phenomenon has also made it to Asia.  As an illustration, our major holding Cosco Capital, owner of the Philippine’s leading discount supermarket with 436 stores serving our “bottom of the pyramid” theme, commands a market capitalization of around 35bn peso.  Recent “hot” IPO Merry Mart, has reached a market capitalization not too far below at around 27bn peso, propelled by retail investors.  Merry Mart says it will have 1,200 stores – by 2030.  Yet, Merry Mart has less than 10 stores, and Cosco/Puregold is more than 40x larger, yet is valued somewhat the same in today’s growth-over-value global stock market.

While small cap under-valuation and under-performance is a global phenomenon looking back the past seven or so years, the severe valuation disconnect where small caps sell for dramatically cheaper prices, is unique to Nestor Fernost’s exposures in Southeast Asia and Hong Kong, largely driven by passive ETF money flows.  All other major markets including Latin America, India, Europe, the US, Korea and Japan, do actually value small caps at premia to large caps.  
A very thoughtful investor asked us earlier this year “how come no tycoons or private equity firms are trying to arbitrage this valuation opportunity, through buy-outs?”.  We have been indeed been seeing such increased activity.  In Singapore, Breadtalk has been privatized, and a KKR-led consortium made an offer for 800 Super Holdings.  Several privatizations with a subsequent relisting at the higher-value Hong Kong exchange have been done, for example Nirvana in Malaysia or Tsit Wing in Singapore.  Investing in potential buy-out candidates is thus becoming a viable research theme.

Finally, if you agree that the current market environment is reminiscent of 2000/2001, you will be interested to learn that from 2001, exactly subsequent to the tech bust, regional equities broke out and earned solid double digit annualized returns through their most recent high in 2013 (yes this is what we have been up against).  As a further parallel that makes us constructive even in a difficult macro environment, Japan’s adoption of zero interest rate policies and QE in 1999 did actually lead to small value outperforming any other asset class in Japan in the subsequent two decades.

Florian Weidinger, Hansabay