Shanghai

Asian Small Cap stocks: about to rise like a Phoenix? – March 2020

In this article, we examine the investment case for Asian small cap stocks which have recently been out of favour with investors. We start with an analysis of the key drivers that resulted in small cap Asian stocks delivering stronger returns than large caps at various points in time after the Global Financial Crisis (GFC). We use the FTSE Asia Pacific ex Japan ex Australia ex New Zealand All Cap and Small Cap indices for the analysis.

We find that the Chinese yield curve has been one of the most prominent drivers of the (out)performance by small caps. There is a strong parallel with the current environment, where we expect that central banks will continue to shift to an increasingly accommodative monetary policy stance, which will contribute to the strength of domestic economies and in turn benefit small caps once again. This is combined with compelling valuations and increasing signs of deglobalisation, further strengthening the arguments for investing in Asian small caps.

Trip report: India – December 2019

Mike Sell and Kieron Kader spent 10 days of December in India travelling to Delhi, Mumbai, Chennai, Lucknow and Kanpur. The team visited 38 companies including 20 of our fund holdings. In addition, they conducted a range of channel checks and also met one of the Transforming Lives Awards winners, Phool, where they held a consumer survey panel.

 

CONCLUDING THOUGHTS

We had said that we expected to see growth from the festival season onwards. Despite the last two GDP prints of 5% and 4.5% which were worse-than-expected and caught everyone by surprise – our initial view has been confirmed by our detailed on-the-ground meetings. The short-term volatility has been pervasive and worse than expected, but the stimulus provided by Modi’s government, the accommodative monetary policy and the strong monsoon has started to buoy the economy from November, and we should thus see improving growth and sentiment. There have also been delays in the construction sector, which have now started to subside even in the key state of Maharashtra which has experienced a change in government. The Kharif crop harvest between January and March will be a strong support for the rural economy. Overall, our expectation is for growth to follow a U-shape recovery rather than a V-shape, with the financial sector a noticeable laggard. Thus, we expect GDP growth of 3.9 – 4.7% in Q4 followed by 5.1% in Q1. Longer term, our view is that the liquidity issues, demonetisation and GST are ultimately positive, as they leave better quality companies in the system and refocuses them on proper capital allocation.

Overall, we remain positive on India and combined with current valuations (especially in the mid cap space, which are compelling, see figure 11 and 12 below), we believe that this market has the potential to deliver one of the best performances within the EM space over the coming years.

Shanghai

Investment notes from Greater China – October 2019

Mike Sell, Alquity’s Head of Asian Investments and Kieron Kader, Asia Investment Analyst spent 11 days in Greater China visiting 18 companies in Hong Kong and 12 across Shenzhen, Hangzhou, Nanjing and Shanghai.
Mike and Kieron visited existing holdings to reassess the outlook for corporate earnings. They also visited competitors to understand the overall environment, as well as brand new investment ideas. This was a valuable opportunity to discuss the effects of the trade war on the Chinese domestic economy, and reactions to the stimulus packages issued by the Chinese government.

 

CONCLUDING THOUGHTS

The main conclusion to draw from our trip is that there are areas of brightness – particularly in our domestic growth focused sectors.
Our long-standing view that the Chinese domestic economy continues to perform well has been confirmed by the key industries. However, some corporates (particularly in exporting industries) expressed uncertainty for the near term, but also mentioned that government stimulus may provide support (e.g. further reserve requirement rate cuts, tax cuts, as well as industry-specific policy). Selective domestic growth driven sectors that we invest in (property, beer etc.) showed confidence for the short and medium term. We have also identified a number of high quality domestic-focused companies that are worthy of further due diligence.
Whilst overall growth is reasonably healthy, some areas are challenged and remain undesirable. However, there are areas of outstanding growth and we remain positive. Combined with the fact that valuations are attractive, we maintain a substantial weighting to the market.

Indonesia: Overlooked and unloved

Mike Sell, Alquity’s Head of Asian Investments, spent a week in Indonesia for his regular on-the-ground meetings with local companies. Mike had 16
meetings and 33 store visits in 3 cities with the goal of re-assessing the macroeconomic and business outlook ahead of Presidential elections in April, and to discover new potential ideas for the portfolios. As a result of the trip, followed by further desk-based analysis, we have already increased our weighting across our portfolios and expect to continue to do so.

 

Concluding thoughts

Indonesia has been largely ignored by investors despite the country’s sound inherent characteristics and its solid economic prospects. The country perfectly encapsulates our key investment themes of monetisable structural growth opportunities thanks to its young and steadily rising population, ongoing urbanisation and the roll-out of structural reforms. Reforms by President Jokowi’s government have already improved the country’s growth prospects. This has not been appreciated by markets, which is also proven by the fact that investors’ aggregate exposure to Indonesia is at historical lows. The re-election of Jokowi should result in capital flows targeting Indonesia again.

Consequently, we are of the view that the Indonesian market offers an attractive entry point from a risk-reward aspect, since there are some excellent companies, who sustainably benefit from the country’s structural domestic growth momentum. Such stories can be found in industries such as cement, consumer or financials. We have already increased the weighting across our funds and expect to continue to do so.

India

Investment notes from India

Mike Sell, Alquity’s Head of Asian Investments, spent nine days in India for on-the-ground meetings with local companies. He met with 33 company managements in total, as well as undertaking a day of retail store visits in Patna (in the state of Bihar).  The goal was to meet with the majority of our existing holdings and to reassess the outlook for corporate earnings following the second quarter results and recent macroeconomic gyrations.

In addition, we wanted to stress test the sustainability of our holdings’ competitive advantage through meeting with challenger brands particularly in the financial and retail sectors.

 

Concluding thoughts

Our on-the-ground meetings with 33 companies were very fruitful, as they reaffirmed our longstanding view that the domestic economy is in a solid shape. Furthermore, economic activity has not been derailed by spiking oil prices or trade tensions, and thus the structural domestic growth will continue without being adversely impacted in a meaningful manner. Once elections are behind us, idiosyncratic sources for asset price volatility should subside. Any volatility before then will provide opportunities for investors.

Specifically, we believe that there are three key trends that investors are missing: the accelerating growth in the rural economy, rising margins across certain industries, and the re-emergence of the private sector capex cycle.

Overall, we remain extremely positive on India, as the economy is on a firm footing and has the potential to deliver one of the best performances within the EM space over the coming 3-5 years.

Fund Manager Diaries: Brazil update

Brazil suffered a severe recession in 2016, experienced anaemic growth in 2017 and will likely continue this trend through 2018. Therefore the fledgling recovery is yet to visibly reduce unemployment and kick-start cyclical growth. Indeed, the market is pricing in a continuation, and even deterioration, of this difficult environment.

We are, however, constructive on the country, currently 58% of our Latin America portfolio, as we find it extremely attractive from a technical, business cycle and valuation perspective.

 

Concluding thoughts

The market is deeply sceptical and has heavily discounted asset prices on the basis of dysfunctional politics. We believe this view ignores the realities; the political class are under no illusions that fiscal reform is required, despite the roadblocks Brazil’s recovery has been delayed rather than reversed and valuations already discount a significant deterioration. In short, we see similarities to 2002, 2009 and 2016, years in which a massive change in Brazilian politics coincided with a violent drop in risk premia and sharp equity market rallies. Our positioning reflects our optimism and is biased towards out of favour, high quality companies that in some cases offer over 100% potential returns.

Investment notes from Greater China

Mike Sell, Alquity’s Head of Asian Investments spent ten days in Greater China visiting 22 companies in Hong Kong and four in Taiwan. He was joined by Dan Billis, a new addition to the Asia Investment team. Despite being caught in Typhoon Mangkhut, Mike and Dan visited both existing and new potential holdings. Our regular on-the-ground meetings in September provided a good opportunity to discuss the relentless negative news relating to the global trade war with the companies we met; whether and to what extent the imposition of tariffs impacts the Chinese domestic economy.

 

Concluding thoughts

The view from all our company meetings regardless of sector was undoubtedly positive. Overall, we returned with our conviction on the macro outlook reaffirmed. As a result, we sustain our long-standing view that the Chinese domestic economy is in a solid and much better shape than most people believe, which also strongly implies that trade woes and the imposition of tariffs are very unlikely to derail the underlying economic momentum in China. Once the majority of market players realise that the domestic economy is well-insulated from external shocks, the high quality stocks of domestically-focused companies (of which we have successfully identified a number) will continue to deliver, despite recent sentiment-driven poor share price performance. We have been increasing the weighting of China across our portfolios and will continue to do so.

South Africa: The long road to recovery

The vast potential of South Africa with its diversified economy, strong institutions and a young population, was restrained over the last decade by a combination of gross mismanagement, policy uncertainty and festering structural challenges, largely due to the administration of Jacob Zuma. Over this 10-year cycle, there was a notable decline in living standards and business confidence, and the South Africa equity market underperformed global emerging markets.

Concluding thoughts:

The conclusions drawn from our on-theground research reinforces our positive view on South Africa, as the foundations for the recovery we predicted are being laid. However, we are under no illusion about the process. The reality is that after 10 years of decline, the revival is likely to be lengthy with several bumps along the way. At the first juncture, we expect political
considerations to make the cyclical uptick develop slowly. The President will balance disparate and competing interests with a view to winning the electoral mandate necessary for the bold reforms which will open the economy and kickstart a job-led economic recovery.

Notably, gross fixed capital formation (a proxy for business confidence and investment) declined to a 10-year low as percentage of GDP in 2017, matching the extent of the fall observed after the global financial crisis of 2007-08. This suggests that the country is near the bottom of its economic cycle. Taking the plans of the companies we met into consideration, gross fixed capital formation will stay depressed over the next 12 months, but we are confident of its recovery over the medium-to long-term.

Trip Report: Mexico

In the last few weeks, we toured 3 major Mexican cities: Mexico City, Monterrey and Guadalajara, to meet with 17 companies and measure the pulse of the economy before this weekend’s presidential election. This trip was taken with an open mind; aiming to stress test our investment thesis for the country, which has been among the lowest allocation in our portfolios since Q4 2016.

 

Concluding thoughts:

The outlook for Mexico is less bright compared to the past 8 years and material risks are not totally discounted by the FX and equity markets, in our opinion. Earnings growth for most Mexican companies remain uncertain and valuations do not price in the risks we identified.

Having said that, I met with some exceptionally well-run companies, mostly in the consumer and infrastructure sectors, that benefit from structural growth trends, have built sustainable competitive advantages and are executing a well-thought strategy. Thus, would certain equities experience price corrections that more than discount the risks, we are ready to be contrarian and buy high quality companies trading at a discount to their intrinsic value.

Trip Report: Mumbai

Senior Investment Analyst Aaron Armstrong has just returned from a three day conference in Mumbai.

Having met with representatives from 23 companies, as well as a host of other market participants, he shares his latest thoughts on the investment case for India below.

 

Concluding thoughts:

Placed in the context of the last four years, since the Alquity India Fund was first launched, this is among the most positive set of insights we have ever come away with from an investment trip. With harmonised positive outlooks for economic growth, corporate earnings and political developments, we maintain conviction that India offers one of the most exciting investment opportunities anywhere in emerging markets at present.