Market Review
The benchmark MSCI AC Asia Pacific ex-Japan fell -2.2% during the second quarter of the year, dampening year-to-date gains to +9.4%.
While Asian markets had a positive month of September, the quarter overall was overshadowed by a string of negative news on the macroeconomics & politics front: a synchronized global slowdown in economic activity, the devaluation of the Renminbi past the 7-handle in August, the deepening trenches in the US-China trade war, and the escalation of demonstrations in Hong Kong.
Performance Review
This past quarter, absolute performance was positively driven by the “ageing Asia/healthcare” theme and our positions in Indonesian media. The major detractors were companies with a significant share of domestic revenues in Hong Kong. Fund performance also benefitted from an active management of the portfolio with respect to macroeconomic risks. 2019 year-to-date performance also remains strong with the NESTOR funds up +15.0%, beating the benchmark of +9.4%.
Corporate earnings have been decent so far this year, with especially Indonesian and Thai companies benefitting from a stronger currency. Hong Kong-exposed companies generally reported acceptable results for the first half. But for those in the retail & consumer segments, management’s indications for July-September operating performance suggest dramatic year-on-year sales declines as people either took to the streets to demonstrate, or staid in their homes – very few people went out for a meal or went shopping. Tourist arrivals are down almost a third year-on-year. For select stocks, a lot of this has been priced in at this point, and we are seeing several Hong Kong companies trading near liquidation values.
Outlook and Strategy
As discussed in the market review, there are several external factors weighing on regional markets. Our view from the past quarter still stands, Asian markets will in the short-term remain highly sensitive to the trade war rhetoric on both sides. However, any resolution of the gridlock could unleash a catch-up market rally. At the time of writing, the US Trade Representative’s and the Chinese vice premier’s delegations are meeting to avert or delay the next round of tariffs.
The trade war is having a profound impact towards the acceleration of the shift of capital from North Asia to South/Southeast Asia. We have been deepening our research in several key thematic areas, including a deep dive into industrial park operators in the region. Manufacturing labour cost differentials are significant, with China around double the level of Vietnam and the Philippines, about a fifth more expensive than Thailand & Malaysia, and about 50% more expensive than Indonesia. Industrial parks across Southeast Asia have experienced significant take-up, both by Chinese companies moving south, as well as Western businesses deciding to either forego or supplement their capacity in China. Vietnamese industrial park rents are growing by more than 10% p.a. at the moment. We regard exposure to this theme as a reasonable portfolio stabilizer, as earnings growth from Asian industrial parks can make up for some deterioration in the China part of the portfolio.
Another pan-Asian theme under research is the power sector, where several countries are trying to emulate Thailand’s success in building a reliable economic framework to attract foreign investment in power generation and distribution. Renewables and cleaner natural gas are playing a significant role in the power development plans of countries like the Philippines and Vietnam.