Asia Dragon Trust (DGN), formerly Edinburgh Dragon Trust, aims to identify well-managed, world-class businesses in Asia and buy them when they are on attractive valuations. The management team at Aberdeen Standard Investments, headed by Adrian Lim and Pruksa Iamthongthong, take a long-term approach to investing. They aim to be an active, engaged shareholder, encouraging good corporate governance and alignment with other ESG goals.
The trust performed strongly following implementation of a number of changes to the process in 2017 and 2018, which saw it increase exposure to IT and China, as discussed in the Performance section. However, in 2020 it has lagged the index slightly in the recovery from the pandemic, thanks largely to its exposure to countries which have struggled to control it.
In the aftermath of the coronavirus crash, Adrian and Pruksa have taken the opportunity to buy high-quality companies they had previously coveted but found too expensive. This has increased their weighting to information technology and e-commerce, and the portfolio has some large single stock positions in Tencent, TSMC and Samsung (together 28.3% of the portfolio). However, the portfolio retains balancing exposures with the bottom-up process leading the managers to a diverse set of companies from across the region (as discussed under Portfolio).
The managers tell us they are wary about the immediate future for the Asian economies, because of the impact of the lockdowns and a possible resurgence of the virus. However, they think their focus on quality and resilient earnings could prove a relative advantage. DGN’s shares are trading on a discount of 13.4% to NAV, wider than the five-year average and the sector average.
DGN is an attractive core Asia holding, in our view. In 2020 the dispersion of returns within markets, including Asian markets, has been extreme, with technology, e-commerce and China outperforming considerably following the emergence of the pandemic. DGN has benefitted from these themes, but it also maintains exposure to other areas which have not kept up and which could do better when the wind changes. The unusual nature of the recent sell-off has been such that this includes more cyclical sectors and also more defensive sectors. In our view this diversification is attractive at this point in time, when valuations in the fashionable sectors are looking expensive and the economic impact of the earlier lockdowns is starting to be felt.
The portfolio has seen an unusual flurry of activity in the aftermath of the pandemic as Adrian and Pruksa took advantage of the crash in valuations to pick up exposure to high-quality companies at attractive prices. This is a tangible outcome of the refinements made to the process in 2017 and 2018 which have made DGN a more flexible proposition.
This discount of 13.4% is wider than the five-year average and the sector average. In our view this reflects the strong momentum trade and concentration of flows into limited areas of the market. The current share price could well prove to be a good entry point into a portfolio with more defensive qualities which may come back into favour.
|The revamped strategy has led to a period of significant outperformance
||The discount has been stubbornly wide
|Deep resources and highly experienced management, with the joint lowest OCF in the peer group
||Structural gearing, although modest, can increase downside risks (while helping on the upside)
|The quality approach should ordinarily lead to outperformance in rocky markets
||Large positions in three stocks could increase volatility|
Asia Dragon Trust (DGN) aims to generate long-term capital returns by taking a patient approach to investing in high-quality businesses listed in Asia. DGN is managed by Adrian Lim and Pruksa Iamthongthong, who draw on the stock analysis of a team of analysts and portfolio managers who are all based in Asia. The team aim to identify businesses with strong balance sheets and resilient earnings streams which should be able to grow through the ups and downs of the business cycle. They then track companies until they think the valuation provides a favourable entry point, aiming to be a long-term holder of the shares. As a long-term shareholder, the management team are highly active in holding company management to account and encouraging positive change in the treatment of shareholders, as we discuss in the ESG section. They consider strong corporate governance to be a crucial characteristic of a good long-term company to own.
DGN was formerly known as Edinburgh Dragon Trust, but was renamed in 2019 following a series of refinements made to the investment process in 2017 and 2018 which were intended to improve performance and create a more balanced portfolio. This has involved a greater focus on the downside risks to holdings and exiting lower-conviction holdings earlier, as well as a reorganisation of the management team by sector and an increase in the weighting to technology and China as these markets have matured. However, the revivified trust remains focussed on finding high-quality businesses.
For the companies that comprise the portfolio, the quality characteristics they display have been helpful in the current crisis, and Pruksa tells us quality continues to be a key focus as economies recover from the initial impacts of the shutdowns. In fact, the team think that after a sharp relief rally, the outlook for Asian and global economies is darkening slightly as the consequences of the lockdowns work through the economy and governments handle potential resurgences of the virus. We think this could make the focus on quality characteristics such as strong balance sheets and resilient cash flows beneficial in the coming months.
Asia as a whole benefitted from its companies having relatively low leverage heading into the crisis compared to their Western counterparts. At the end of January (see our last note) the net debt to equity on the MSCI AC Asia ex Japan benchmark was just 6%, less than half the c. 14% of the S&P 500 in that month (measured at 31/12/2019). As the below table indicates, the index as a whole now has a net cash balance sheet as companies have responded to the pandemic by paying down debt. However, DGN’s portfolio has had had a net cash balance sheet as a structural characteristic. The portfolio displays a higher ROE and ROA than the index, which is indicative of high-quality financials, and is trading on a slight valuation premium to the index. This reflects the fact that although valuation is important to buy decisions, the team are long-term holders and so don’t generally sell out of companies unless their valuation grows to egregious levels. It is also influenced by the decision to make greater adjustments to valuation expectations in the light of growth prospects, which has allowed the weighting to information technology to rise.
|Asia dragon Trust Plc
||MSCI All country asia ex japan
Source: Aberdeen Standard, as at 31/07/2020
Adrian and Pruksa have focussed on improving the quality of their portfolio during the crisis months. This has involved building positions in high-quality companies they had previously found too expensive until the market crash in February. As well as adding more to existing high quality tech holdings TSMC and Samsung as they sold off, they added Silergy, a Taiwan-listed chip designer. They believe this company should be able to do well whatever the outcome of the trade war – it does 50% of its sales in the USA but operates its factories in China, so would be the beneficiary of any drive to China localisation. The managers also added Meituan-Dianping, an e-commerce operator with a strong presence in food delivery which is expanding by opening up its platform to selling other goods and services. This is another company to have suffered a large sell-off in March but which is placed to benefit from the long-term structural trend, in this case the digitalisation of commerce. Another new purchase was GDS, a data centre play in China which serves Alibaba and Tencent amongst others. Again, the company was considered too expensive before the coronavirus sell-off. After topping up their positions, Samsung and TSMC are both close to 9% of the portfolio, but Pruksa and Adrian believe the sustainability of their earnings and high quality balance sheets make them attractive stocks to hold even in a cloudier economic environment.
top ten holdings
|Samsung Electronics Pref.
|Ping An Insurance
|Bank Central Asia
|China Resources Land
|Housing Development Finance
|China Tourism Group
Source: Aberdeen Standard, as at 31/07/2020
In terms of sales, the financials exposure has been cut, which decreases the cyclical exposure of the portfolio. This included exiting Bank Rakyat of Indonesia. In India, HDFC Bank was exited but the team added to Kotak Mahindra Bank. In the latter case they took advantage of the main shareholder having to place out the stock of the founder shareholder in order to meet listing rules. Unilever Indonesia was also sold.
An addition in India was Info Edge, another e-commerce player whose core business is a job listing platform. It has also developed a real estate listing platform as well as investments in other verticals, such as a food delivery platform.
This flurry of activity is unusual for the management team, who are usually slow to change the portfolio. According to Morningstar data, over the past three years the turnover has averaged just 15%. These have been exceptional circumstances, however, and it is interesting that the focus on IT and e-commerce has been increased further. In fact, as the below chart shows, IT is the largest single sector exposure at 23%, now ahead of financials, the largest sector in the benchmark. Some e-commerce names sit within the consumer discretionary and communication services sectors too. Nonetheless, the portfolio retains significant allocations to other areas such as the more cyclical banks, real estate sectors and the consumer staples sector. In our view, DGN’s balanced exposure is attractive on a relative basis at this point in time after such a strong run-up for IT and e-commerce names. In fact, Adrian and Pruksa have added to the oil & gas sector, and to real estate and gaming companies too in the recent disruption, indicating that they are still looking for opportunities in more cyclical or less fashionable parts of the market.
The country weightings are an outcome of stock selection decisions, which have resulted in more balanced exposures than the index, which has a strong bias to China, Taiwan and Korea (see below). The trust’s long-standing overweight to India, with its good corporate governance and strong demographics, remains, even as the team’s conviction in Indonesian companies has been falling. Indonesia and the Philippines remain overweights for DGN, but the positions have been cut. Thailand has also been cut, and is now an underweight.
These changes are not macro calls, however. The portfolio is built from the bottom up, rather than by taking thematic, country-specific or sector-specific views. However, themes do come through, and the impact of the pandemic has negatively impacted the outlook for some companies in countries which have been relatively hard hit (such as India and Thailand). We think the relatively high turnover does reflect the impact of the changes made to the investment process since 2017 and 2018, in that the managers have been more ruthless in selling out of positions quickly when they feel the investment case has worsened.
However, the process remains centred on detailed fundamental analysis, and the managers are cautious in taking and building positions in new holdings. After analysing the financials, the team are diligent in meeting management and coming to conclusions about management’s attitudes and abilities, as they place great weight on good corporate governance. Stocks are typically introduced at a low weighting and then increased as the team’s knowledge and conviction rise.
DGN’s board believes a modest level of gearing is an appropriate way to enhance returns over the longer term. As a result, DGN has a moderate level of structural gearing, with £25m having been borrowed in July 2019 for three years. This amounts to roughly 4% of net assets (£604m), with the total net gearing (as of the end of July) being 4.6%. The remainder was debt drawn down from a £25m revolving credit facility, which is currently offset by 3.7% held in cash. Pruksa tells us that the managers are happy with the gearing at this level, given their desire to balance being modestly geared over the long run with their cautious view on the prospects for markets in the remainder of the year. They are generally cautious in their moves with the gearing, and so did not make any tactical changes following the emergence of the pandemic.
DGN embarked upon a strong period of relative performance in 2018 thanks to the refinements made to the process and the portfolio. An increased weighting to China and to technology bore fruit, although this was mainly a function of stock selection rather than sector or country allocation, as DGN remained underweight to these areas. The strong performance is visible in the cumulative relative performance graph below, where a rising line indicates relative outperformance of the iShares MSCI Core AC Asia ex Japan ETF, which tracks the trust’s benchmark. Performance has clearly tailed off in relative terms in 2020.
This tailing off of performance in 2020 is due to the extreme outperformance of China and technology-related companies. DGN, despite its recent tilt towards those areas, retains a more balanced set of exposures. China is up over 18% in 2020 and the regional technology indices are up a similar level, compared to a 7% rise for the MSCI AC Asia ex Japan. China has benefitted from lifting economic restrictions early, while technology companies have been in vogue thanks to the pandemic and restrictions on movement associated with it increasing demand for homeworking and online shopping and services. DGN does have exposure to these themes, such as through its single largest holding Tencent (10.4% of the portfolio). WuXi Biologics has also done well this year, as has China Tourism Group, which has reinvented itself as a domestic-focussed business with exposure to e-commerce. However, DGN has been held back by its overweight exposure to India and Indonesia, both of which have struggled to control the pandemic. India also suffered from a banking crisis before the coronavirus crash. As a result, over one year DGN has generated NAV total returns of 3.6% compared to a return of 8.7% from the index. The average of the AIC Asia Pacific peer group is 9.9%. The slower recovery from the crash is visible in the graph below.
In the financial year from August 2018 to August 2019, the trust’s strongest period of relative performance, China International Travel, Shanghai International Airport and Kweichow Moutai were all major contributors. Insurer Ping An was another major winner, while financials in Indonesia (Bank Central Asia) and India (Housing Development Finance Corporation) also did particularly well. The themes of consumer aspiration and urban development come through in these picks. In both 2018 and 2019 DGN outperformed, after lagging the index in the sharp rising market of 2016 to 2017. The sharp rally in Asia was led by internet- and technology-related stocks, particularly in China, but the trust didn’t quite keep up thanks to its preference for high-quality businesses and a cautious approach to valuations.
The poor performance in 2015 was thanks to the collapse in the oil price and poor results from Standard Chartered and HSBC, as well as an overweight to Singapore. This period caused some soul-searching on the team, and led to the refinements made to the process and portfolio which bore fruit in the following years. These changes involved being more decisive on underperformers, as well as closing the historical underweights to China and technology.
DGN has a capital growth objective rather than an income objective and yields 1%. Dividends have grown steadily in recent years thanks to earnings growth on the underlying portfolio. However, the board does not explicitly target a growing dividend. The board’s policy is to pay a dividend marginally in excess of the minimum required to maintain investment trust status (85% of net income), which means that stable or rising dividends cannot be assumed in future.
Adrian Lim, a long-serving member of the Aberdeen team before it merged with Aberdeen Standard in 2017, has managed DGN from Singapore since 2013. He was joined in 2019 by Pruksa Iamthongthong as co-manager, after Aberdeen Standard decided to dedicate greater resources to the trust. Adrian has been with Aberdeen since 2000 and is therefore well steeped in the quality-led approach of the company. Although the managers are ultimately responsible for buy and sell decisions for the trust, Aberdeen Standard takes a team-based approach to its portfolios, with the Asia Pacific equities team working together to build consensus views on stocks. Flavia Cheong heads up the Asia Pacific equities team, which includes 50 equity fund managers. Of these managers, 20 (including Adrian and Pruksa) are based in Singapore, where the team includes three dedicated ESG professionals. Flavia has been with Aberdeen Standard since 1996.
The aim is to gain consensus on all stock buys and sells and take a long-term view with investments. However, the team decided they had been slow to sell out of some companies in 2015 and 2016 when the evidence of a change in the companies’ fortunes was already evident (most notably as regards Standard Chartered). As a result, the team have created sector specialist groups in the analyst team to aid international comparison, rather than specialising by country. They believe this creates more accountability for individual stock picks and is more appropriate for an increasingly globalised investment universe. They have also assigned certain significant holdings to analysts in ‘Bull’ and ‘Bear’ roles in order to focus discussion and help uncover problems with holdings sooner rather than later. This process is implemented for companies where the team feel the need to more vigorously test the investment hypotheses.
Aberdeen’s merger with Standard Life Investments (SLI) in 2017 has not affected the management of the trust. The Asian equities team remain in place from Aberdeen, with Aberdeen’s strength in this region complementing SLI’s greater UK capabilities. Devan Kaloo remains head of equities at the merged entity.
DGN’s shares trade on a 13.4% discount to NAV, wider than its five-year average of 12.1% and the AIC Asia Pacific sector average of 8.5%. The rating has been weaker since the coronavirus crash in February. DGN has slightly underperformed the MSCI AC Asia ex Japan benchmark year to date and in the recovery, but in absolute terms the returns have been good compared to those of global markets, so this discount is a little surprising. It is possible that many investors were loath to invest after the crash, and this may be suggested by the fact that discounts on the whole sector are wide, despite the strong performance of Asia versus other major markets (with the exception of the USA). Another factor is that when investors have taken equity exposure it has been to crowd into the tech giants. This is the same case in Asia as in the USA (and in fact is a major explanatory factor behind those two regional indices doing so well). However, we worry that this trade is very crowded and valuations have got far ahead of themselves, and so we think more diversified exposure such as that provided by DGN is wiser in the coming months.
DGN conducted a tender offer in January 2019 which saw 30% of shares repurchased and cancelled. The board has continued to conduct regular buybacks since the tender offer. The board gives no target level, but discounts were paused during the worst of the crisis this spring and were restarted in June.
DGN is the second-largest trust in the sector, but is the joint cheapest (in OCF terms) of its peers. The ongoing charges figure (OCF) is 0.83%, which compares to a weighted average for the AIC Asia Pacific sector of 0.95%. This includes a tiered management fee, with 0.85% charged on the first £350m of net assets and 0.5% on the remainder. With net assets at £591m, we calculate the effective management fee to be c. 0.68%. The KID RIY is 1.09%, which compares to a weighted sector average of 1.45%, although calculation methodologies can vary.
The Asian equities team at Aberdeen Standard believe ESG and sustainability issues are intrinsically linked to the ‘quality’ of a company and that sustainability in the broader sense is important for the sustainability of a company’s earnings. In the past, Aberdeen Standard (and Aberdeen, long before the 2017 merger) was a standard bearer when it came to corporate governance in particular. It has always placed great importance on the incentives and attitudes of management to minority shareholders. In recent years, the team have integrated environmental and social issues more into their assessments. Team members generate their own ESG ratings for candidate stocks and also consider the ratings of external providers in order to understand the difference. Once invested, the team view themselves as long-term partners of management, and encourage companies to improve their behaviour vis-à-vis shareholders and stakeholders more widely.
As an additional resource, the team are also able to receive inputs from Aberdeen Standard analysts based in Edinburgh who consider top-down, global issues such as plastic use and climate change. There are also three dedicated ESG analysts sitting with the team in Singapore who cover the Asian region, and their task is to consider what progress is possible and desirable within the regional context.