The signing of a phase one deal between the US and China on 15 January could have heralded a return to some sense of normalcy after an 18-month trade war, had it not been for the emergence of the coronavirus ahead of a particularly important time: Chinese New Year.
‘Covid-19’ has shifted the focus of president Xi Jinping and his government away from tariff disputes and fixed it firmly on containing the spread of the virus.
On 1 March, there were approximately 90,000 cases across nearly 60 countries and more than 2,900 deaths; the vast majority in China.
To get a better understanding of how the virus has affected the investment outlook, Expert Investor reached out to the managers of three Asia ex Japan equity funds, all of which have a Morningstar rating of silver, to find out how they are navigating the situation.
[For context, it is important to note that these interviews took place in late February]
‘There is no real playbook’
Some people have been comparing covid-19 with the severe acute respiratory syndrome (Sars) outbreak of 2003, but Suranjan Mukherjee does not believe it is a useful exercise.
“There is no real playbook,” says the manager of the Fidelity Asian Special Situations Fund, because China’s standing in the world is vastly different.
“It was a booming economy in 2003, both in absolute and nominal terms. After the trade war and recent slowdown in the economy, it’s really not growing at its fastest pace. Plus, in 2003, China was far more investment driven and less consumer and services sensitive.”
Mukherjee recommends “throwing away the Sars playbook”.
“New home sales in the first 18 days after Chinese New Year contracted by more than 90%. In early February, auto sales were also down over 90%.”
Depressed consumer demand is to be expected when so many areas are in lockdown, but restricted movement is hitting the manufacturing sector especially hard.
Companies need a permit from the local government to restart production, and these have been slow to come by, Mukherjee says.
This delay is compounded by the low numbers of workers returning to site, either because of a lack of transportation or companies having to put measures in place to reduce the risk of the virus spreading through their workforce.
Another challenge for firms is “a lack of clarity on consumer demand”.
Mukherjee points to Alibaba’s recent results announcement as providing some insight, because the firm “touches pretty much every aspect of the Chinese economy” and its size means “you sit up and take note” of what it says. “They expect a significant slowdown in sales growth, while the e-commerce space might have negative growth in the first quarter.”
Mukherjee “took money off the table” at the end of 2019 after an “extremely strong re-rating across a whole host of stocks” in China. This meant he entered 2020 with the country as one of the biggest underweights in his fund.
It’s not yet clear how badly covid-19 will hamstring growth but he is seeing “very interesting pockets of opportunities to buy into long-term fantastic companies at a discount”. As a result,
he expects the underweight to be much reduced at the end of the first quarter.
“What really piqued my interest was Xi Jinping’s comments alluding to the government not choking the economy,” says Mukherjee.
The People’s Bank of China has injected liquidity into the system and there has been a lot of monetary easing. But that, on its own, “will not help the economy, and there has to be fiscal stimulus”, he says. “I think there will be similar packages put in place down the line.”
Two sectors he expects to benefit are infrastructure and automotive.
When it comes to a favourite stock already in his portfolio, Mukherjee points to Taiwanese private bank ESun, which he describes as “very technology driven” and “a beneficiary of the trade war”.
A growing pool of entrepreneurs, “especially in the technology and textile sectors, are repatriating and redeploying capital in Taiwan”. This has been partly driven by the government, which has introduced a range of measures, including a tax amnesty to encourage overseas money to flow back to the country.
“Taiwan is seeing interesting and accelerating growth, which creates a very favourable backdrop for a bank to perform well.
“The other interesting part of the ESun story is that it has invested heavily in technology.
“Banks that have done this have seen massive revenue synergies and great growth where the cost/income ratio has gone down dramatically.”
Says Mukherjee: “It is currently in the mid-50s at ESun and what we should see, over the next five to seven years, is a steady drop in that ratio, all of which goes to generate higher return on equity.”
‘A number of good-quality companies now trading significantly cheaper’
While human beings are bombarded with emotive news articles about the victims of covid-19, technology can filter through the facts, unimpeded.
Investec Asset Management deploys a quantitative screen “which shows us a subset of the market that should be attractive”, says fund manager Charlie Linton.
“The screen doesn’t know anything about what’s going on in terms of coronavirus; it just tells us whether companies are attractively valued, whether they’re good quality, if there are good earnings coming through and how the share price is reacting.”
But the region hasn’t just had to deal with the coronavirus, as there have also been the wildfires in Australia, along with more global issues, such as the killing of Iranian major general Qasem Soleimani by the US.
“January was particularly volatile,” says the co-manager of the Investec Global Strategy Fund-Asia Pacific Equity Opportunities, which he runs with Greg Kuhnert.
When that happens, the market “tends to change the discount rate when the initial news comes out, with everything selling off pretty indiscriminately”. This was the case with the coronavirus, he says.
But before the phase one agreement was signed, the slowdown of growth in China had started to turn around, with global indicators, on the economic side, “becoming more positive”, Linton says.
“Our screen was still saying Asia is one of the most attractive regions, not just because of improved earnings but also because valuations and returns, generally, have been a lot better.”
People are in two camps, he says: those that are very worried and others who see it as a buying opportunity.
“There are a number of good-quality companies that are now trading significantly cheaper than before.”
Without trying to compare Sars and covid-19, Linton says that the former saw around six months of people becoming infected, with the market down about 10% “from peak to trough”.
“We don’t know how long covid-19 will last but the market tends to look through disruption, as long as it is
viewed as shortlived.”
Chinese New Year is “a big time of year when people spend money”, so there have been significant hits to sectors such as real estate and transport. But pent-up demand can be a positive.
Inventories have been high but are returning to more normal levels, Linton explains. “There is potential impact around whether firms could meet first-quarter numbers but, ultimately, low inventories give companies the ability to price attractively.”
Regional firms have also been benefiting from the trade war, as it has shifted the focus to “players where less of the intellectual property comes from US companies”.
“You’ve seen a gradual shift in the near term to companies in Taiwan, Korea, Japan and some domestic Chinese, which are at less risk of having sanctions imposed on them by the US.”
When constructing the portfolio, Linton and co-manager Kuhnert “think about what companies are emerging from Asia that could compete on a global scale in future”.
This is what recently drew them to car manufacturer Geely. With Volvo as its parent company, Geely is able to share in its research and development.
“About five years ago, it started to release new models, which looked remarkably similar to a Volvo but at half the price.”
Geely went from selling about 400,000 units in 2015 to about 1.6 million today, Linton says.
The firm is also well positioned to take advantage of the shift to more environmentally friendly cars. “It has its own electric vehicle battery plant,” he says, after forming a joint venture with Korea’s LG Chem in 2019.
“Could you see a Geely car driving around the UK or Europe in five or 10 years’ time?” Linton asks. “Potentially, because they have the technology.”
‘Tours, airlines, hotels, taxis, restaurants and retail have all been hit’
Barely two months have passed since coronavirus was officially reported on 31 December 2019, so it is very difficult to assess the damage beyond the scale of the human tragedy.
“Companies have been fairly quiet in terms of the economic impact but a lot of people are drawing comparisons with Sars,” says Alistair Thompson, co-manager of the First State Asian Growth Fund, which he runs with Richard Jones. “I think the numbers have shown this is far worse, though.”
Currencies seem to be “pricing in that this could be a bit of a problem”, with the yen and Singapore dollar both down 4%, he adds. “But equity markets are not, because you’ve seen fiscal stimulus.”
The situation could change, however, when companies start to announce their results, which is a concern, as Thompson says “markets have been so quick to see through the problem”.
“The caveat is that, with Sars, share prices did rebound within six months.”
Of the sectors taking the biggest hits in the interim, he points to tourism. Compared with Sars in 2003, China attracted nearly 10 times the number of tourists in 2018. “If you look at tours, airlines, hotels, taxis, restaurants, retail … all have been significantly hit across Asia.”
There is also a growing risk around component shortages, which has global implications.
When it comes to looking for deals in the market, Thompson says “the good-quality companies tend not to trade at discounts”.
With a portfolio turnover of about 15%, “a year from now we’re still going to be talking about Aussie healthcare, some domestic consumer names, Indian private banks and select technology names”, he says.
The Asian Growth Fund has long been invested in four healthcare companies based in Australia and New Zealand, meaning the weighting has nothing to do with coronavirus.
The other key sector where Thompson sees good growth potential is Indian private banks. As their state-owned rivals are saddled with non-performing loans, they are losing market share of about 1% per annum to the newer, more tech-savvy entrants.
Digging deeper into the portfolio, Thompson flags an Indian haircare company as one of its most interesting positions.
Godrej Consumer Products is currently chaired by the fourth generation of the Godrej family. “We like family run businesses because they typically take a much longer-term view.”
“The business has been very successful in its home market, with its single sachets of shampoo and hair dye.”
But the dependence on plastic was a cause for concern as the used sachets could not be recycled. So, the First State team introduced Godrej to a private UK business called Polymateria, which has “devised a technology that can biodegrade plastic packaging”, Thompson says.
“Within a week, the two companies had agreed to do a pilot project and the results are exceptional.”
The Godrej share price “hasn’t done particularly well over the past couple of years”, he admits, and the firm is currently only a small holding in the portfolio.
Where they see an opportunity is its expansion into Africa, where Godrej bought out its joint venture partner 18 months ago. “But Africa is a very difficult continent to do business in,” Thompson adds, pointing to the different stages of development between countries and the political and currency risks.
“But we like their long-term approach and they are a bit of a sleeper in the portfolio. If they get Africa right, it could be really big.”
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