A significant change in government policy and the “end of the 1980-2020 period of effectively unfettered capitalism in the West” are the likely long-term outcomes from the COVID-19 crisis, according to Robin Parbrook and Lee King Fuei, managers of Schroder Asian Total Return investment trust.
They believe massive government intervention in private sector operations, whether it be compulsory orders for landlords to offer rent-free periods, instructions for banks to cancel dividends, and government directed bank lending, signal the move to a new era. This has huge consequences for investors as policy making increasingly drives asset prices rather than the economy or business fundamentals.
The managers also think the policies to offset the severe slowdown caused by COVID-19 may ultimately herald the end of the low inflation and economic stagnation seen since the global financial crisis in 2008. This is leading them to gradually add risk to the portfolio by rolling off some of the ‘hedges’ they had in place against market falls and to modestly increase gearing – borrowing to invest.
The Trust, one of our preferred investments focused on the region and part of our Direct Investment Service Preferred List, aims to achieve market-beating performance while offering a degree of capital preservation through tactical use of derivatives. These have the effect of cushioning the effects of falling markets and reducing volatility – though it can also mean returns are lower if they are deployed during periods when markets rise.
As with all areas of the world, the sudden outbreak of COVID-19 has completely transformed the economic environment in Asia. In 2019 the net asset total return was 15.7%, which compared to its benchmark index return of 14.6% in sterling terms. However, 2020 has seen Asian markets slump and the Trust has seen a fall in net assets broadly in line with the wider market, albeit the share price itself has shown greater volatility.
In 2019, outperformance principally came from avoiding or minimising exposure to some of the sectors facing disruption due to technological change. In particular, the Trust had minimal exposure to banks (outside India where the private sector bank exposure did well), and broadly avoided more economically sensitive areas which generally performed poorly. Having avoided the major pitfalls, the managers were, however, somewhat frustrated that returns were not more sizable.
While they had large weightings in technology and internet stocks which did well (for instance, Taiwan Semiconductor Manufacturing, Alibaba and Samsung Electronics), the managers were cautious on newer and less proven internet names like Meituan and Pinduoduo. As such, with markets in a bullish mood they missed some of the better gains in the sector. They believe that even after the COVID-19 related correction, valuations of some of these stocks are expensive and they are happy to remain on the side-lines.
The other key negative for performance in 2019 was the portfolio’s exposure to good-quality, high-yielding Hong Kong companies like Jardine, Swire Pacific and Hang Lung where the Hong Kong protests caused a big correction. The managers believe these stocks, as well as similar blue chips in Singapore and Australia, offer an important balance to other areas of the portfolio invested in technology, exporters and Chinese consumer stocks. The hedging overlay (to reduce the risk of adverse price movements) was also a small drag on performance in the rising market.
Since the onset of the COVID-19 virus, the manager’s immediate attention shifted to gauging the financial strength of each holding in the fund. This resulted in the sale of a couple of stocks they felt uncomfortable with should the economic situation continue to deteriorate. However, they feel most holdings are well placed with net cash on their balance sheets. Having been through several crises many Asian companies are sceptical of leverage and mistrustful of banks, so balance sheet strength is not hard to find in the region.
There are also areas that the managers are now keen to avoid. Some companies, especially in South East Asia, are burdened by dollar-denominated debt, and with local currencies falling in value there is likely to be some pain. The managers also remain cautious on banks who they feel will be “required to do national service” and property where rent free periods for retailers and restaurants could become widespread.
In the past couple of weeks, Robin Parbrook and Lee King Fuei have been adjusting the portfolio so it can benefit more from an upswing in markets. They have been gradually removing the remaining hedges in the portfolio that serve as capital protection, deploying some gearing and buying into some of the blue-chip companies whose share prices they believe have fallen too far. Given the unfolding crisis this is an incremental process as they have no idea on the shape and timing of recovery.
The managers’ preference is for high-quality but resilient businesses. These might come at a higher price tag than cheaper ‘value’ stocks, but they believe the current crisis may cause trends around disruption to accelerate and mean the faster demise of many old business models. This implies, to them, that much of the ‘value universe’ is a ‘trap’. Instead, they are principally looking at businesses in areas where technological change or patterns in consumer behaviour are driving a business forward. Examples include Cochlear, which makes hearing aids; e-commerce stock SEA, which is benefitting from increasing on-line shopping in South East Asia; Mediatek, a chip designer benefiting from the rise of auto electronics, factory automation and 5G handsets; and Seek which offers on-line recruitment across Asia.
Geographically, they favour economies with strong, effective governments and a good institutional framework, notably Singapore, Australia, Taiwan, Hong Kong and China. They are generally cautious on much of South East Asia, for instance the Philippines, and India where they perceive the handling of the crisis has been poor.
A key attraction of the Trust is its ability to go some way to protect capital in weak markets while still harnessing long term returns from the region. Having greater exposure when markets are cheap and gradually reducing and focussing on relative performance as markets get expensive makes sense – although in practice the timing can be difficult to achieve.
With a reasonable year for NAV in both absolute terms and relative to broader Asian markets, the Trust builds on its strong longer-term record – though past performance is not a guide to the future. Given the consistent investment approach and the deep resources of Schroders across Asia, the Trust remains part of our Direct Investment Service Preferred List of preferred funds across the major sectors for new investment.
Table: First quarter 2020 and discrete annual share price performance of Schroder Asian Total Return Investment Trust, peer group sector and benchmark
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