Aberdeen Standard Asia Focus (AAS), formerly Aberdeen Asian Smaller Companies, aims to generate long-term capital growth by investing in high-quality Asian smaller companies. The management team has a valuation-sensitive approach and aims to hold companies for the long run.
Relative performance has been strong over the past year, with the trust outperforming the MSCI AC Asia Pacific ex-Japan Small Cap index by 5%, although shareholders have made almost twice that thanks to the narrowing discount. The trust lost much less than the market during the slump in the fourth quarter of 2018, with the defensive qualities of its portfolio having the expected effect. It also gained more than the market during the May and June 2019 rally thanks to its large overweight to India, which led Asian markets following Prime Minister Narendra Modi’s emphatic election victory.
Hugh Young, one of the most experienced fund managers in the Asian market, was named lead manager in November last year as part of an overhaul requested by the board. He has cut the number of holdings and increased the concentration in the highest-conviction ideas in order to increase the potential for outperformance. The strategy, however, remains the same. The focus is on identifying companies with high-quality financials and management, and buying in at attractive valuations and holding for the long run.
The approach is highly active, with some significant over and underweights in terms of country, sector and holding. For example, the trust has long been underweight China, largely due to corporate governance concerns. On the other hand, its overweight to India is a multi-year feature and likely to remain. The manager’s judicious use of increasing gearing into the fourth quarter of last year has also helped performance.
The discount has responded somewhat to the overhaul and the improving performance, with the average for 2019 being 11.7% compared to 14% for 2018. However, it still trades 11.5% below par at the time of writing.
The trust yields 1.5% and, while this is not high, the track record of dividend growth is strong, with 6.8% compound growth per annum achieved over the past five years. In fact, the trust has managed to grow or maintain its dividend in each year since launch in 1995 – excluding 1997 and 1998 – and investors at launch would now be earning a 17p dividend on their initial investment of 100p, representing a compound growth of around 7%.
The improvement in NAV performance over the past year has been impressive, as a period of strong stylistic headwinds has come to an end. With the outlook for Asian markets looking cloudier, we could well see the trust’s more defensive characteristics doing relatively well in the coming months. We don’t think this potential and the improving NAV performance has been fully reflected in the share price yet and continue to consider the discount of 11.9% to be an interesting value opportunity. Aberdeen Standard Asian Focus remains in our portfolio of discount opportunities.
|A highly attractive discount relative to peers with an improving performance record||The strategy has led the trust to have long-term underweights to China and technology; if these outperform it will lag|
|A more concentrated portfolio will increase the potential for the trust to outperform
||More concentrated portfolio will lead to higher NAV volatility / higher tracking error, which could lead to periods of underperformance
|The experience of the manager is second to none
Aberdeen Standard Asia Focus (AAS), formerly Aberdeen Asian Smaller Companies, invests in Asian smaller companies in order to generate long-term capital growth. The managers’ strategy is to purchase quality growth companies with attention paid to valuation at the time of purchase. This is the same basic strategy followed across the Asian and emerging market portfolios run by the Aberdeen Standard team. In 2018, following a disappointing period of performance, the managers conducted an overhaul of the portfolio to make it more concentrated, as well as give greater personal responsibility to Hugh Young, now the named lead manager, who had been the long-term head of the team in charge of the trust.
The approach has always been highly active, with a portfolio that differs significantly from the index in country, stock and sector weights. However, Hugh has cut out some lower-conviction names and sharpened the quality characteristics of the trust. AAS offers access to a portfolio on a lower valuation to the market, but with far superior return on equity, return on assets and debt to equity ratios, as the below table shows.
quality and value characteristics
|MSCI AC Asia Pacific ex Japan Small Cap
Source: Aberdeen Standard, as at 30 June 2019
We understand that around 7% of the portfolio remains invested in small positions that Hugh wishes to exit, but is waiting for a more advantageous selling environment. For example, the market sell-off in the fourth quarter of 2018 has encouraged some investors to submit lowball offers for certain Aberdeen Standard positions. However, Hugh makes clear that this has been a “refresh” rather than anything more drastic; the trust is still managed in line with the strategy that has generated outstanding long-term returns for the emerging market equity teams at Aberdeen (now part of Aberdeen Standard).
The key components of the strategy are a low turnover, long-term approach, a focus on good corporate governance, and a focus on quality – both in terms of financials and management teams. There is also great importance placed on the price that is paid; the team covers a shortlist of candidate stocks that pass all their quality screens and wait for valuations to be sensible before they buy.
Following the overhaul, the trust will have around 60 holdings. It currently stands at 72, down from 80 in September 2018. Of these, 30 are considered core holdings that have been given greater weight. Hugh tells us that he has concentrated on selling the lowest conviction positions first, particularly where exposures were doubled up. For example, the trust owned four plantation companies and Hugh sold those in which he had the least confidence. Despite the increased activity, the turnover in 2018, according to Morningstar data, was only 10% compared with a three-year average of just 7.4%.
The positioning, which is driven by bottom-up analysis of stock fundamentals, remains substantially the same. For example, the trust has a long-term underweight to China based on corporate governance concerns. The managers refused to compromise on these grounds during the equity bull run in the country in 2016 and 2017.
Hugh appreciates the huge potential in China, but the influence of the Communist Party on companies and widespread corruption make it hard for him to be comfortable becoming a long-term investor in the market. However, he views things on a stock-by-stock basis, and has added one Chinese company: Precision Tsugami China. This is controlled by a Japanese company, which influences management culture, although it sells into the vast Chinese market. Hugh stresses that many of his stocks also sell into China, so although there is minimal exposure to its stock market, the portfolio does benefit from Chinese economic growth. The trust continues to have its long-term overweight to Hong Kong, where corporate governance is generally stronger.
Hugh’s highly active management style comes through in the geographic allocations of AAS. As can be seen in the graph below, the trust has large underweights and overweights. India has been a long-term overweight. Hugh has been selling some of the best-performing stocks here in recent months after their very strong run, so the weight in the portfolio has remained constant despite it growing significantly in the index thanks to performance.
The manager has a long-standing preference for the ASEAN countries. Thailand, Malaysia, Singapore, Indonesia and the Philippines are all substantial overweights. Malaysia, Singapore and Thailand all have highly significant exposure to Chinese growth, with an average of 9.6% of GDP accounted for by intermediate goods exports to China, according to the OECD. Although the trust is not necessarily directly exposed to these exporters, the financials and consumer stocks that Hugh prefers depend on the growing wealth of these countries from trade for their revenue growth. This means that Hugh’s main worry on the macroeconomic front is the trend towards tariffs and protectionism.
Most recently, the manager has taken up a position in Vietnam, an off-benchmark country, with two new holdings: real estate developer Nam Long and tech conglomerate FPT. Nam Long specialises in affordable housing developments that are much in demand in the booming economy. FPT has a software outsourcing business that is gaining business from multinationals and does business across various other segments about which Hugh is optimistic.
Financials are a long-term overweight of the trust, along with consumer defensives and consumer staples. One consequence of the overhaul of the trust has been an increased weighting to technology, which increased from 3% of NAV at the start of 2018 to 9% by the end of that year. Additions here include Australian software firm Citadel Group and South Korean software company Douzone Bizon. To pay for these acquisitions, the allocations to consumer defensives, financials and industrials have fallen slightly.
A low allocation to technology has held the trust back in recent years. Even so, Hugh has had good reasons for avoiding significant parts of the sector, which have been riding the boom in smartphones. Many of these stocks are listed in Taiwan, a perennial underweight. Hugh believes they are too dependent on the whims of a handful of large customers and so have little pricing power and little scope to gain and maintain market leadership. Meanwhile, global smartphone sales peaked in 2017 and the trust’s underweight to Taiwan became a tailwind, on a relative basis, in 2018 after years of holding it back.
In May 2018, the trust issued £37m of convertible unsecured loan stock (CULS) maturing in 2025, paying interest at a rate of 2.25%. CULS-holders can convert their stock into ordinary shares every six months, in May and November. Following this spring’s transactions, there is just under £34.6m of this debt remaining, or approximately 8% of NAV in structural gearing. The trust also has bank loan facilities that allow it to supplement the CULS with up to $25m (£20m) of gearing, half of which has been drawn down and fixed to June 2020 at a rate of 2.5%. The remainder of the facility can be drawn down on a flexible basis.
A total of £56m of gearing was fully employed as of the end of December as the trust geared up to take advantage of the sell-off in Q4 2018. It has drifted down very slightly since then, but Hugh tells us he is comfortable to be significantly geared over the long run given the low beta nature of the portfolio and the low debt levels on the underlying companies. The current gearing level is 12% of NAV.
Relative performance has been strong over the past year, with the trust outperforming the MSCI AC Asia Pacific ex-Japan Small Cap index by 5%; shareholders have made almost twice that thanks to the narrowing discount. The trust lost much less than the market in the slump that took place in the fourth quarter of 2018, with the defensive qualities of its portfolio having the expected effect despite gearing being increased as the market fell. The NAV gained more than the market in the rally of May and June 2019 thanks to its large overweight to India, which led Asian markets following Prime Minister Narendra Modi’s emphatic election victory. The below graph shows the outperformance in relative terms, with an upward sloping line denoting a period of excess returns relative to the benchmark.
one-year relative performance
AAS has also outperformed the index over five years by 1% thanks to this strong period, despite a poor patch of performance in 2015. NAV total returns have been 45.4%. We note that the wider Asia ex-Japan investment trust sector has done better, but it is dominated by large-cap trusts that have outperformed in the strong run for large-cap tech stocks in 2016 and 2017.
Looking back over past calendar years, 2015 was the one really rough period for the trust. AAS lost 10% while the index was up 3%. 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. It is important to note that it was not stock selection but geographic positioning that hurt returns. In keeping with the manager’s conviction to follow the fundamentals of the companies rather than macro-economics, the positioning vis-à-vis these countries was not changed.
When analysed in terms of both geography and sector, the outperformance in the falling market of 2018 was due to stock selection. In particular, stocks in the financials and consumer sectors outperformed, as well as those in Thailand, Hong Kong and the Philippines. Of the top ten contributors to performance, eight do not appear in the benchmark, highlighting the active nature of the strategy. This strong period reflects the growing preference for quality and value over the highest-growth, more speculative names that drove global markets in 2017. We think this preference is likely to prevail in the current market environment, dominated by macroeconomic and political threats, and with the potential for tighter monetary policy, even if it seems like the US Federal Reserve might ease in the short term.
The trust has a total return objective rather than one based on income, and all expenses are charged to the revenue account. The trust yields just 1.5%, but has steadily grown its dividend by 6.8% a year over the past five years. We note that the trust has managed to grow or maintain its dividend in each year since launch in 1995, except in 1997 and 1998 in the midst of the Asian Crisis. This means that investors at launch are now earning a 17p dividend on their initial 100p investment, representing a compound growth of around 7%pa.
Hugh Young is one of the most experienced Asia 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 – and is also a shareholder – since it was launched in 1995. His appointment as named manager on this trust last year followed a period of rough performance across Aberdeen’s emerging markets mandates.
Although Hugh has taken more personal control, he continues to work within the Asian Equities team with a process that depends on building consensus. The approach is patient, with all members having to agree on a stock before they place a buy or sell recommendation on it. While this has not changed, the equity analysts are now assigned sectoral responsibilities to give clearer lines of responsibility. The intention, as with Hugh’s greater personal control on this trust, was to facilitate swifter decision making. The post mortem analysis on the period of weaker performance suggested the teams had been too slow to cut their losses on some troubled or lower-conviction stocks – hence the trimming of the tail of this portfolio. However, it is clear that there were also stylistic reasons behind the rough period too.
We are reassured that nothing essential in the strategy will be changing and impressed that the team has stuck to its approach during a period that has been stylistically very hard for a valuation-sensitive quality growth mandate. In our view, the next few years are likely to be much more hospitable to such a mandate given the more clouded macro-economic environment.
NAV performance has been strong against the index over the past year following the revamp of the strategy under the greater personal influence of Hugh Young. There has been some effect on the discount, with the average for 2019 being 11.7% compared with 14% for 2018. We believe we can trace this back to the improving relative performance in the fourth quarter of 2018 and the announcement that Hugh would be revamping the trust. Nonetheless, the trust still trades on an 11.5% discount, which we view as an opportunity given the expertise and track record of the manager, and the likelihood that the market will be more conducive to his style in the coming years.
The outlook for Asian markets is cloudier than it was in 2016 and 2017, with the risks of the trade war between the US and China, the strong US dollar and uncertainty around US interest rates all providing tail risks. This should lead to a better environment for a portfolio with a more defensive tilt implied by a quality and value investment approach. Given Hugh’s reputation and the greater role he is playing a named manager, we believe there is scope for the trust to trade on a tighter discount than the average Asia Pacific ex-Japan sector, as it did prior to the trust’s poor year of performance in 2015. In the meantime, however, the board has been active with buybacks, buying when the discount is around 12% or wider.
The OCF is 1.22%, compared to 1.01% for the other Asian smaller companies trust, Scottish Oriental Smaller Companies. This includes a management fee of 0.96%, which was reduced from 1% in November 2018 when the overhaul of the strategy was announced. At the same time, the management fee began to be charged to market value rather than NAV, giving the manager incentive to close the discount by improved performance. The KID RIY is 1.7%.