When looking across the vast array of Asian funds available, a few company names keep cropping up. Taiwanese Semiconductors, insurance firm Ping An and various members of the BATs (Baidu, Alibaba, Tencent)
Guinness Asset Management’s Asian Equity Fund doesn’t have these well-known names in its top holdings but has managed to outperform consistently. Speaking to its veteran manager Edmund Harris, he takes a slightly different approach to Asia than other managers concentrating on the region.
Mr Harris employs a screening process to the vast universe of emerging market stocks. He screens for stocks that have a cash flow return on investment of at least eight percent for eight years to narrow the selection. Then he looks for companies that have a debt to equity ratio of no greater than one to ensure that companies haven’t leveraged up and sets a minimum market cap of $500 million to ensure liquidity.
His portfolio of 36 names might seem overly concentrated to some but this fund is equally weighted which in his words “gives a sufficient level of conviction but enough diversification in there that you have sufficient liquidity”.
He admits there’s no “particular science” on picking 36 names but now that number is set it can’t altered. So if a company is added, one is removed. The fund’s turnover rate is between 25 to 35 percent per annum so fairly low.
In terms of his holdings share prices, when their price-to-earnings multiple is decreasing he will take advantage and add to the position. “We don’t get shaken out of positions” he says.
Macro view
Unlike certain fund managers who look at Asia as a growth story and pick stocks that seem to benefit from this, Mr Harris looks at the company fundamentals first.
Mr Harris points to Chinese fashion retailer Lilanz as an illustration of his managing style. This company has increased its return on capital over 10% per annum, profit growth of 9.2% a year and dividend growth of 11.8% a year yet it only trades on a forward p/e of 9-times, it yields 5.2% without considering special dividends.
The fact that this company fits into one of the Asian themes of a growing middle class having greater spending power is a by-product of the fund’s screening process. Mr Harris doesn’t seek companies that are part of the well-known themes that are attracting investors to Asia. Rather, through a disciplined process he is still benefitting from the changes to Asia’s demographics but doing so by focusing on company fundamentals first.
This said, Mr Harris does take some of the macro considerations into deliberation. For instance the China-US trade war rhetoric. He views it from a company level, if it chooses to pass on extra costs to the consumer it will impact volume and if it absorbs them it will impact pricing. A big concern for a major exporter like China.
He has an almost profound view of the changing demographics in China. Given the aging population the economy has to be more productive as it can’t rely on debt fuelled expansion. He produces some interesting charts on how China has moved its economy, in 1995 its top three exports were models and stuffed animals, leather footwear as well as knit sweaters. Fast forward to 2016 and its top three exports are computers, broadcasting equipment and smartphones.
One unfortunate by-product of this climb up the technology ladder is “the hollowing out of the US middle class, whether through job relocation to China or stagnant wages has, they have let out this visceral howl and now we have Trump”.
China has been accused of intellectual property theft by the US for some time but its move to construct more complex products has been steadily increasing with no signs of abating. This is why Mr Harris is unconcerned with the well publicised slowing of China’s GDP. In his words, “Debt to GDP is not a problem but its ability to service the debt is” adding that the country’s growing profitability should not make this a problem.
If investors look at the difference between China and India, they are stark. In 1978 both countries had GDP per capita of $280. Now China is at $9000 while India is just above $3000. China built up its manufacturing base to higher end good while India didn’t and China’s domestic market consumes them Mr Harris sums up eloquently.
This is a fund for those wishing to maintain an income stream even during down periods in the market. In fact, Mr Harris concedes the fund doesn’t do so well in rising markets or after a downturn when the ‘dash for trash is on’.
Investors may find it odd that an income fund doesn’t look for dividend yield when screening for stocks. Perhaps looking at Provident Financial in the UK is a good case for not singling out this metric. At one point it was trading on 3.5-times forward price to earnings with a very generous 25 percent dividend yield. It seems Mr Harris’s method of looking at the long term picture of profitability and dividend growth is a wise move in what can be a volatile region.
Guinness Asian Equity Income Fund
Fund Size $142.6m
Fee 1.99%
12 month yield 4.24%
Three year annualised returns 13.1%
Top Holdings Hanon Systems, Corporate Travel Management, China Merchants Bank
Net Asset Value Growth
Read more about this fund here
