14 Oct 2019
For the first time I flew straight into Singapore, arriving at the airport at half past midnight. It must have been one of the last flights of the day into the new Terminal 4 as there were no queues at immigration. The airport infrastructure at Singapore is known to be amongst the best in the world and, as you’d expect, my bags were waiting for me at the luggage carousel when I arrived. With no queue for the low-cost taxis, we arrived at the hotel around 45 minutes after touching down, ideal for my meetings the next morning. With a seven-hour time difference it didn’t feel like the early hours but I managed to sleep straight through until breakfast time before heading off to my first meeting with the Stewart Investor Sustainability Team.
The Stewart Sustainability Team prefer to work from the low key, Duxton Road shopfront building rather than the financial centre. In portfolio construction terms the sustainability team have now separated from their St. Andrew’s Partners colleagues and the bulk of the Sustainability asset management team are split between Sydney and Singapore. There’s a real focus on the team’s own definition of quality and a strong bias in the fund to family controlled/influenced businesses where the founder still has a significant stake. These account for 76% of the NAV, compared to around 20% of the NAV of the top 50 stocks in the Index. The portfolio only has 1% exposure to state-owned enterprises, as the team believe that these aren’t run in the interest of minority shareholders. There’s still a spotlight on avoiding large losses when building the portfolio on a bottom up basis and the team are very aware of potential risks in businesses when investing. Whilst this is a large, cap-orientated strategy, the top 10 names, which account for 45% of the fund, are only 3.4% of the Index. As a result, there’s a high active share of over 93%. The largest holding is Indian IT outsourcer TCS, which benefited from the dollar strength in 2017, when the sector was out of favour. Another significant holding is CSL, the Australian listed international blood plasma company.
There are also some Japanese listed names in the portfolio that have significant business now deriving from the China/Asia region including Unicharm, which produces diapers and Pigeon, a market leader in baby feed bottles. Both Unicharm and Pigeon have diversified away from their home market due to the poor demographics in Japan, where the annual birth rate has declined to under 1 million. In contrast, the numbers in Indonesia are 5 million, in China 14 million and in India 24 million.
Within financials, there is an emphasis on plain vanilla banking, as this is an excellent way to gain exposure to increased levels of consumer prosperity. Banks held, such as HDFC Bank and Kotak Mahindra Bank, are both benefiting from digitalisation and have much lower leverage than Western banks.
Whilst country exposure is driven by bottom-up stock selection, the Indian subcontinent, at 33.4% of the fund, reflects the team’s long-term bias towards this market due to the strength of rule of law and certain favoured family-owned businesses. Indian management and family-controlled businesses vary enormously in governance and quality, with some treating minority shareholders extremely well, whilst others follow practices that are far less robust. The team rigorously assesses families and takes succession issues into account prior to and at the point of investment, before backing the chosen few over the longer term. Families perceived to be dependent on political favour, such as the Gujarat based Ambani’s and the Adani’s are avoided.
Whilst the funds’ direct exposure to China is very low at below 1%, it doesn’t have a negative view on all China-related businesses. The team do have stewardship and franchise concerns about some Chinese companies and these views have been held for several years. They prefer to find exposure to parts of the Chinese economy through names listed elsewhere. This includes the Japanese stocks Unicharm and Pigeon, together with Hoya, a leading provider of eyeglasses, Nippon Paint Holdings, the number one decorative paint brand in China and Vitasoy, the number one soymilk brand. Lactose intolerance is common in China, which has helped drive demand for the product. Other China-exposed names include Chroma, the electrical vehicle testing manufacturer, and Advantech, the number one industrial PC manufacturer.
The team doesn't believe that they can successfully predict macro events and has built their own method of assessment looking at management, quality of franchising and quality of financials. A company that doesn’t satisfy the set criteria will either not be invested in or sold if there is a deterioration. This was the reason for the sale of Idea Cellular, which has left the portfolio at a loss, but has prevented further deterioration.
Since launch, cumulative performance numbers remain excellent, and even during the last five years, where there has been a positive market environment overall, the fund has remained ahead of its benchmark index. The strength of the franchise that the Stewart Investor Sustainability team have established in the region relates to the downside protection and focusses on avoiding stocks where significant losses could occur.
The separation of various investment units within the First State business has seen the team headed by Martin Lau rebranded as FSSA and their Global Emerging Markets Focus Fund was launched. The portfolio construction team working on this product is headed by Rasmus Nemmoe and assisted by Anders Heegaard, who previously worked together at Lloyd George in London and Naren Gorthy. Whilst all managers work as generalists, the EM product is looking to fully utilise the strong resource that the team have in both the Chinese, Indian and broader Asian regional market, where funds run by individual team members in these areas have delivered outstanding performance. The GEM products are managed with the same strong valuation disciplines and absolute return mind set, focusing on quality companies over the longer term, that can deliver sustainable and predictable growth. The team target businesses that have the potential to return US$ 10% p.a. over the longer term to investors and the fund looks for management teams that act with integrity, have a long-term strategy, are risk aware and are excellent capital allocators.
Whilst the portfolio is built bottom-up, a look through at the fund shows India, the largest country in weight, at 25%, followed by China at 18%. Within the top 10 holdings, four names are listed in India; HDFC Bank, Axis Bank, Godrej Consumer Products and Kotak Mahindra Bank. Within the top 10 stocks, there is good diversification with names such as Bank Rakyat, the Indonesian micro lender, Yum China, AVI, a South African consumer stock, Banco Santander Mexico, Tsingtao Brewery and Universal Robina, the Consumer Staples name listed in the Philippines. The top 10 holdings are 34% of the fund but only 0.8% of the benchmark index. At current valuation levels, Mexico is preferred to Brazil, which was reduced after the rally, post the election of Bolsonaro. The fund also invests in some off benchmark/frontier markets, such as Pakistan, Peru and Argentina. The funds’ largest holding is HDFC Bank.
One of the newer top holdings came from the China team, Tsingtao Brewery, which has both an ‘A’ and ‘H’ share listing. Whilst the Chinese beer market is mature, the premium end is much smaller than in developed markets at 10% and further premiumisation of the market is expected. Price rises flow straight through to the bottom line. A litre of beer costs only $1 in China versus $8 in the States. This is a reformed SOE with management compensation linked to the profitability of the business, which is low today. The company has 62 breweries in China, but as capacity utilisation is only 55%, some rationalisation of the business looks likely. The stock was purchased on 1x EV/sales where most global breweries trade at 3x sales. With 30% of its market cap in cash, this stock appeared to have little downside when purchased and is a prime example of how the fund uses the expertise and deep knowledge of the China team to cherry pick some of the best ideas in that market for this portfolio.
This fund launched on 1st December 2017 and has delivered strong returns versus the Index, benefiting from its focus on the domestic consumer, through both consumer staples, consumer discretionary and domestic orientated banks. There are zero weights to communication services, utilities, energy and real estate. The fund has now built a credible record over two years which, when combined with the long-term record of the regional Asia funds managed by the team, looks to be a strategy which can deliver strong risk-adjusted terms going forward.
FSSA also have a long running offshore Indian Subcontinent fund which has now been made more easily available to European investors. The team manage around $840m in specific Indian mandates, although there are considerable Indian holdings in other portfolios. The investment process remains unchanged with a focus on identifying opportunities on a bottom-up basis. FSSA believe that there is huge and long-term opportunity in India, due to the large population, attractive demographics and low penetration of many basic consumer-orientated goods. Within the universe, many businesses are fast growing and have high ROCE. Within India, there is the benefit of strong rule of law dating back to the days of the British Empire, but management quality does vary considerably, allowing active stock pickers significant scope to add value. Within India it is important to own the right franchises, even if the overall industry or market is a secular growth one.
The bull market in India, post the Financial Crisis, was one driven very much by small caps, but the managers of this multi cap strategy recognised the over valuation in this part of the market and pulled back exposure significantly to close to 10% at one point. The team now believe that, with the weakness in the Indian economy, there will be excellent opportunities over the next 12 months to buy into businesses with strong growth potential at highly attractive levels.
One of the interesting small caps currently in the fund is Blue Star Limited, which has a market cap of around $700m, much smaller than the global industry leaders in air conditioning, which include Chinese names Gree and Midea. Both these stocks have market caps in excess of $30bn. Air conditioner penetration remains very low in India at 8% versus 74% in China and 88% in the States and even in countries such as the Philippines, Indonesia and Thailand, penetration is respectively at 13%, 33% and 36%. This business has doubled its market share in India between 2011 and today. The CEO is Vir Advani, the third-generation promoter family, who have a focus on increasing profits, rather than market share.
The top 10 holdings in the fund account for 45% of the portfolio, but only 11% of the index. The largest holdings are bigger listed business, such as HDFC Bank, Kotak Mahindra Bank and ICICI Bank, together with Axis Bank. There is also considerable exposure to consumer names, such as Nestle India, Godrej and Colgate-Palmolive India. There is one mobile business held, Bharti Airtel, which is now benefiting from the demise of Vodafone Idea, leaving the Indian mobile market, in effect, a duopoly.
Lead manager, Vinay Agarwal, has just returned from a trip to India, and with company management and other investors now pessimistic, is looking to deploy some of the cash he has held in the portfolio. The non-bank financial crisis has impacted on both market sentiment and the broader economy. In India, a liquidity squeeze is now happening, and poorer quality stocks are suffering. An example of a sector in stress is autos, where loans to finance new cars have dried up at a time of stronger emission compliance regulations and changes in insurance requirements, necessitating the upfront purchase of policies for three years. While this fund is specialist in nature, it can be a useful satellite holding for investors looking for a market with strong long-term growth potential over the next decade, as India continues to play catch up with its more developed neighbours within Asia. This fund in its offshore format has delivered outstanding returns over the past eight years under the current manager, both in absolute and risk adjusted terms.
Graham O’Neill,
Senior Investment Consultant
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