First State Stewart Asia Pacific Equities team, shed lights on topics such as their team structure, how various risks have affected their investment decisions, and the major portfolio changes over last year.
Category Winner: Best Asia ex Japan Equity Fund - First State Asia Innovation Class I USD
Key Stats
Inception Date: 2002 Oct 18
Morningstar Rating (as of 2015-03-31): 
Total Net Assets (Mil, as of 2015-04-30): 44.71 USD
Manager: Richard Jones, Alistair Thompson
Manager Start Date: 2011 Jul 01, 2013 Jul 01
M: Morningstar F: First State Stewart Asia Pacific Equities Team
M: Could you highlight any major changes you made to the portfolio over the course of 2014? Were there any particular holding that drove the fund’s performance for the year?
F: Despite some trimming in holdings, our India weighting has continued to increase, though that has now fallen below 25% last year. The bulk of the uplift has been due to market appreciation, though investments in a few Indian banks such as HDFC Bank were increased earlier in 2014.
Otherwise, the fund has benefited disproportionately from an ability to invest into some smaller market capitalization companies in India. Some companies have been sold since the year-end on valuation grounds, while investments in consumer packaging company Huhtamaki and United Breweries have been helpful on positive contributions.
The other country where there was most portfolio change was Korea. It remains as challenging as ever. We have sold positions on corporate governance concerns. For example, we sold Samsung Fire & Marine after the undesirable injection of a construction company into the balance sheet from a sister company. Unfortunately this is not the only example of poor governance in South Korea where it is becoming increasingly difficult to identify quality investments.
More generally, China remains a clear drag on the fund, with the recent 7.3% GDP growth figure apparently at a 24-year low. Some companies are struggling to grow in such environment. We continue to keep our watching eyes on the economic development.
M: What is your economic outlook for 2015 specific to the markets you cover and how are you positioned to take advantage of opportunities and/or mitigate potential risks?
F: Looking forward in 2015, we maintain our cautious stance as we continue to be worried about debt levels across the world and the vulnerability of companies, individuals and governments to an increase in interest rates which is more rapid than expectations. Valuations are extended and it is difficult to find buy ideas.
In China, we expect that slowdown is likely to continue although the economy may stabilise in the short term. Banking, property and oversupplied sectors could pose significant risks to growth. These are all well-flagged, but critical issues nonetheless. Market leading companies with healthy balance sheets should perform better during the downturn, while small and less conservative players could face difficulties. On the positive side, there have been selective measures to promote sustainable development in the areas of the environment, product upgrading and the livelihood of the general public.
The continuing expansion of the Indian economy was a significant development over these years and we are optimistic about this market. Our bottom-up focus is generating plenty of ideas in the Indian market which is now a large part of our portfolio. India is the market where we are able to find the most interesting and exciting companies for the long term. The market has risen strongly since Narendra Modi won elections to become Prime Minister in May 2014. We believe that progress is being made on the reform front in small incremental steps in areas such as the labour market and land purchases, but investors may be too optimistic about what can realistically be achieved.
The rise of Southeast Asia as an economic powerhouse was also a feature. In coming years we expect to see an expansion of the investment universe as other markets become more prominent. We anticipate that the portfolio may contain companies from Bangladesh, Burma, Cambodia, Sri Lanka or Vietnam in the future.
As a result of the above, cash levels in our Asian portfolios remain high. We are conservative in our investment approach and are likely to have little exposure to commodity companies, favouring stocks in the Consumer Staples, IT and other defensive sectors.
In addition, we continue to own more companies in Hong Kong and Taiwan rather than China and more companies in Singapore than other Southeast Asian countries. It is much more difficult to find good ideas in China nowadays, although the opening up of the A-shares market to foreign investors should provide more choice in China and improve the quality of Chinese companies over the next decade. For India, we have no immediate plans to change the level of the country exposure because of the high quality companies which the country offers. We have also recently sold some positions in South Korea as we see the increasing difficulty to identify quality investments in the country due to corporate governance concerns.
In general, we believe the Asian markets offer a selection of high quality companies which should provide good returns for investors over the long term. We continue to look for attractively valued companies which meet our quality criteria.
M: Can you comment on the macro risks facing the global economy, including potential US rate hikes, QE programs in the Eurozone and Japan, and the growth headwinds facing the emerging world? How do these risks affect your investment decisions?
F: We are operating in a slow growth and low rate environment. US may do better, while Europe may still struggle a bit. We do believe China’s growth will structurally come down, and therefore we are light on commodities. Our focus is still more on the domestic consumption side, which we see longer-term upside.
Expectations of a US rate hike have already triggered long bond yields to go up in Asia, a strengthening US dollar and repatriation of capital from certain Asian countries. Like the Fed QE program, the latest QE-like programmes of the European Central Bank and Bank of Japan have caused asset prices to continue rising regardless of fundamentals. New ideas are scarcer than before and quality companies are very expensive.
We believe the risks are set to continue so we maintain a very cautious position with high cash levels in our Asian equities portfolio and it is difficult to find ideas to buy unless markets pull back. Earnings growth is likely to be pedestrian and company valuations are already elevated. We are more focused on the resilience of our existing companies given the high valuations of quality businesses across the region.
Despite the concerns mentioned above, we believe the Asia Pacific markets offer a selection of high quality companies with strong fundamentals which should provide reasonable returns for investors over the long term. We are particularly optimistic about the outlook for companies in the Indian market.
M: How is your investment team organized? Have there been or do you anticipate any changes to the investment team or structure over the course of the year? Do you anticipate adding to the team in the near future?
F: Embracing a boutique culture, our equity investment team operates under a flat structure involving all team members in decisions. The strength of our investment philosophy attracts a certain type of investor who would find it hard to fit in at many other teams or firms. We do not look to hire people for specific jobs, but rather we look for people on an ongoing basis. We do not want to rule anyone out and want to hire people with a genuine passion for investing. The team is incentivised mainly on the long-term performance of the overall portfolio. This approach means that all members of the team are encouraged to participate in debating the research and quality of ideas. While individuals are assigned specific geographical responsibilities, all members are involved in the total portfolio, which means broader experience for each individual and better management of key person risk.
We do not believe in ‘silo mentality’ and rely on each team member to form a view on a company they have met and bring genuine insight to the portfolios – after all the more views we have the better so to increase the levels of breadth in the coverage. We try not to be hierarchical so that every analyst can participate in stock discussion. The more perspectives we have the better.
There has been no major change to the investment team and structure over the course of the year. Over the long term, we continue to keep the investment team dynamic to allow more flexibility to act on the best interests of our clients, and also for the long-term sustainability of the team. We will be looking to add more resources to support the ongoing development.
M: Can you highlight any areas where you feel that the investment team or the investment process can be improved upon?
F: Meanwhile, management evaluation remains a challenge for China A-share investing. It is more difficult to gain access to management than it is in Hong Kong; therefore more regular visits to Mainland China are necessary. We often do not gain direct access to the most senior company management and have to judge quality and corporate culture based on meetings with investor relations officers or checks with external sources. We have found that it takes time to develop sufficient management understanding as a result. We hope to develop direct contacts and meet/call more chairpersons and CEOs in the future.
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