It’s a numbers game

Investment literature is replete with the idea that periods of pessimism provide the best opportunities. “Buy when there is blood in the streets,” Nathan Rothschild is purported to have said over 200 years ago. More recently, in his letter to investors in 1986, Warren Buffet echoed that sentiment, saying “we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.” But in 2022, when ‘permacrisis’ was named by the Collins English dictionary as its word of the year, it is perhaps not surprising that you won’t find many people arguing along the same lines as Buffet or his Regency Era antecedent.

We have instead seen a scramble to find ‘safe’ assets and a move out of those that seem less certain to deliver returns. In the 12 months to the end of October, for example, not one of the 24 trusts in the Association of Investment Companies’ UK Smaller Companies sector had delivered positive NAV or share price returns for shareholders.

A similar story has played out in Asia, with many trusts investing in the region facing headwinds. Fears about a prospective recession and how that will impact the region have likely been behind some of the sell-offs we’ve seen in the sector.

Those macroeconomic fears are understandable but they don’t necessarily reflect the long-term potential that Asia has. The region contains 60% of the world’s population and looks likely to be a key area of global economic growth in the years ahead. According to the Brookings Institute, a US think tank, people in Asia made up less than 20% of the global middle class in 2000. By 2020 that had risen to 50% and the region is forecast to add another billion members to the consumer class by the end of this decade.

It's this potential which the team at JPMorgan Asia Growth & Income (JAGI) look to take advantage of. The managers look for high quality businesses across the region that can deliver compounding returns to shareholders via strong earnings growth. They attempt to achieve this via bottom-up stock picking, taking advantage of a large research team, comprised of close to 100 analysts, half of which are based across Asia.

As that implies, this means the JAGI managers are not driven by top-down macroeconomic data when making investment decisions. Instead they find that their bottom up approach to markets means the companies end up fitting into three broad themes, namely lifestyle upgrades, demographic changes and financial deepening. It’s worth noting that these are the themes which emerge from the portfolio today but this could change moving forward.

“What we’re not doing is saying, ‘these are the themes, let’s see what companies fit into these three buckets,’” said Investment Specialist Emily Whiting at a Kepler Trust Intelligence event in September. “But when we take a step back from the portfolio and see the stocks that to us are the most appealing, we find these are the themes that continue to shine through.”

All three of the themes fit with the wider economic growth, and rising middle class, that we see across Asia. For instance, lifestyle upgrades might mean consumers starting to use certain products or spending more on them. Unilever Hindustan, one of JAGI’s holdings, illustrates this. The company has seen its profit increase by 11% on an annualised basis over the last five years, with India’s growing middle class spending more on things like shampoo and tea.

It's a similar story with the financial deepening theme, with individuals across Asia using a wider array of financial products and services as they become wealthier. Indonesians, for example, now use debit cards 3x as much as they did a decade ago.

Bank Central Asia (BCA) has catered to these developments and seen tremendous growth over the past two decades as a result. The bank, a JAGI holding that mainly serves customers in Indonesia, has expanded its range of mortgages and added products like debit and credit cards and mobile payments in that time. The results have been positive, with the banking group delivering annualised profit growth of 11.25% over the past ten years.

Part of the reason JAGI has been able to take advantage of the opportunities that companies like Hindustan Unilever and BCA present is because of the comparatively low level of coverage that they receive relative to their peers in developed markets.

According to FactSet, there were around 21 analysts covering the average US large cap in 2021. Even US micro-caps had an average of three analysts covering them. In contrast, there are companies across Asia that receive little to no coverage from analysts, despite the opportunities that are available in the region.

In the past this has arguably been a contributing factor in active managers ability to generate alpha for their investors. One comprehensive study by the Wall Street Journal looked at returns for active managers by country from 2008 to 2018. It was in China and India that active management was able to deliver the highest average level of alpha. In contrast, most US managers struggled to generate any outperformance of their benchmarks.

Despite this, Asian companies still receive comparatively less coverage relative to their peers and JAGI, with its large team of on the ground analysts, is still well-placed to take advantage of this dynamic.

The same is true of the themes that the trust managers try to take advantage of. Even though we’re in the midst of a tough economic environment, the mix of population growth and an increasingly wealthy consumer class is still there and looks capable of driving returns for investors in Asian companies in the future.

Whether or not that actually does happen is up to investors to decide and – given the myriad risks which investors face at this time – we would caution those emboldened by the rhetoric of Rothschild or Buffet to remember that there is a fine line between aphorism and platitude. That said, with JAGI trading at a close to 11% discount, those who believe the long-term case for Asian equities remains intact – supported by the factors we have described here – may see an opportunity in these troubled times.

Login to read the full article...