Aberdeen Standard Asia Focus (AAS) aims to identify market leading businesses in Asia with high and sustainable earnings when they are trading on attractive valuations and invest in them for the long term.
In 2018 the trust implemented a number of changes intended to improve long-term performance, after which it has become more concentrated, increased its weighting to technology companies and reorganised the investment team to be more ruthless with stocks that don’t match up to expectation. Hugh Young has taken more personal control and responsibility for the trust’s portfolio, although he has worked on the team since AAS was launched in 1995, and heads up Asia at Aberdeen Standard.
Over the long term, AAS’s performance has been outstanding. Over ten years, it has more than doubled the average annual NAV total return from the MSCI AC Asia Pacific ex Japan Small Cap Index. However, the trust did underperform in the 2016 and 2017 rally in China and tech-related names. Performance has improved since these changes were made to the process, helped by a change in market dynamics (as we discuss in the Performance section).
Since the changes, which were accompanied by a change of name from Aberdeen Asian Smaller Companies, the discount has been significantly tighter on average, although it is still wide at 11.5%. This is in line with its closest small-cap peer, but wider than the average of the all-cap AIC Asia Pacific sector, which is 7.8%.
Dividend growth has been strong in recent years, and the board does aim to maintain or grow the dividend. However, the yield is relatively low at 1.8%.
The changes made to the process since late 2018 – and which are now almost fully completed – have resulted in a more balanced portfolio, in our view. However, the trust still maintains the traditional characteristics which have served it well over the long term: a focus on quality above all else, and then on buying at attractive valuations. As we understand it, what has really changed has been the appreciation of value in higher growth names, so some loosening of the manager’s definition of value in certain sectors, rather than a weakening of the quality characteristics.
The portfolio still displays highly attractive, resilient characteristics in our view: low leverage, high return on equity and return on assets, and a reasonable level of valuations. The rock-solid balance sheets of the underlying companies should protect the portfolio in any falling market, and should also ensure the companies benefit from operating leverage and the ability to invest in themselves in any rising market. Over the long run we would expect these advantages to lead to good results for shareholders.
Taking a long-term view, we think the discount is attractive as an entry point. Investors have flocked to large caps in Asia in recent years as they have led the market – chiefly internet and tech-related names. This has led small-cap trusts such as AAS to trade on wider discounts than large-cap-focussed trusts. However, we would expect long-run returns to be higher from small caps, although it is hard to pinpoint exactly when the current trend might change.
|The investment process has been highly successful over the long term
||Structural gearing increases the downside risks
|A reinvigorated portfolio, under Hugh Young’s personal control
||Highly active country allocations can lead to large under- or overperformance at times
|Region-wide discount to NAV
||Yield is low
Aberdeen Standard Asia Focus (AAS), formerly known as Aberdeen Asian Smaller Companies, aims to invest in market-leading businesses in Asia at an early stage of their development. The Asian equities team at Aberdeen Standard, led by veteran investor Hugh Young, look for companies with high and sustainable earnings in strong competitive positions. They track a shortlist of companies in the region which pass their quality screens and invest when they think prices are attractive.
This means there are value elements to the investment approach, but the chief focus is on finding those market-leading businesses with strong earnings prospects. The fundamental characteristics of the portfolio, visible in the table below, reflect these priorities. AAS’s portfolio trades on a slightly lower P/E than the market (represented by the MSCI AC Asia Pacific ex Japan Small Cap Index) and an identical P/B. However, the growth metrics are significantly higher, with both the return on assets (ROA) and return on equity (ROE) well ahead of the index average.
|Aberdeen Standard Asia Focus
||MSCI AC Asia Pacific ex Japan Small Cap
Source: Aberdeen Standard
It is notable that, on aggregate, the underlying companies in the portfolio have net cash on their balance sheets. Hugh prefers companies with low or no levels of debt as it decreases their beta in falling markets and gives management teams flexibility to handle recessions or to invest in order to grow their businesses. Hugh’s three decades of experience include the Asian financial crisis of 1997, where countries and companies with high levels of leverage were severely punished.
Since the second half of 2018, Hugh has implemented a number of changes intended to improve long-term returns. This was prompted by a period of underperformance, largely due to the consistent sector and country biases shown in the trust’s portfolio but also (according to the manager’s post mortem) due to being slow to sell certain lower-conviction positions. One of the major changes has been to increase the exposure to technology stocks and thereby to growth characteristics rather than ‘traditional’ value. This has been an evolution of the process rather than a revolution, but as regards valuation, Hugh has given more latitude to companies in this sector if he thinks the growth expectations embedded in them are justified. The upshot has been to increase the weighting to technology from under 4% in May 2018 to 10.4% as of the end of December 2019. According to Morningstar data, this has been at the expense of the consumer sectors, financials and materials, all of which have fallen over that time. Hugh has also increased the weighting to industrials, another high-growth sector in Asia where companies in the region often have a strong competitive position. He explains that the overlap between industrials and technology is rising too, so these are for the most part ‘new age’ industrial companies.
The other main change has been to increase the concentration of the portfolio. The number of stocks has fallen from 80 in September 2018 to 66 in December 2019, according to Morningstar data. Lower-conviction ideas have been sold, a process which Hugh estimates is almost entirely completed now, with only 3% of the portfolio waiting to be disposed of when there is an appropriate price on offer in the market. This is down from 7% of the portfolio when we published our last note in August 2019. There has also been an effort to increase the concentration in the highest-conviction ideas, with the top 30 names considered to be the core of the portfolio. As a result, the weighting to some long-held names has increased, and these have been supplemented with some new stocks in the technology sector.
top ten holdings
|Bank OCBC NISP
|Millennium & Copthorne
|Ultrajaya Milk Industry & Trading
Source: Aberdeen Standard, as at 31/12/2019
Despite the recent changes, portfolio turnover has remained low. Morningstar data suggests it rose from single figures in 2016 and 2017 to just 10% in 2018 (2019 data is not yet available). This is in line with the long-term philosophy of the manager: the aim is to find market leaders, buy them at an attractive price, and then hold them while they grow to many times their original size. Hugh will trim positions when they get expensive and add to them when they look cheap, but generally speaking there will be few new purchases or sales in the ordinary course of events. Positions are entered into cautiously, after extensive desk research and company meetings. The team has to agree on each purchase and sale, and the focus is on picking the right company for the long run rather than taking advantage of short-term market movements.
Hugh’s highly active management style comes through in the geographical allocations of AAS. As can be seen in the graph below, the trust has large underweights (notably to China and Australia) and overweights (chiefly to Thailand and India). This is driven by bottom-up stock selection rather than any views on the countries themselves.
One factor behind the low allocation to China is market capitalisation. The trust limits itself to companies with a market cap at or below $1.5bn at the time of investment, and China is such a vast market that there are relatively few market leaders to be found in that segment. Another factor is the standard of corporate governance, as historically this has been worse in China than in other markets in the region. Hugh says that there have been definite improvements, but in the small-cap segment, governance can still be poor. By contrast, India has relatively high standards of corporate governance which have helped give the team confidence to invest there for the long term. A great deal of importance is placed on the management of candidate companies, with their incentives analysed as well as their past behaviour towards shareholders.
The Aberdeen Standard Asian equities team take a highly active approach to being a shareholder, aiming to improve the treatment and rights of minority shareholders. They therefore do not insist on perfection from portfolio companies, but look for companies that are willing to listen. They view improving corporate governance as a part of their long-term approach. Indeed, management’s willingness to take shareholder views on board is taken as an indication of their long-term approach. We discuss this more in the ESG section.
While the headline exposure to China is low, the portfolio is still exposed to Chinese growth. This is true of its holdings in the ASEAN countries, for example, where the trust has long been overweight. Even if not directly doing business with China, the trust’s holdings in the financial and consumer sectors there are dependent on trade with China boosting their respective local economies and encouraging spending. This means that Hugh’s main worry on the macroeconomic front is the trend towards tariffs and protectionism.
The large underweight to Taiwan is partly explained by Hugh’s wariness about many of the technology stocks listed there, which he views as being too dependent on the whims of a handful of large customers and thereby having little pricing power or scope to gain and maintain market leadership. While the weighting to technology has increased in recent years, Hugh has been determined not to compromise on quality.
AAS has long-term gearing in the form of convertible unsecured loan stock (CULS). This matures in 2025, and between now and then holders can convert units into shares every May and November. £37m of CULS was issued in May 2018, of which £36.7m remains, amounting to roughly 9% of net assets at current levels (c. £400m). The trust also has bank debt, and is currently 12.5% geared in total. Gearing was increased in a counter-cyclical fashion during Q4 2018 in order to take advantage of the sell-off. Hugh tells us he is comfortable running a significant level of gearing over the long run, given the low beta nature of the portfolio and the low debt levels on the underlying companies.
Over the long term, AAS’s performance has been outstanding. Over ten years, the trust has returned an average of 12.3% a year in NAV total return terms, compared to returns of just 5.2% per year for the small-cap index. Since inception in 1995, the trust has delivered NAV total returns of 12.6% per annum, compared to 4.5% for the index. However, it has had some weaker periods. Most recently, the trust suffered underperformance in 2017 when China rallied hard – AAS has always had little exposure there versus the index. Performance has improved since then, but five-year numbers are still suffering as a result.
Over the last five years, AAS has now generated NAV total returns of 31.2%, behind the 34.5% generated by the MSCI AC Asia ex Japan Small Cap Index (although this is not a formal benchmark, it represents the trust’s investment universe quite well). It is notable that the large-cap market has done even better – the MSCI AC Asia ex Japan Index has returned 53.7%. This period has been relatively unusual in that when the market has been rallying, it is the large caps which have outperformed. Most of this has come from a relatively small basket of technology- and internet-related names.
Following its weak 2017, AAS outperformed in 2018’s falling market, before outperforming again in 2019. As well as the outperformance of China declining (to which the trust is underweight), AAS has also been helped by its more defensive qualities. The focus on quality and on valuation means that the trust is less exposed to high-growth stocks which can trade on high valuations when sentiment is elevated. This can lead to outperformance in a falling market, as it did in the fourth quarter of 2018.
Over the past year the trust’s performance has been more or less in line with the index. In the below graph the small-cap index is the green line. It is apparent that at times when the market has rallied hard the index has outperformed the trust, such as in April 2019 and January 2020. Interestingly, since August 2019 the large caps have outperformed again and AAS has underperformed, illustrating how the factors behind AAS’s underperformance and large caps’ outperformance are correlated. However, the degree of underperformance in these periods has been small. We believe this indicates the success of the work done on the portfolio discussed in the Portfolio section. The trust is now more balanced on a sector basis and has greater exposure to growth. Both the longer-standing positions and newer, ‘growthier’ stocks have contributed to performance over the past year. For example, whilst John Keells and Bank OCBC NISP are both long-standing quality positions which have contributed to relative performance, the more recent addition of Singapore-listed technology stock AEM Holdings has also done particularly well.
Over the long run, the quality- and value-based approach of the Asian equities team led by Hugh Young has been well rewarded. Before the underperformance in 2017, the most recent blot on the trust’s copybook happened in 2015, when it uncharacteristically underperformed in a falling market. At that time the trust had a high weighting to Malaysia and that market fell 15% during the year. The long-term underweight to China also hurt returns as that market rallied then crashed, but the trust ended the year up higher than the market. A third issue was the underweight to Taiwan, which hurt performance. However, it is important to note that it was not stock selection but geographical positioning that hurt returns. In keeping with the manager’s conviction to follow the fundamentals of the companies rather than macroeconomics, the positioning vis-à-vis these countries was not changed and all three country biases are still expressed in the current portfolios.
The trust has a total return objective rather than one based on income. The shares currently yield 1.8%, which is unlikely to interest those looking to draw down an income. However, dividend growth has been strong over the past five years, at 6% per annum. Excluding specials, the growth has been higher at 7%. The board has stated its intention to continue to maintain or grow the payout each year, as it has done since the 1997 Asian crisis. The dividend has generally been covered, despite the fact that all fees and interest are charged to the revenue account. According to our calculations, AAS has revenue reserves worth around 2.4 times last year’s full dividend.
Hugh Young is one of the most experienced Asian equity fund managers, having run Asian equity funds since 1985. He is head of Asia Pacific at Aberdeen Standard and has been based in Singapore since 1992. Hugh has been involved with the management of the trust since it was launched in 1995, and is also a shareholder. In 2018 the board requested Hugh take greater personal control over the trust, and he was named lead manager; previously, AAS had reported itself as ‘team managed’. In reality, although Hugh has taken more personal control – and is supported by a couple of key fund managers – he continues to work within the Asian equities team with a process that is highly collaborative.
The approach is cautious and patient, with significant due diligence done by the firm’s large team of analysts before companies receive a buy or sell recommendation. Since 2018 the team members have been assigned sectoral responsibilities in order to facilitate swifter decision-making, and they concluded they could have sold out of certain stocks earlier in their periods of underperformance. Nevertheless, the essentials of the process and what the team are looking for have remained the same (as discussed in the Portfolio section).
The improved performance since Q4 2018 has had a significant effect on the discount. In the calendar year 2019 the discount averaged 11.8%, having averaged 14% in the three previous years. In the graph below we have compared the trust to the all-cap AIC Asia Pacific sector, as there were only two trusts in the small-cap sector until recently. With the average discount of this sector changing little over these four years, AAS has re-rated versus the peer group. That said, at 11.5% the discount is still wider than the peer group average of 7.8%, with discounts being volatile at the time of writing thanks to concerns about the coronavirus.
In our view this reflects the fact that Asian small caps have not followed the usual pattern of behaviour versus large caps, and have actually underperformed in rising markets and over the course of the last cycle. This is largely due to the relative absence of technology- and internet-related companies, to which AAS’s exposure has also been light. However, in our view it is likely that this period will prove to be the exception rather than the new normal. As such, the relatively higher ratings for large-cap technology- and internet-heavy portfolios should eventually revert to the mean.
The board uses buybacks in order to limit the discount and control its volatility, and buybacks have been frequent and consistent. The last time the trust traded on a single-digit discount for a number of days (in January 2019), buybacks halted. The board has not given a discount level that it targets.
Ongoing charges are 1.16%, slightly more expensive than the other Asian smaller companies trust, Scottish Oriental Smaller Companies (which has an OCF of 1.01%). These charges include a management fee of 0.96%. Management fees are charged on market capitalisation rather than NAV, incentivising the manager to close the discount. There is no performance fee.
The KID RIY is 1.61%, compared to 1.25% for Scottish Oriental Smaller Companies, although methodologies can vary.
Before ESG was fashionable, Aberdeen Asset Management (which merged with Standard Life in 2017) was investing in Asian equities, with sustainability issues incorporated into its stock-selection process. The Asian equity teams inherited by Aberdeen Standard have always viewed good governance as being an essential attribute of a ‘quality’ company. While it has historically focussed chiefly on governance, environmental and social issues have become more significant as the years have gone by. Asian equity team members conduct their own assessment of the performance of candidate companies on ESG grounds, but also consider the ratings of external analysts and try to understand the reasons for any differences. The team view themselves as being in partnership with the management of their portfolio companies, and so use their position as a shareholder to encourage better practice. They believe this should lead to better long-term returns to shareholders, as they believe ESG issues are frequently material to long-term company performance.