Periodically, we are faced with a ‘black swan’: an unexpected event with significant repercussions. The Covid-19 pandemic is one of those events. This has led to a significant contraction in economic activity and considerable uncertainty over the timing and pace of recovery. It has also caused a sharp fall in equity valuations. While unsettling in the short term, especially given the human cost of this crisis, the opportunity to buy stakes in companies at bargain prices is what we live for as active managers.
What effect has the downturn had on the Invesco Asia Trust plc?
The NAV performance of the Invesco Asia Trust has been really disappointing so far this year, both in absolute and relative terms (see figure 1), and can be attributed to the way the portfolio was set-up going into 2020. Before Covid-19, there was growing evidence that the long slowdown of global growth, that began in early 2018, was beginning to reverse supported by the lagged effect of global policy easing. Trade tensions between the US and China had also been improving. We believed that this would lead to a recovery in earnings momentum and a broadening out of market performance. The portfolio was positioned with the aim of benefitting from this turn in the cycle.
Instead, the spread of Covid-19 has turned this prospect on its head, or at the very least delayed it significantly. The economically sensitive sectors, such as financials, which were likely beneficiaries of a recovery, were sold off, in some cases indiscriminately. The portfolio’s exposure to technology, health care and internet businesses has offered some reprieve but not enough to fully offset the weakness in cyclicals. However, Asia has historically delivered strong positive returns from current valuations levels (see figure 2 below as of 8 May 2020) and we believe that the trust currently holds a number of significantly undervalued businesses.
Re-evaluating the portfolio in testing times
Even accounting for the weak economic backdrop that is expected over the next year or so, some companies will emerge stronger. The most innovative technology companies, as well as the Chinese internet companies we own, come to mind. Working from home has led to increased demand for PC-related equipment and cloud capacity. There has also been an acceleration in the trend towards online shopping and gaming. These are enduring themes that are well-represented in the portfolio and will remain so for as long as valuation levels permit.
Conversely, some businesses will take time to return to the level of profits they achieved in 2019. This may include high quality businesses in more economically sensitive areas. In many cases, valuations reflect limited expectation of recovery and we see this as a source of opportunity. The key questions for us during this period of uncertainty are as follows:
- Is the business robust enough to withstand the current economic downturn?
- Is the business worth much more than reflected in the share price using conservative assumptions about the next 3 years?
- What is the best way to position the portfolio in these markets?
We have run the ruler on every single portfolio holding with this framework in mind. Currently, over 75% of the portfolio (excluding financials) is held in companies with net cash positions1.
What actions have we taken in the Invesco Asia Trust?
Firstly, we have not changed the way we manage money or how we analyse companies. We believe that buying companies at a discount is the most sustainable way to make money for investors over the long term.
We have significantly reduced our overweight in financials given the likelihood of a low interest rate environment and the potential for some asset quality deterioration. Our remaining bank holdings tend to be very well capitalized, have loss-absorbing capabilities and are focused on the more under-banked parts of Asia, like India.
We have also identified several companies which we believe have been hit indiscriminately and have scope to do well in a rebound, without making too optimistic an assumption about the trajectory of earnings over the medium-term. For all our holdings, balance sheet strength remains an important consideration. In India, we have continued to build a position in Mahindra & Mahindra which has a highly profitable tractor business trading at a mid-single digit multiple. We also believe that there is an emerging capital allocation improvement story which the market has yet to appreciate. In China, we have purchased Tencent Music Entertainment, a live streaming and music subscription company. It has more than twice Spotify’s monthly active users but only a quarter of its market value. We believe the market is underestimating its ability to convert its users into paying subscribers. We have also introduced Genting Singapore: an integrated resorts operator with a strong balance sheet and material upside potential over a three-year horizon, in our view. We think that its growth prospects are being significantly undervalued even if we assume no earnings for 2020. It has over 30% of its market cap in net cash and a dividend yield of almost 6% which is unlikely to be cut2.
It's impossible to predict how and when Covid-19 will be defeated but history has repeatedly demonstrated that buying the market at low valuations has led to very good subsequent returns. This is because markets tend to extrapolate short term news too far into the future, leading to low expectations, and policy responses eventually provide enough impetus for an economic and earnings recovery. This time the monetary and fiscal easing is unprecedented.
Our job is to hold the shares of around 60 Asian companies we believe have strong upside potential while aiming to minimise the risk of a permanent loss of capital as we navigate through these testing times.
1 Source: Invesco 30 April 2020.
2 Bloomberg 30 April 2020.
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
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The product uses derivatives for efficient portfolio management which may result in increased volatility in the NAV.
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