Portfolio review

It has been a year beset by multiple crises for Asian equities, including the coronavirus resurgence, war in theheart of Europe and recession risk. China experienced localised lockdowns under Beijing’s zero-Covid policy, which disrupted international supply chains and constrained domestic growth. China’s stance was in stark contrast to that of other countries in Asia, where loosened Covid measures led to a gradual re-opening of their economies.

Meanwhile, Russia’s invasion of Ukraine triggered an commodity price shock, pushing up already-high inflation and hastening the reversal of accommodative monetary policies globally as evidenced by rising interest rates. This, in turn, deepened concerns over a global recession. In market terms, rising interest rates resulted in significant rotation away from growth stocks towards value across the globe.

Against this background the MSCI Asia ex Japan Index fell by 7.1% on a total return basis. In comparison, your Company’s net asset value (NAV) fell by 8.4%. We continue to take a longer-term view with regard to investment and our longer-term investment record remains positive when compared to the benchmark index.

Given the volatile markets it is perhaps unsurprising that performance was impacted, both positively and negatively, by more factors than usual. China remains the Company’s largest individual exposure and, because of our strong stock selection in the country, it had the largest positive impact in relative performance terms when compared to our benchmark. The largest detractor from performance, again in country terms, was India. In sector terms, the largest positive contributor was the Food and Beverages sector and the largest detractor, where we had no exposure, was the Energy sector. We have sought to provide more colour on each of these below:

China & Hong Kong

The mainland Chinese market was amongst the worst regional performers over the period. Strict Covid controls, regulatory tightening, liquidity concerns around the real estate sector and continued tensions with the US weighed on investor confidence, even while extensive policy support dispelled some of the gloom. Our average portfolio exposure was somewhat below the benchmark’s 36% China weighting and this, helped by our overweight to more domestically orientated stocks, aided returns relative to the index.

This portfolio positioning reflects our focus on key investment themes such as aspirational spending, digitalisation, renewable energy, health and wealth. Although Covid and a slowing economy have placed short-term pressure on aspirational spending, we believe the consumption upgrade is a generational shift and one supported by the government to increase self-sufficiency.

Over the year our stock selection in China contributed positively to our performance, helped by our bias towards high-quality companies and an emphasis on these structural growth opportunities. Among the portfolio’s standout performers in China were holdings that reflected our core themes of green energy and aspiration, where rising affluence spurs demand for premium goods and services. Nari Technology was buoyed by policy supporting the development of renewable energy in China. This grid automation provider, an indirect play on clean energy, is well placed to benefit from power-grid reform. Liquor maker Kweichou Moutai defied the market slump thanks to its pricing power and earnings resilience. The liquor maker’s brand value gives it significant competitive advantage in the domestic Chinese market, and we believe that it is well placed as demand for premium products and services grow alongside rising incomes from a growing middle class in China. Other names that outperformed included Hong Kong companies Budweiser APAC, which fared well from a share price and demand perspective, notwithstanding Covid-related disruptions, and AIA Group which benefited from the economic reopening outside of China and anticipation of better investment yields. AIA Group’s premium market position and diversified pan-Asian revenue sources give it notable defensive characteristics in the current environment.

The performance of these stocks offset the negative impact of a period of regulatory uncertainty around the Chinese internet sector where we had a number of holdings. We have consolidated these into our core holdings, including Alibaba Group, Tencent Holdings and Meituan. We also built on the small position in JD.com, after receiving its shares from Tencent Holdings through an inspecie distribution. JD.com directly procures inventory which it sells to consumers and delivers primarily via its inhouse logistics network. The company has built up significant scale and differentiates itself through superior customer experience. Valuations are attractive, while the sector’s long-term outlook remains promising. Although policy changes are disruptive, they could help to create a better functioning market and more sustainable growth, which should drive re-ratings for e-commerce companies over the longer term.

We have been increasing our China A-share exposure where we see unique longer-term opportunities not available offshore, particularly those aligned with Beijing’s strategic objectives. Localisation of supply chains, for example, has accelerated as a result of China’s pursuit of self-reliance in critical industries. Battery maker Contemporary Amperex Technology (CATL), an earlier initiation highlighted in the interim report, is well positioned, given its economies of scale and know-how, to gain from China’s push towards electric vehicle (EV) adoption. More reasonable valuations also allowed us to add to Mindray, another beneficiary of China’s self-sufficiency drive. The medical equipment maker’s high-quality diversified portfolio of products reflects its heavy focus on research and development. Other noteworthy top-ups include well-established snack producer Chacha Food, where we see considerable growth potential given the highly fragmented industry.

With the recently ended Party Congress in China we believe that the overall direction remains broadly unchanged. The main focus remains on the continued drive for Common Prosperity and technology localisation efforts to improve resilience and self-sufficiency. Following the Congress, both onshore and offshore Chinese stock markets saw a sell-off on the back of concerns that President Xi could sacrifice economic growth for policies driven by ideology. In particular, the market was disappointed at the lack of a specified timeline for bringing an end to the zero-Covid policy and also the fact that no detailed stimulus plans were laid out. Taking a step back and reviewing the economic policies and reform initiatives of the government over the last few years, these measures have largely been positive and aimed at better positioning China for future growth and increasing the country’s long-term competitiveness. For example, the deleveraging of the property sector and channelling of capital to more productive and strategic areas have been correct, directionally at least. However, these good policy intentions have at times been plagued by poor execution which has led to underwhelming outcomes, to say the least. With a more aligned new leadership team, we believe execution should be more efficient and effective going forward but the jury is clearly out at this stage and geo-political tension has increased, at least in the short term. The themes that are driving our investments in China have not been impacted as a result of these political changes.

India

In India, several of our financial sector holdings added value. SBI Life Insurance, mortgage lender Housing Development Finance Corp (HDFC) and Kotak Mahindra Bank all outperformed, helped by higher interest rates and the economic reopening. Separately, we believe HDFC’s merger with subsidiary HDFC Bank will drive scale efficiencies and create new growth opportunities for the group over the medium term. These contributions, however, failed to offset the overall negative impact of our India exposure on portfolio performance. Stock selection in India – notably the lack of exposure to Reliance Industries – was the key driver of underperformance. The conglomerate rallied on higher oil prices and expectations of stronger refining margins. Additionally, our small position in online insurance platform PB Fintech suffered due to the rotation away from growth stocks, referred to above.

We remain sanguine about India which is home to many quality companies underpinned by structural tailwinds. A salient introduction over the year was Power Grid Corporation of India. The power transmission company will play a prominent role in the growth of renewable energy delivery to the grid in the decades ahead as India shifts to clean energy. We also added Infosys, a leading software developer backed by strong management, solid financials and a sustainable business model. We view both firms’ openness to engaging with us on ESG matters favourably. With regard to the portfolio, as a whole, we have a strong conviction that sound ESG credentials can both complement a company’s quality and reduce portfolio risks while improving long-term returns. A comprehensive report of our active engagement with the Trust’sunderlying companies can be found on pages 23 to 25.

Energy

The Trust’s zero exposure to energy detracted from performance as energy prices surged following the outbreak of war in the Ukraine. We are wary of the cyclical nature of earnings that typifies the sector, as well as the significant State interference in many national oil companies. The Ukraine war has also highlighted the vulnerability of an over-dependence on fossil fuels and accelerated the global adoption of renewable energy, which is a clear structural trend over the medium to long term. Hence, our preferred exposure to energy is through the renewables space via investments in renewable energy, batteries, the EV supply chain and related infrastructure; these do not feature in the MSCI’s Energy sector. The global green-energy transition is well underway, and Asia is dominant in the clean energy supply chain. In addition to the aforementioned CATL and Nari, we are positive on China-based Longi Green Energy Technology, the world’s largest solar wafer maker, and Sungrow, a global supplier of solar inverters. We added to both of the latter two over the year as their many strengths include a formidable cost advantage and superior product quality.

Financials

Financial stocks are traditionally among the beneficiaries of a rising interest rate environment. As well as in India, the Trust’s exposure in this area was positive in Southeast Asia, as the region’s belated relaxation of Covid restrictions resulted in growth during the year. Our long-held conviction in Indonesia and Singapore was especially rewarding. Indonesia’s Bank Central Asia and Singapore lenders DBS Group and OCBC advanced on higher interest rates and improving economic growth. We added to them over the period as rising interest rates should boost net interest margins. They are already seeing improving asset quality metrics and increased demand for loans as restrictions ease.

Other Portfolio Activity

The growth company sell-off impacted our holdings in South Korean internet application provider Kakao Corp and Taiwan-listed integrated circuit maker Silergy Corp.

Meanwhile, market turmoil led to opportunities to add some new names to the portfolio. Apart from Thailand’s Kasikornbank, which we detailed in the interim report, more recent additions included Astra International and Singtel. Astra is a well-managed conglomerate; as well as being the industry leader in cars and motorcycles, it is also a strong player in auto financing, mining services, plantations and infrastructure. Telecom operator Singtel has steady operations in Singapore and Australia, while its regional franchises are exposed to growth in Asia’s emerging markets. The company offers a healthy dividend yield, buttressed by sound financials and cash flow, with new leadership executing well on more efficient capital allocation and management.

To help to navigate the near-term challenges we took a number of other actions. We trimmed our technology exposure as recession risks clouded the demand outlook, especially for the semiconductor hardware segment, with sales of ASM Pacific Technology, Accton Technology and GlobalWafers. We are also monitoring the broader cost inflation picture and its subsequent impact upon corporate profitability. We have scrutinised our holdings, ascertaining their ability to pass on cost pressures and protect their margins. Accordingly, we trimmed and exited positions in companies that could be more vulnerable in the rising cost environment, with Midea and Wanhua Chemical among the divestments.

Outlook

Volatility has been a feature of global stock markets in recent years. That appears unlikely to change any time soon. Markets continue to face a daunting set of challenges: rising interest rates to stem inflation, geopolitical risk, energy and food crises, and an increasingly fragile world economy.

Asia will not be immune to global developments. The good news is that the region is likely to be in a better position than developed economies in the West. The pace at which consumer prices are rising across most parts of Asia is still relatively slow; this has allowed central banks to adopt a more gradual stance in raising interest rates to stem inflationary pressures.

On a related point, this difference in the pace of interest rate increases between the developed West and Asia is also resulting in US dollar strength, with US dollar assets yielding more, and relative Asian currency weakness. We have seen some Asian central banks intervene in the foreign exchange market to support their domestic currencies, some of which have fallen to multi-year lows against the US dollar.

On the ground, we are receiving more reports from our holdings of rising input costs and the pressure on margins but, encouragingly, the earnings of many of our holdings have met our expectations in the latest results reporting season. This environment reinforces the importance of innovation, a premiumisation strategy, brand equity and/or channel control.

We should also not forget that many economies, particularly those in South-East Asia, are still recovering following their post-Covid reopening, and this should help to support earnings.

China continues to be a cause of market angst, with Beijing’s zero-Covid policy a key overhang. However, we are cautiously upbeat about its outlook. The country remains an outlier in the global tightening cycle thanks to benign inflation. We expect a continued recovery in economic activity as monetary easing and stimulus measures take effect. The next few months should also provide greater clarity on the policy front, and we think the central government will continue with measures to support and stabilise the economy.

More broadly, we would highlight that valuations of Asian stocks are attractive, below the long-term average and below the valuations of US and global markets.

Against this backdrop, we have sought to position the portfolio to weather near-term risks while keeping in mind Asia’s long-term structural trends. Our focus remains on quality companies with sustainable business models, robust finances and access to structural growth drivers. We continue to favour fundamental themes like consumption, technology and green energy, which we believe will deliver positive results for Shareholders over the long run.