Market Review
The benchmark MSCI AC Asia Pacific ex-Japan fell -1.4% during the second quarter of the year, bringing year-to-date gains to +11.9%.
Triggers for market turns throughout the quarter were once more the trade war, and the market’s reaction to monetary policy in the US, and overall stimulus measures in China. In addition to the US-China trade war contributing to a return of the risk-on/risk-off cadence from prior years, the political situation in Hong Kong has started to impact equity market sentiment, affecting also H-shares of domestic Chinese firms. In strong contrast stands the performance of the domestic Chinese A-share market, which reacted very favourably to the prospect of Chinese policymaking stimulus.
Performance Review
For the past quarter, while the fund performed in-line to slightly above benchmark, our outperformance could have been greater. US–China trade tensions rose sharply in early May and disrupted the positive lull in financial markets. At that point we repositioned the portfolio more defensively in view of market volatility lasting for a longer period, but were surprised by a significant beta rally following a simultaneous improvement in the trade negotiations concurrent with rising doubts about the health of the US economy leading to lower interest rate expectations.
For 2019 year-to-date, the NESTOR Far East funds are ahead nicely with +14.3% based on both thematic investments continuing to perform well as well as two of our investments receiving takeover offers. We hope to see similar catalysts for some of our more event-driven positions.
The NESTOR Far East funds lost -0.3% over the last twelve months accounting period, slightly underperforming the benchmark’s return of +0.2% for the same period. In the twelve months to June 2019, the strongest performance contributors were our high conviction investments in the Philippine food business San Miguel Food & Beverage, supermarket holding company Cosco Capital, Indonesian contractor Wijaya Karya, Chinese e-commerce platform JD.com and pan-Asian insurer AIA Group Ltd. Positions in Alibaba, exporter Ten Pao, cement manufacturer CEMEX Holdings, special situation Future Bright were the largest detractors in the portfolio.
Since the portfolio includes many Hong Kong-listed names with semi-annual reporting, autumn is generally more meaningful for an assessment of corporate results.
Outlook and Strategy
Our thematic strategy frequently leads us to investing in smaller and medium size companies, and across emerging markets, we still see the phenomenon of a significant tailwind for large cap companies relative to smaller/medium caps due to ETF flows. We believe that for a long-term investor the gradual unwinding of these valuation discounts of up to 60%, depending on the Asian market, represent a potentially valuable future tailwind. At the very least, these discounts should stop being a source of valuation headwinds.
Our thematic strategy doesn’t take a view on a pro-value or pro-growth outlook. Most of the businesses we invest in generally have a positive growth outlook based on underlying thematic drivers. However in portfolio construction we tend to pay quite some respect to value, and act conservatively. We thus expect to generally perform slightly better in a global capital market environment that rewards value. To that end, we noticed last week’s all-time high set for the S&P500 Growth/Value ratio, which now surpassed the levels seen during the dotcom crash of 2000. Similar to our view regarding small cap discounts, we can’t see the drag on value factors remain a headwind for much longer.
There are a few developments to look forward to in the region as we enter the second half of 2019:
Firstly, we are seeing increasing evidence that our thesis of Southeast Asia being a net beneficiary of the trade war does hold true. With trade in particular in the Mekong countries of Cambodia, Laos, Myanmar and Vietnam up significantly, and trade in the other major countries (excluding Singapore) holding up during a global downcycle in trade.
Secondly, political gridlock is cleared, with elections in Thailand and Indonesia returning the status quo and governments getting back to work. The Thai infrastructure projects, e.g. the high-speed rail linking Suvarnabhumi, Don Mueang and U-tapao airports, are moving ahead. Indonesian president Jokowi has indicated a focus on rural economies and household wealth, which should play well into smaller companies with business outside Jakarta. We have been increasing our Indonesian exposure and we see room for an expansion of our allocation to the theme of financial inclusion, where we invest in leasing and microfinance companies. The central bank projects that credit growth will reach its optimal point at a 15% annual growth rate by 2022-23, supported by macro-prudential policies that still have room to accommodate credit growth.
Thirdly, the recent improvements in Chinese manufacturing data (Caixin survey) may finally symbolize the effects of accommodative fiscal policy which together with changes in monetary policy (or at least policy expectations) would be a fertile ground for positive equity performance for Chinese firms. The government appears to have learnt from prior mistakes in aiding in a misallocation of capital: the current set of interventions was well timed and target, but much more measured, with fiscal easing of around 2% of GDP, half the level of the 2015/2016 stimulus.