What do China’s recent regulatory changes mean? Where else should investors be looking in Asia? Pendal’s Samir Mehta has answers in this short video with portfolio specialist Chris Adams.

Watch the video or read the transcript below

TRANSCRIPT

Portfolio specialist Chris Adams speaks with Pendal Asian Share Fund portfolio manager Samir Mehta about investment opportunities in Asia

Portfolio Specialist Chris Adams:

If we think about the last 18 months or so there are a number of important pieces in play in the Asia region. There are questions about global supply chains, geopolitical tensions and a great diversity in terms of managing the human and economic consequences of Covid.

We’ve seen regulatory shifts in China that have dramatically altered the outlook for entire industries. All of this is driving heightened uncertainty, which drives the opportunity for active investors.

Today we want to share with you where we’re seeing the opportunity in Asia.

I’m joined by Samir Mehta, a senior fund manager at J O Hambro Capital Management. J O Hambro is part of Pendal Group. Samir has been investing in Asia for 31 years. He’s been with J O Hambro for since 2011 and he’s the manager of Pendal Asian Share Fund.

Samir, your funds had very strong relative performance over the last 12 months.

What are the key calls that you’ve made that have driven this?

Senior Fund Manager Samir Mehta:

Thank you, Chris. As you mentioned, there have been so many changes over the past two years or so.

When I look back at the last year of performance, two big things stand out in terms of the positioning of the fund.

First, I was reasonably early in taking cognisance of risks in China — particularly the regulatory risks — and therefore had a big underweight position in China.

If you go back in history even from 2018 onwards and look at the fund, I haven’t held any American-listed Chinese companies because the risks on ADRs was starting to come to the fore ever since the trade tensions between the US and the Chinese started to come in.

That prompted me to rethink the risks.

So there was the underweight position in China, particularly recognising the regulatory risks.

Second, in China valuations had gone to levels where I did find them to be a touch expensive.

And there’s a possibility of the Chinese economy slowing, having gone into Covid first in 2020 and coming out of it first in 2021.

Combined with that was a relatively big overweight position in India.

It’s a country you could say hasn’t really handled the Covid situation well yet.

There has been significant consolidation among businesses, which has allowed the better-managed companies to generate supernormal profits in what has definitely been a challenging year.

And we’ve had some very good stocks in our portfolio.

So those two – a big underweight in China and a big overweight in India – have effectively been the difference.

Chris Adams: The Chinese underweight obviously has been a good call. A lot of international investors are increasingly wary of China, given the signs of slowing growth and then the recent regulatory crackdown. So are you maintaining your Chinese underweight?

Samir Mehta: For the moment yes, but I also have been taking advantage of the dips that have come in.

As you know in July we had a big sell-down. I added to our existing holdings a couple of names like Tencent which is one of the large companies in China you would have heard about. And Meituan, which is the largest food delivery company.

When we had the complete panic towards the end of the month I did add to it at valuations I thought were quite cheap.

Then I’ve been running my screens because, as many of my peers around the world are starting to become a lot more cautious, I want to ask: “what can go right?”

Because now the risks are well known. The government’s come down quite hard on several industries, regulatory risks have come to the fore and there is, for example, in the education sector an attempt by the Chinese government to make them non-profit.

So the natural question people are asking is: “should we even invest in China?”

I say valuations are now reasonable and risks are to the fore.

Therefore it is incumbent on someone like me – who’s been lucky enough to be underweight in China – to take advantage of the situation, to find opportunities.

It’s not going to be immediate, but I do find several companies that I want to add in the portfolio in China.

Chris Adams: Can you tell us what kind of sectors might be attractive to you in China?

Samir Mehta: Yes sure. I did mention a couple of our existing holdings [above], which have good growth prospects, high returns on capitals and good cashflows.

I’ve then added a lens to ensure they are unlikely to be in contradiction with what the Chinese Communist Party wants for its society.

Tencent and Meituan for me are the standouts.

I realise games might be a controversial topic. But I feel at some point businesses will adapt and Tencent is already doing that.

They have curbed the ability for kids to use games. They’re looking for identification, etc.

And Meituan creates a phenomenal service for society. Imagine in a period of Covid, not having the ability to order food at home.

So these services I think are going to be quite critical.

Another sector to be aligned with policy of the party and the government is energy.

China has been a large emitter of carbon and has suddenly put its foot down in terms of what they want to achieve for the economy by 2030 or 2050 or 2060.

Energy is going to be a very large part of that attempt to move towards a carbon neutrality.

So in the portfolio, we own a company called ENN Energy. It transports natural gas which is much better than burning coal.

They’ve also gone into a business in industrial estates. In China there are hundreds of industrial estates spread around the country which used to have coal as a primary energy source.

ENN goes into these industrial assets, converts them from coal into natural gas, and takes over other utility functions such as steam and water.

So that’s one company I have.

The other thing I’m looking at is investments in the State grid. As the Chinese government and industries use a lot more solar and wind power, you need to have a smarter grid.

These smarter grids require significant investment in better automation and better control of how these alternative sources of energy are used in that grid.

I’ve looked at a couple of companies, one which I’ve already started to buy.

I prefer not to mention the name because I’m just starting out. But these are examples where I’m trying to make sure a) they are reasonably good in terms of what they do for society and b) I’m trying to be aligned with what the Party and the government wants.

Chris Adams: India and China are large allocations in the portfolio but that’s obviously not all there is to Asia. Can you give us a flavour of where else you’re finding opportunities? And what are some of the risks you’re thinking about – whether Covid or otherwise – when it comes to Asian equities at the moment?

Samir Mehta: If you look at one of our top holdings in the fund is a company called Kakao, a South Korean company which is completely digital – native digital as they say – and have done a marvelous job in several aspects.

They have a business in developing games. They are into music. They have a vertical that is into payments. They started a bank. They’re in cartoons and media properties.

The key has been their instant messaging platform called Kakao, which has 46 million monthly active users out of a total population of about 51.5 million people in Korea.

It is as dominant as you can get. They have the ability to create verticals around those customers.

The founder is very good. His ability to bring on professionals to run these verticals and give them autonomy has worked out very well.

Just to give you a bit of flavour, Kakao Bank is an internet-only bank. They launched it in 2017. That’s just four years ago.

They did an IPO last month. And today it trades at a valuation of $US30 billion. Kakao, the company we own in our portfolio, owns about 27.5 per cent of the bank.

Similarly, they own minority stakes in several of these verticals I mentioned earlier.

So Korea has been a good hunting ground for us and this is one exmaple.

Then south-east Asia I’m doing a lot more work on. It’s been one part of the world that has taken a really big hit from Covid.

Infrastructure has been poor. Governance in many of these countries hasn’t been up to scratch. The challenges from Covid have been particularly bad for companies in these countries and Southeast Asia.

As valuations have come off, people have ignored these countries.

Now my screens are showing many companies that are cheap.

So I’ve started to buy a company in Indonesia as well as one in the Philippines.

Again, I won’t say the names because I’m just starting to buy them.

But I do find in Southeast Asia companies are trading at valuations that are reflective of the risks. And if we are able to find better management of Covid – which I hope will happen over time – you might find these opportunities will deliver performance for our fund.

Taiwan I’ve been a bit underweight. The reason is it’s a primarily a technology-oriented market.

I feel at some point in time this massive bull run we’ve had in tech stocks – particularly around hardware and semiconductors – may be a bit long in the tooth. I’m a little bit cautious on that.

So I’m underweight in Taiwan – there are good businesses, but valued highly. So I’ve stuck to Korea and Southeast Asia – that’s where I’m now looking for opportunities.

Chris Adams: One final thing I want to touch on – which is increasingly important to investors here in Australia – is the ESG (Environmental, Social and Governance) element. It would be good to get your thoughts on ESG factors in Asia and how that figures into your process.

Samir Mehta: You mention a very good point. We have clients who are based in the US or Europe and have been at the forefront of ESG – just like Australians have been.

I’ve benefited from my clients asking me to think about ESG much earlier than what regulations have forced many fund managers to do.

In Asia you have to accept that we have a spectrum – it’s neither black nor white.

These are countries that are quite poor. Many of them are focused on development. Coal for industrial use – not only for generating electricity – is a very big portion.

This is a real challenge that we face. Governments and companies want to get towards a better and cleaner future but it is a very expensive proposition.

So I lean on my colleagues at Regnan (Pendal Group’s responsible investing business). They have world-class resources and expertise. I use their research to find companies that meet some of the best adherence to ESG principles.

We engage a lot with many of these companies and the issues are quite wide ranging.

I am not here to say that I’m going to be successful at every single one that we take on.

But we do try our best. With our colleagues at Regnan who provide such great and fantastic back-up, I’m able to hopefully achieve for our clients a very good outcome on ESG as well.

Chris Adams: Thank you Samir and thank you very much to our viewers today.

If you have any more questions, please don’t hesitate to contact your Pendal account manager.

Thank you very much.

About Samir Mehta and Pendal Asian Share Fund

Samir manages Pendal’s Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia. Samir is a senior fund manager at UK-based J O Hambro, which is part of Pendal Group.

Pendal Asian Share Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI AC Asia ex Japan (Standard) Index (Net Dividends) in AUD over the medium-to-long term.

Find out about Pendal Asian Share Fund

About Pendal Group

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management. 

Contact a Pendal key account manager.

 

 

James has nearly 24 years’ experience leading emerging markets funds, and throughout his career has been responsible for over 14 mandates with peak FUM of over $4bn. He previously headed the emerging market investment teams at SG Asset Management and most recently Baring Asset Management, where he managed numerous strategies with his colleague Paul Wimborne. He has also worked with Henderson Investors as a portfolio manager and with H Clarkson as an analyst. James is a CFA Charterholder and obtained a Bachelor of Arts (Geography) with honours from the University of Cambridge.

Here are the main factors driving Australian equities this week plus the key points of August reporting season from our head of equities Crispin Murray. Reported by portfolio specialist Chris Adams

>> Scroll down for Crispin’s four themes of August reporting season

>> Register for Crispin’s bi-annual Beyond The Numbers live webinar tomorrow (Tue Sep 7)

US PAYROLL data came in weaker than expected last week, putting paid to any residual risk of an earlier-than-expected tapering of Quantitative Easing (QE) purchases.

There probably wasn’t enough in the report to delay the expected commencement in December, however.

The US dollar weakened slightly, which helped commodities and resource stocks strengthen during the week. The S&P/ASX 300 was up 1.1% last week while the S&P 500 gained 0.62%.

COVID and vaccines

Vaccination trends remain constructive.

NSW is on track to reach full vaccination for 70% of the population by the end of this month and 80% by mid- October.

The national vaccinate rate is running at about 1.1% of the population per day. NSW is at 1.4%. We expect NSW case numbers to deteriorate further from here, peaking in late September before the effects of vaccination start to take hold.

The key issue is hospital capacity. There are 845 ICU beds in NSW, of which 172 (20%) are occupied by Covid patients. There is some scope for surge capacity. But we are mindful that when Covid patients reached about 40% ICU occupancy in the US it started to cause issues.

Victoria has 426 ICU according to the Department of Health. Queensland has roughly 30% less capacity per capita than NSW, while Western Australia has about 50% less ICU capacity per capita. This is a material factor in caution towards re-opening in these states.

The effect of children returning to school in the northern hemisphere will soon become apparent. Scotland returned two weeks earlier than England and experienced a renewed surge in Covid cases. This is something to watch. The number of patients in Scottish hospitals is still below 30% of peak levels. It’s below 20% in England.

It is worth noting that NSW now has a higher percentage of Covid patients in hospital than the UK. This is despite cases per capita at about 40% of UK levels, highlighting the impact of vaccine penetration.

In the US, cases and hospitalisations continue to plateau and the effective reproduction or R(eff) number is below 1 in the majority of states. R(eff) measures the average amount of people an infected person goes on to infect. The return to school is again likely delaying a roll-over in these numbers.

About 39% of the US population lives in areas with ICU occupancy greater than 85%. Breakthrough hospitalisations (hospitalisations of fully vaccinated patients) remains at 1.8% of all Covid admissions.

Economics

In the US, August payrolls came in much weaker than expected at the end of last week. There were 235,000 new jobs added, versus an expected 733,000. There were extensive upwards revisions for previous months, but not enough to compensate for a very soft result.

Leisure and hospitality provided the missing ingredients — where no new net jobs were added, versus 400,000 last month. Delta is playing a role here, but there is also a supply side effect of people taking time off after summer. This is likely to quash any further talk of an early tapering of QE.

We are mindful that wages continue to grow — up 0.6% month-on-month versus +0.3% expected and up 4.3% year-on-year. The unemployment rate also continues to drop — from 5.4% in July to 5.2% in August.

As a result, we think the expectation of a tapering announcement in November, to be commenced in December, remains reasonable.

The key point is this data takes some steam out of the service sector, limiting potential inflation from a large part of the economy, thereby extending the favourable environment for equities. 

This, combined with Biden’s slumping popularity, may provide impetus for more fiscal stimulus.

There is scope for adjustments to the infrastructure bill currently under debate so benefits are more front-ended. As benefits end in 2022 this may mean the fiscal cliff is not so high.  

The European Central Bank (ECB) meets this week. Some members have been talking about economic improvements and a rise in inflationary pressures, signalling a potential tapering of their own QE program.

European bond yields rose in response. The market is expecting a shift in the target from EUR80 billion to EUR70 billion a month — but there is risk of a bigger reduction.

Markets and August reporting season themes

Markets were quiet last week. There was something of a bounce in resources and energy, but growth stocks remain well supported.

It will be important to watch any response in the US dollar to ECB action this week. Any weakness in the USD would help commodities. There has also been some speculation around further Chinese stimulus, which would likewise be helpful.

There were four key themes to highlight from the full-year reporting season.

1. Rising fears of a slowing global economy. This led to underperformance in the mining and energy sectors.

2. Elevated merger and acquisition (M&A) activity. 2021 has already broken through previous highs in terms of the dollar value of M&A activity with four months still left to run. This reflects strong confidence in board rooms.

3. Confidence in a demand rebound. Management teams pointed to a better-than-expected June quarter – before restrictions were imposed – as evidence of strong underlying demand when the economy does re-open.

4. ESG (Environmental, Social and Governance) was a major factor in corporate strategy. This was evident in BHP’s (BHP) shift out of oil and gas; moves by Woodside (WPL) and Santos (STO) to create scale to de-risk and become more cash-generative; more detail around Fortescue’s (FMG) FFI project; and BlueScope (BSL) flagging a need to invest in decarbonisation.

The equity market continued to grind higher in August despite the challenge posed by the Delta spread.

Paradoxically, we are in an environment where the constraint on growth from Delta supports markets, given that it means policy remains easier for longer.

The S&P/ASX 300 gained 2.61% for the month. The S&P/ASX Small Ordinaries was up 4.98% and S&P/ASX 300 A-REIT index gained 6.38%. Financials finished up 4.92%.

The S&P/ASX 300 Resources index dropped 8.37%. This was driven in part by falling commodity prices and was exacerbated by BHP’s proposal to collapse the company’s dual listing. Operationally, results were generally fine within the sector.

We saw a rotation to growth and some of the more richly-valued defensive stocks during the month. This was driven largely by the expectation that rates would remain lower for longer, supporting valuations in these parts of the market.

Technology (+16.2%) led the market on the back of the rotation to growth, though results in the sector were not as strong as the price action might imply.

Register for Crispin’s bi-annual Beyond The Numbers live webinar tomorrow (Tue Sep 7)

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About Crispin Murray and Pendal Focus Australian Share Fund

Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management. 

Find out more about Pendal Focus Australian Share Fund here.  

Contact a Pendal key account manager here.

Drawing on over 24 years’ experience investing in top-performing Australian companies and a background in accounting, Jim manages our Long/ Short Fund and manages our Imputation Fund. He previously managed a number of funds for Colonial First State. Prior to this he worked at Arthur Andersen in a variety of audit, advisory and corporate finance roles. Jim holds a Bachelor’s degree in Economics (Accounting and Finance). He is a Chartered Accountant with membership of the Australian Institute of Chartered Accountants.

Fund Objective: The Fund aims to provide a return (before fees, costs and taxes) that exceeds the S&P/ASX Small Ordinaries (TR) Index over the medium to long term.

The national accounts show potential for a solid 2022 when economies reopen and we learn to live with Covid, writes Tim Hext in his weekly bond, income and defensive strategies outlook

REMEMBER the complacent days of June?

When a limo driver transporting aircrew from the Delta-infected US was legally allowed to drive unvaccinated — with no mask and no testing?

When only a quarter of adults had their first vaccine shot and we were last in the OECD vaccination race (which was “not a race”?)

Before we discovered 99.9% control was 0.1% too little, spelling doom as the highly infectious variant began to spread?

This week we got a glimpse of how well the economy was doing back then with the latest National Accounts data from the Australian Bureau of Statistics.

We are now seeing what could have been.

The National Accounts showed an economy 1.6% higher than pre-pandemic.

A rise of only 1.6% over 18 months would normally be cause for concern. But I think everyone can agree it was very impressive given everything that’s happened.

The V-shaped recovery did its job. Now we’ll no doubt debate which letter Recovery Mark II will look like as we dip down in Q3.

The June quarter was dominated by the return of the consumer.

Household spending was back to pre-pandemic levels as consumers returned. Service spending was up 1.3% in the quarter. Compensation of employees was also up 1.2% — more hours and more jobs.

GDP is a volume measure. A fall in export volumes and pick-up in imports means the external sector subtracted 1% from GDP, keeping the overall number down at 0.7%.

Year-on-year numbers show a rapid climb back from June last year:

However the nominal economy is more important to our hip pockets and here the news was even better.

Strong commodity prices, particularly iron ore, meant the nominal economy expanded 3.2% in the quarter.

The terms of trade got back to the dazzling days of 2012. The RBA will be thankful this time the Australian dollar is 73c rather than $1.10. 

Probably the most encouraging aspect of the report was business investment, which increased by 2.4%.

Generous write-offs no doubt played a part. But after a decade of flat-lining, the growth will be welcomed.

This is one area where we think the post-Covid economic reset will help.

Of course this is all rear-vision mirror now. But it shows the potential for a solid 2022 once economies reopen and we learn to live with Covid.

Bond markets largely ignored these numbers. But yields moved slightly higher this week, mainly on the back of better numbers out of Europe.

Perhaps the light at the end of the tunnel is getting brighter…

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About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

Find out more about Pendal’s fixed interest strategies here

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About Pendal

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

Contact a Pendal key account manager

 

With over 25 years’ experience spanning equities research and advisory, initial public offerings and capital raisings, Julia has managed our property trust portfolios for over a decade. Before joining the company, she worked for the Attorney General’s Department and on the sell side for 10 years at broking houses now known as Citigroup and Merrill Lynch, where she was a highly rated analyst. Julia holds a Bachelor of Economics from the University of Sydney and a Diploma of Law from the Solicitor and Barristers Admission Board, specialising in property and insolvency law.

Global energy and financial stocks have been unloved, but as inflation comes through it’s time to take another look. Pendal’s head of global equities Ashley Pittard explains why

• Financials and energy have been unloved compared to tech and healthcare
• But Inflation will provide an inflection point
• Find out about Ashley Pittard’s Pendal Concentrated Global Share Fund

IT’S A PERFECT time to be a contrarian investor.

If you ever wanted a reason for investing in global energy and financial stocks, have a look at their weighting in global indices relative to technology and healthcare stocks, says Pendal’s head of global equities, Ashley Pittard.

Not since the tech boom in the late 1990s and early 2000s have technology and healthcare stocks played such a dominant role in global indices — as you can see in the graph below.

The two sectors contribute about 43 per cent of the MSCI World index, led by Apple which recently passed the $US2.5 trillion market capitalisation point.  

You have to go back even further to find a time when energy and financials have been so unloved, at least in a relative sense.

Even though the past six months have seen an improvement — due to upward revisions in earnings forecasts — the two sectors now make up just 18 per cent of global indices.

Extreme index positioning

“You’ve got people in extreme index positioning – index funds and active investors are in tech and healthcare, and extremely underweight energy and financials,” says Ashley Pittard, head of Pendal’s Global Equities boutique.

“It’s because no-one believes inflation is coming.”

Inflation is the critical factor going forward. It’s true that during the past decade, the lack of price rises has meant growth stocks were a good place to be.

“But now we are getting to an inflection point,” Pittard says. “Globally, earnings are beginning to broaden out.”

In the Unites States, there was earnings growth of nearly 100 per cent during the June quarter, led by basic materials, financials and materials.

It was even higher in Europe, with earnings growth of more than 240 per cent.

“And inflation is increasing. The argument is whether it’s transitory or structural — but we know there is inflation and it’s higher than it’s been over the past 10 years,” Pittard says. “Wage inflation is still compounding at around 3.5 per cent.”

Long term bond yields remain very low, supporting the argument for growth stocks like technology and healthcare companies.

“This is a timing issue. One day you’re going to get inflation that’s going to be more structural than transitory. It’s going to come via wages and commodity growth. And that will come back to money supply.

“Money supply is up 25 per cent year-on-year.” Pittard explains. “There was similar money supply growth after the global financial crisis. But back then the money stayed in the financial system and didn’t get in the mainstream because regulators increased banks’ capital ratios and buffers.

“To me this is a timing issue about when you see inflation coming through. That will feed back into this extreme index positioning of energy and financial being on their knees compared to healthcare and technology.”

Ashley Pittard, Pendal’s head of Global equities

“Fast forward to today, the money is going back into the real economy. And when you get that much money going into the money supply, you will see inflation.

“You are already seeing that in house prices and second-hand cars,” Pittard says.

“To me this is a timing issue about when you see inflation coming through. That will feed back into this extreme index positioning of energy and financial being on their knees, compared to healthcare and technology.

“When inflation does come back through, that’s when you want to be in financials and energy.”

About Ashley Pittard and Pendal Concentrated Global Share Fund

Ashley Pittard leads Pendal’s Global Equities investment boutique. He is responsible for setting the strategy, processes and risk management for the boutique and its funds including Pendal Concentrated Global Share (COGS) Fund.

Ashley has more than 24 years of finance experience, including roles in petroleum economics, global energy investment analysis and 20 years as a global equities fund manager.

Pendal COGS Fund is an actively managed, concentrated portfolio of global shares diversified across a broad range of global sharemarkets.

Find out more about Pendal Concentrated Global Share Fund

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

Contact a Pendal key account manager here.