Overview

The six month period under review was volatile as markets were impacted by a number of factors. Initial optimism as Covid-19 restrictions were lifted in parts of the region provided a much-needed boost to sectors such as tourism and travel, but soon other events began to influence sentiment, especially the rapid tightening of US monetary policy in response to rising inflation. A sharp increase in commodity prices, caused mainly by the Russia-Ukraine war, raised fears about the potential impact on corporate profit margins. Rising interest rates have led to forecasts of a global recession next year, but inflation in Asia has not been as high as in other parts of the world meaning that the region may see lower rate increases than elsewhere.

Within Asia, the implementation of China’s ‘zero-Covid’ policy and debt concerns in the real estate sector became a focus as their impact on the mainland economy was increasingly apparent. However, the central government did take action to address these issues with an apparent relaxation of some of the ‘zero-Covid’ rules and the introduction of a number of support measures for the economy.

Towards the end of the period, the Communist Party Congress in China agreed to give President Xi Jinping an unprecedented third term in office, and he reinforced his position by installing key allies in the powerful Politburo Standing Committee. While it is worth highlighting that this could result in better co-ordination of policies, it also led to concerns about a lack of checks and balances at the top of the Chinese government.

The news for investors was not all negative over the period, however. Corporate earnings growth remained relatively healthy and the push for more renewable energy remained firmly on track. Particularly relevant for the Company is the move towards localisation, where companies find customers closer to their base of operations, and a trend towards greater self-sufficiency. While economic growth overall in China slowed significantly, there was still an encouraging amount of activity in some sectors.

Results and Dividends

Reflecting these difficult conditions, the Company’s net asset value (“NAV”) was down 12.7% over the six month period ended 31 October 2022 in total return terms. This compares to a fall of 13.7% in the benchmark MSCI All Countries Asia Pacific ex Japan Index (in Sterling terms). The share price at the end of the period was 244.50p, representing a discount to NAV of 13.0%.

The Board has declared an unchanged interim dividend for the year of 1.0p per Ordinary share, which will be paid on 10 February 2023 to shareholders on the register on 6 January 2023 (the relevant ex-dividend date being 5 January 2023). As in previous years, future dividends will depend on the level of income from the portfolio and the Board will decide on the level of the final dividend at the time of reviewing the outcome for the financial year.

The portfolio proved more resilient than the wider market, thanks largely to the Investment Manager’s focus on finding quality companies. The financial holdings made a positive contribution to relative performance, especially the banking sector in South-East Asia. The companies in that sector include DBS Group and Oversea-Chinese Banking Corporation in Singapore, and Bank Central Asia (“BCA”) in Indonesia. Rising interest rates were beneficial to those companies, but the appeal of these banks as investments goes much further than that. BCA benefits from a stable low-cost deposit base that funds its lending and DBS offers a very good return on equity thanks to a clear strategy, good digital infrastructure and the efficiency of its returns. The holdings in all three companies were increased over the period.

Good stock selection in China made a positive contribution to performance, as did the underweight position to the market. The latter proved to be a wise move given the significant weakness in that market over the period. Indeed, the Investment Manager took advantage of that weakness and selectively bought shares at more attractive valuations. Renewable energy stocks, including Sungrow Power Supply, performed well due to expectations that demand for energy storage systems in China and overseas will be even higher than previously forecast. The localisation trend was evident in the positive contribution from medical instruments manufacturer Shenzhen Mindray Bio-Medical Electronics. The company is one of those in the healthcare sector to benefit from recent moves by the Chinese authorities to source more equipment from domestic suppliers. A new position was acquired in Meituan Dianping, which operates a food delivery and local services app and is seeing a strong increase in returns. The company is well placed to benefit as the country moves towards a more service-driven economy and the online penetration of these services grows.

In challenging market conditions, it is useful to have the flexibility to be able to invest across a wide range of sectors and countries. Unlike most of its peers, the Company has the option to invest in Australia and the Board is pleased to note that this proved beneficial during the period. OZ Minerals performed well thanks to its focus on copper, which is seen as a play on the global trend towards electrification. The company’s shares were also lifted by a takeover bid from BHP during the period, which was rejected. OZ Minerals has subsequently received approval for a large copper and nickel project in Western Australia that makes it an even more appealing takeover target. BHP has since come back with a revised offer that has the support of the OZ Minerals board, so this should stand a good chance of going through, assuming it receives the backing of shareholders.

The portfolio received shares in Woodside Energy through a share distribution as a consequence of the decision by BHP to sell its oil and gas assets to Woodside; the Investment Manager has since added to the position. Woodside has benefited from the significant rise in commodity prices but is the only oil and gas holding in the portfolio. The Investment Manager is naturally aware that the company is a big carbon emitter, but it has a very credible, and clear, carbon reduction strategy. It is also worth noting that, in overall terms, the portfolio has a carbon footprint well below that of the benchmark index.

Investor concerns about the impact of a global economic downturn on the demand for electronic devices were behind the underperformance of the export-oriented, technology-heavy markets of Taiwan and South Korea. Geopolitical tensions between Taiwan and China were also a factor. Taiwan Semiconductor Manufacturing Company (“TSMC”) was not immune from these concerns, but, in the Investment Manager’s view, TSMC has an almost unassailable position in the sector and remains an attractive investment given its scale and technological leadership, while its shares already price in many of the headwinds.

The Indian market proved fairly resilient over the period. The portfolio is exposed to the country mainly through the Aberdeen Standard SICAV - India Equity Fund, but not having direct holdings in stocks such as Reliance Industries and Axis Bank, which have done well, weighed on performance. The Company would like to be able to invest direct in Indian stocks but progress with the necessary formalities is slow.

The Investment Manager responded to market events and the changing macroeconomic outlook by adopting a more defensive approach, reducing cyclical investments and taking advantage of attractive valuations to initiate positions in quality companies that they have been monitoring for a while. A good example of this was the addition of Telkom Indonesia, which dominates the telecoms sector in its home country and should prove defensive through the current market uncertainty. Growth is being driven by the greater use of data, the roll out of 5G services, and the rising penetration of broadband.

A number of positions were sold during the period. A sharp fall in construction activity led to the sale of the holding in Shenzhen Inovance Technology. Xero, which is facing a challenging short-term environment in its key UK market, was divested along with positions in Hangzhou Tigermed and Vinamilk.

ESG

Turning to ESG, it is in exactly these types of challenging market conditions that it becomes even more important for investors to remain vigilant. Experienced market-watchers say that when the tide goes out, companies reveal their true colours through their behaviour and priorities. The Manager has always given a high level of attention to governance issues in the region, and in recent years has extended its processes for the active management of environmental and social risks. Resources are in place within the region to ensure investors’ expectations are met. A company’s willingness to engage is a fundamental aspect of the decision-making process for investment, as can be seen in the case studies on DBS Group and BHP later in this report.

Gearing

At the end of the period, the Company's borrowing facilities amounted to £40 million, comprising a fixed rate loan of £20 million, which matures in December 2023 (with an interest rate of 2.626%), and a £20 million multi-currency revolving loan facility maturing in June 2024. An aggregate Sterling equivalent of £30.0 million was drawn at the period end and gearing (net of cash) was 9.0% as at 31 October 2022, compared to 7.7% at the beginning of the period.

Share Buy Backs

In common with other investment trusts, the Company has bought back shares with the aim of providing a degree of liquidity to the market at times when the discount to the NAV has widened. It is the view of the Board that this policy is in the interests of all shareholders. The Board closely monitors the discount and the operation of the share buy back policy is reviewed at each Board meeting, as well as considering other options for managing the discount.

During the period, the Company bought back 743,000 Ordinary shares, representing 0.70% of the issued share capital. These shares were bought back and held in treasury. The Company's stated policy on treasury shares is that these can only be re-issued to the market at a premium to the NAV per share at that time.

Outlook

The combination of rising interest rates, the strong US Dollar, currency depreciation and an increasingly fragile global economy will continue to create uncertainty in the months ahead, but Asia is starting from a better position than many developed economies in the West. A number of countries in South-East Asia are recovering after their post-Covid-19 reopening, which should help to support earnings growth. The resilient performance of the equity markets in India and Indonesia is another source of optimism, and the Investment Manager is also seeing potential signs of recovery in South Korea and Taiwan as the stock markets in those countries recover from significant selling in the technology sector. In China, the economy should benefit from any action taken by the government to address flagging growth, such as further loosening of Covid controls and increasing fiscal support.

Whilst the headwinds experienced in the period are likely to continue to cause market volatility in the short term, it is important to note that this potentially creates some good opportunities to invest at more attractive valuations, and the longer-term advantages of having exposure to growing Asian economies remain very much in place.