As the world continues to lurch from Covid-surges to reflexive and localised lock-downs, everybody is now looking through to a mythical status quo ante bellum – the before-Covid-times, when the world was just hunky-dory.
We are back in familiar territory and the new-old obsessions are the central banks, the rate of money-printing and inflation.
And so, it is not surprising that markets have sold off on the actual arrival, as opposed to just the mere expectation, of better times. Interest rates have moved upward, as bond markets have sold off and there has been quite a rotation in equity markets.
Bond-like equities, those that benefited most from lower discount rates, have fallen. The most speculative, Covid-bolstered, technological and crowded-end of the market has been hit the hardest. In particular, those requiring the greatest imagination and suspension of disbelief, such as the high revenue-multiple and total addressable market (TAM) dream plays, have been disproportionately affected.
Markets now seem reminiscent of where they were before Covid. The difference is that there is a load more corporate debt, public finances have been traduced and market valuations are broadly higher. Policy-wise, we would not be surprised if Covid proves in time to mark a broader shift to more government intervention in markets, alongside higher taxation and greater regulation.
Meanwhile, the West’s latest social upheavals look like some version of a cultural revolution. While that hopefully proves to be temporal, these things could just as easily signal the start of a permanent generational shift in favour of labour over capital, the primacy of environmental, social and governance (ESG) issues over profits and a preference for societal as opposed to corporate solutions.
Our investment philosophy remains our North Star
Against this backdrop, we have remained true to our investment philosophy and focused on seeking high-quality companies to invest in for the long term. Although we are bottom-up investors, there are powerful structural themes that support the underlying businesses we have invested in – from the growing middle class to rising consumption, an ageing population, better healthcare and technological disruption, to name some of them.
This can be seen in the concentrated sector breakdown of our Asia Pacific portfolio. The largest exposure is to consumer companies, with Consumer Staples and Consumer Discretionary businesses amounting to 25% of the portfolio according to MSCI’s categorisation. In our view though, you could easily consider Techtronic Industries, Jardine Matheson and Shanghai International Airport (SIA) as being consumer-driven companies. MSCI considers and classifies them as Industrials.
Home Depot accounts for 50% of Techtronic sales; and Chinese tourism (both domestic and international) should give SIA a strong tailwind. Although Jardine Matheson is a conglomerate, its two largest businesses (Jardine Cycle & Carriage and Dairy Farm) are both consumer businesses. We would additionally consider Voltas, the Indian air-conditioning manufacturer, to be another consumer business, although MSCI categorises it as another Industrial company. If you add all of that together, consumer companies more broadly account for 35% of the portfolio.
Who decides sector classifications?
Similarly, according to MSCI, Information Technology (IT) accounts for just 25% of the portfolio. However, Naver, Tencent and Seek are all categorised as Communications Services businesses. We think it is more correct to consider them as IT companies. But, even that is not really correct. All three are broad IT-platform businesses.
Together, they make up just under 10% of the portfolio. What really drives them is again the rising wealth of Asian consumers and the growing middle class. JD.com is already categorised by MSCI as a Consumer Discretionary business, which rather proves the point, in our view. Putting all of that together, IT accounts more correctly for around 35% of the portfolio.
We have tended to segregate the portfolio’s IT exposure into three segments: IT platforms, hard-tech and IT services companies. Hard-tech consists of those companies that manufacture and supply the global multi-nationals with components and services. This includes Taiwan Semiconductor (TSMC), Mediatek, Largan and Advantech, with an exposure collectively of circa 15% of the portfolio.
Together, the IT services companies amount to about 10% of the portfolio. These are Indian-based multi-national companies (MNCs) that are quite simply digitising the world. Covid has obviously given them multiple additional tailwinds. We believe they are collectively very high-quality companies, with high returns, strong cash flow and typically net cash balance sheets. We own Tata Consultancy Services (TCS), Tech Mahindra and Cognizant.
The other major sector exposure is to financials. These collectively account for approximately 25% of the portfolio. The main exposure is to the Indian private banks. We see plenty of growth-runway for these high return-on-equity (ROE) compounding businesses. Though the news from India has latterly been dire, at least in human terms, businesses appear to have mostly endured. We believe Covid has strengthened the competitive position of the banks as well, with competition diminishing.
Outside of these three broad sectors, other company holdings cumulatively account for just 5% of the portfolio. These are companies that we consider individually attractive, such as Fanuc (the Japanese manufacturer of robots), Indocement in Indonesia and Central Pattana (the shopping centre owner in Thailand). Fanuc’s biggest source of growth has been China, with the business in particular benefiting from a recovery in the capital investment cycle in IT (particularly smartphones) and autos.
What we know, and what we know we don’t know
Nearly everybody agrees that the future is thoroughly unknowable. As the saying goes: It’s tough to make predictions, especially about the future. While we don’t know much about the state of the macro-world, portfolio-wise we do believe that all is well.
They say that fund management, when practised well, requires an unusual combination of arrogance and insecurity. Managing these opposing forces remains the key to success, but having a very strong philosophy and process helps greatly.
Although we remain broadly confident about the companies in the portfolio overall, at the same time we absolutely appreciate the dangers of complacency. Doubt, as has been said, might not be an entirely pleasant condition, but in this context it probably remains a constructive emotion.
Source: Company data retrieved from company annual reports or other such investor reports. Financial metrics and valuations are from FactSet and Bloomberg. As at end June 2021 or otherwise noted.
Note: Reference to specific securities (if any) is included for the purpose of illustration only and should not be construed as a recommendation to buy or sell the same. All securities mentioned herein may or may not form part of the holdings of FSSA Investment Managers’ portfolios at a certain point in time, and the holdings may change over time.