Invesco Asia Trust — Ready to exploit valuation dislocations in Asia

While the global macroeconomic slowdown translates into heightened macroeconomic risks across Asia, the International Monetary Fund (IMF) still forecasts in its October 2023 World Economic Outlook solid GDP growth across emerging and developing Asia of 5.2% and 4.8% in 2023 and 2024, respectively. We note that governments of several Asian countries (including China) may have greater fiscal and monetary headroom to stimulate economic growth. This is underpinned, among other factors, by 1) lower general government gross debt to GDP across emerging and developing Asia of 77% expected by the IMF in 2023 versus 112% for advanced economies and 128% for the G7 countries and 2) less severe inflationary pressures, eg the IMF expects inflation in China at 0.7% in 2023.

In the longer term, Asian emerging and developing economies offer structural growth above the global average (which should support dividend growth, among others). This is illustrated by the IMF’s forecasted GDP growth across the region of 4.5% pa to 2028 (vs the US at 2.1% and the euro area at 1.3% pa). Some important themes to explore in the region include: 1) growing consumer spending driven by the rising income of large populations, an expansion of the middle class and urbanisation; 2) the role of countries such as South Korea and Taiwan in the global tech value chain; 3) reconfiguration of supply chains; and 4) green transition, including renewable energy and electric vehicles (EVs).

However, prospective GDP growth across some countries may be below the average 6% pa posted by the region in 2010–19 due to persistent macroeconomic challenges and structural shifts in the world economy, and a potential greater reliance on consumer spending rather than investments and exports (as suggested recently by the Economist Intelligence Unit). Most notably, the IMF now predicts China’s GDP to grow by only c 3.4% pa to 2028. On the other hand, it expects India’s and Indonesia’s solid momentum to continue at 6.3% and 5.0% pa to 2028, respectively.

As Asian equity markets remain muted while corporate earnings started rebounding, valuations across the region are now somewhat below historical averages, with the one-year forward P/E for Asia ex-Japan equities at c 11.9x compared to a 10-year range of 11.1x to 17.9x and average of c 13.1x, according to Refinitiv data. Moreover, it is worth noting that the Asia ex-Japan markets currently trade (based on the one-year forward P/E ratio) at a 23% discount to global equities versus a 10-year average of 16%. Together with the valuation discrepancies across countries seen by IAT’s managers, this provides a fruitful ground for IAT’s contrarian, valuationmindful approach.

We consider IAT an attractive route to gain exposure to the emerging and developing Asia region for the following reasons.

Within the AIC Asia Pacific Equity Income sector, there are three trusts that focus primarily on income (underpinned by their higher value tilt): Henderson Far East Income (HFEL), abrdn Asian Income Fund (AAIF) and Schroder Oriental Income (SOI). In contrast to this, IAT and JPMorgan Asia Growth & Income (JAGI) provide a regular dividend to investors, which is normally paid partially out of capital, given their balanced approaches to income and growth (see Exhibit 2). We also note that JAGI has a somewhat higher growth bias than IAT.

IAT’s current last-12-month (LTM) dividend yield of 5.1% (see Exhibit 5) is broadly in line with the peer average excluding Henderson Far East Income. For a detailed discussion of IAT’s dividend policy, see the dividend section below.

IAT delivered five-year and 10-year NAV total returns (TRs) to end-November 2023 of 6.6% and 9.4% pa, respectively, despite the weak performance of the Chinese equity market in recent years. This is ahead of both the MSCI AC Asia ex-Japan index (2.9% and 6.4%, respectively) and its peers included in the AIC Asia Pacific Equity Income group, which performed more in line with the abovementioned index (4.0% and 6.4%, respectively). It also faired quite well against the AIC Asia Pacific peer group, ranking second over three years and being broadly in line with the average NAV TR within the group over five and 10 years. We note that both Pacific Assets and Pacific Horizon (which outperformed IAT over five and 10 years) are more growth-orientated and have a greater proportion of small- and mid-cap companies in their portfolios, hence are not fully comparable with IAT. They also have a much higher allocation to India, which IAT’s managers now consider a quite expensive equity market.

IAT is looking for ‘unloved’ investments with strong fundamentals trading at undemanding valuations. IAT’s managers are also open to exploring emerging trends and turnaround stories. As a result, the trust pursues an unconstrained, bottom-up approach to stock picking, allowing it to benefit from attractively priced equities across the region. We consider it an important advantage over a plain vanilla exchange-traded fund with exposure to Asia ex-Japan. We have compared IAT’s historical NAV TR with a synthetic Asian index based on Datastream country indices and IAT’s historical country weights (see Exhibit 6). While the analysis is likely subject to a certain error margin stemming from the somewhat different stock compositions of the Datastream indices versus the MSCI indices, we still believe it clearly shows that IAT’s historical outperformance of the benchmark does also come from good stock selection.

IAT’s disciplined approach to valuations is illustrated by the fact that the average valuation multiples across its portfolio (one-year forward P/E at 10.5x and current P/BV of 1.4x as at end-October 2023) were below the levels for its benchmark (11.5x and 1.6x, respectively). Moreover, IAT has a quality bias and often holds a portfolio where most holdings have net cash on the balance sheet. For instance, the average net debt to equity ratio across IAT’s portfolio (excluding financials) at end-October 2023 stood at negative 8.0% versus the benchmark at positive 2.0%.

We believe that the above investment philosophy assisted IAT in limiting capital losses during market weaknesses and in outperforming the benchmark on the upside. This is well documented by its cumulative upside and downside capture ratios over the last 10 years of 107% and 94%, respectively (see Exhibit 7), even if this may partly be the result of the underweight to China during most of the period. IAT’s solid risk-adjusted returns are also illustrated by its superior five-year annualised Sharpe ratio of 0.35 (vs c 0.12 and 0.16 for the benchmark and the average for its AIC Asia Pacific Income peers, respectively), according to Morningstar.

In late 2022 and early 2023, IAT’s managers decided to position the trust’s portfolio to benefit from China’s reopening story, closing its underweight position to China and Hong Kong equities, now having a weight of 43.4% at end-October 2023 (c 3–4pp overweight versus benchmark); see the Exhibit on the front page. Simultaneously, IAT slightly increased its net gearing from c 2.2% at endAugust 2022 to 5.5% at the local peak at end-November 2022 (now down to c 0.7% at endOctober 2023).

The post-reopening rebound in China may be considered disappointing for investors who expected a quick, strong recovery (which we understand was not the base scenario assumed by IAT’s managers). China’s seasonally adjusted, annualised GDP growth slowed from 8.9% in Q123 to 4.0% in Q223, according to the IMF, amid weak consumer sentiment (despite excess savings accumulated in recent years). This has also been reflected by the local equity market, which has given up some of the gains from the initial rally, weighing on IAT’s NAV TR over the LTM of negative 3.7%, which was broadly in line with the benchmark (negative 3.5%). That said, we note that China’s retail sales improved somewhat during the year, with a 7.6% y-o-y increase in October after 5.5% y-o-y in September.

China’s weaker economic growth is partly due to the deteriorating local property markets, with a potential deepening of the real estate crisis highlighted as one of the major risk factors for the global economy by the IMF and potential spillovers especially for commodity exporters. China’s growth is important for the entire region, with the IMF recently estimating that every percentage point of higher growth in China leads to a 0.3pp rise in output in the rest of Asia. The IMF believes that the state of China’s real estate sector represents a complex policy challenge, and that restoring confidence will require: 1) a quick restructuring of struggling property developers; 2) preserving financial stability; and 3) addressing the strains in local public finance. Moody’s recently lowered its rating outlook on China’s A1 debt to negative from stable, as it expects government support and possible bailouts of distressed local governments and state-owned enterprises to impact the country’s fiscal, economic and institutional strength. High youth unemployment (c 20% for people aged 16–24) also weighed on consumer confidence in China. Moreover, the IMF highlights that declining foreign demand and geopolitical uncertainty affected Chinese industrial production, business investment and exports. Finally, the US/China tensions remain a risk factor for the Chinese economy.

According to the IMF’s latest forecast, China’s GDP should still grow by a robust 5.4% in 2023 and 4.6% in 2024, ahead of most Western economies. Moreover, IAT’s managers believe that Chinese valuations returned (after a temporary rally in late 2022 and early 2023) to ‘deeply discounted’ levels, offering a good entry point into quality growth names for IAT. The one-year forward P/E for China A-Shares currently stands at 9.7x versus a 10-year range of 7.2x to 17.0x and average of 11.7x, based on Refinitiv data. In its latest market outlook, JPMorgan Asset Management shared its 2023 long-term capital market assumptions with expected returns in the coming 10–15 years in China at c 10% pa in sterling terms (based on data as at end-September 2023), ahead of both eurozone and US large caps.

We note that IAT (as well as its closest peer, JP Morgan Growth & Income Trust, JAGI) has the highest combined weighting to China and Hong Kong, compared to other constituents of the AIC Asia Pacific Equity Income sector (see Exhibit 8), which follow a mandate with greater exposure to Australia and also have a higher weighting to Singapore (that may be at least partly due to a greater appetite for the high dividends paid by Singaporean banks).

In Exhibit 9, we summarise IAT’s country weights versus the MSCI AC Asia ex-Japan Index. Beyond China, IAT’s major overweight positions at present include South Korea and Vietnam. IAT considers South Korea as relatively cheap and believes that the discount overstates corporate governance concerns, geopolitical risk and the economy’s cyclicality. IAT’s exposure to South Korea is a combination of a play on the tech sector (to benefit from the rise of AI), as well as Chinese recovery (as roughly 50% of the country’s exports are attributable to China). Three of its major South Korean holdings include Samsung Electronics (7.4% of end-September 2023 portfolio, a c 3pp overweight vs benchmark), memory semiconductor producer SK Hynix and LG Chemical. It also holds positions in insurer Samsung Fire & Marine, Hyundai Motor Corporation, as well as LG Household & Healthcare. IAT’s managers decided to exploit the less demanding valuations in Vietnam to tap into the growth story of the country, with two positions held at present: Vietnam Diary Products and steel manufacturer Ho Phat Group.

IAT’s major underweight (and year-on-year weight reduction) are Indian equities due to their demanding valuations following a period of strong performance, according to IAT’s managers. IAT’s weight to Indonesia has also gone down year-on-year (by 3.3pp), but IAT retains a slight 1.1pp overweight versus the benchmark as the managers’ recent trip to Jakarta left them confident in the long-term prospects of the country. Finally, IAT is still underweight Taiwan by c 2.2pp despite some year-on-year increase in exposure and being overweight TSMC. We note that IAT’s managers generally aim for IAT to remain within a 0.5–1.5x range in terms of weighting to a particular country versus the benchmark to avoid taking any excessive country risk.

While IAT’s stock selection process is bottom-up, the trust’s current portfolio is now positioned to benefit from several sector themes. First, IAT’s managers maintain a focus on technology, most notably exposure to semiconductor proliferation trends and specialised parts. Secondly, they consider consumer and internet an interesting area, including especially e-commerce (see eg IAT’s overweight in Alibaba following earlier share price weakness) and gaming (which IAT’s managers believe has proved relatively defensive, eg NetEase). This contributes to IAT’s overweight in consumer discretionary versus the benchmark (though reduced over the LTM, even if partly due to reclassification of Astra International to industrial). However, IAT shies away from unprofitable tech and the internet. Furthermore, IAT’s managers expect volumes in the automotive sector to recover as shortages are resolved and also seek exposure to the increasing EV penetration, for example through LG Chemical as the largest producer of EV batteries outside China (or the recently sold POSCO), while they avoid pure EV plays, which they consider expensive at present. IAT’s exposure to the sector and its value chain includes, among others, Hyundai Motor Corporation (South Korea), Astra International (automotive supplier, Indonesia), China MeiDong Auto Holding (auto dealership, China) and Minth Group (automotive supplier, Taiwan), contributing to IAT’s marginal overweight position in industrials. All the above, together with IAT’s overweight position in real estate, illustrate its cyclical portfolio tilt (at the expense of more defensive sectors, such as utilities, healthcare and communication systems).

Within the financials bucket, IAT puts emphasis on well-capitalised businesses with strong core profitability, which may be considered consumer proxies and may benefit from the recent interest rate normalisation. It holds banks and non-bank lenders operating in countries with potential for sustained acceleration of credit growth. This applies especially to India and Indonesia given their low levels of household and non-financial corporate debt to GDP and the fact that they went through a credit downcycle in the last five years. In these two countries, IAT holds positions in HDFC Bank, Shriram Finance and ICICI Bank (India), as well as Bank Negara, the largest bank in Indonesia where the managers saw improvements to governance and risk management lately. It also holds a stake in Kasikornbank (Thailand) and United Overseas Bank (Singapore), having no exposure to Chinese banks. Furthermore, IAT has several insurers in its portfolio: QBE Insurance Group (Australia) and Samsung Fire & Marine (South Korea), the latter as a play on profitability turnaround, as well as Ping An (China) and AIA Group (Hong Kong), both being a bet on the longterm prospects of the Chinese life insurance industry.

IAT has also started exploring potential beneficiaries of a turn in the rate cycle in the region. Within real estate, it holds a stake in Link REIT, which offers exposure to retail properties, car parks and related businesses, as well as some exposure to office properties, mostly in Hong Kong and to a lesser extent in mainland China, and in Australia, Singapore and the UK. IAT’s managers consider Link REIT as a potential beneficiary of falling rates (or peaking expectations) which is traded at an unjustified discount to fair value. IAT also holds a stake in China Overseas Land and Investment, a residential and commercial property developer and commercial property operator, which IAT’s managers perceive as a business with relative balance sheet strength versus peers, which is well positioned to take market share as overleveraged developers retreat, which should support the company’s margin growth. Finally, it invested in the property developer and investor CK Asset Holding. IAT’s portfolio also includes contrarian growth opportunities arising from long-duration, ‘darling-turned-fallen-angel’ assets, for instance Grab, a Singaporean business that offers a mobile app comprising ride-hailing, food delivery and financial services.

IAT’s shares trade at a 13.2% discount to cum income NAV (11.8% to NAV excluding income), which is broadly in line with its five- and 10-year averages (both at c 11%). We note that IAT’s board believes that in normal conditions, the shares should trade at a discount of below 10% to the ex-income NAV. While the discount to NAV widened above 10% earlier this year, the board decided to not undertake any share buybacks in FY23 or after the reporting date to allow IAT’s managers to fully take advantage of the long-term investment opportunities they currently see.

We note that, in August 2020, IAT introduced a performance conditional tender offer for up to 25% of IAT’s issued share capital at a discount of 2% to the prevailing NAV per share (after deduction of tender costs) in the event IAT fails to outperform its benchmark by 0.5pp per annum over the fiveyear period to 30 April 2025 (during the three years that already passed, IAT outperformed the benchmark by 3.3pp pa).

Based on the dividend policy revised in August 2020, the board aims to pay six-monthly dividends in November and April each year, each equivalent to 2% of NAV at the end of September and February, respectively. This means that the dividend per share may be lower year-on-year during financial years with an NAV decline. IAT will pay dividends from a combination of the company’s revenues, revenue reserves and capital reserves if required (under the previous policy, dividends were usually fully covered by income). As a result, IAT is not restricted to stocks that are pure income plays.

Following the above change to the dividend policy, IAT maintains a relatively low revenue reserve on its balance sheet at £1.3m at end-FY23, equivalent to c 14% of its FY23 total dividend payment. IAT’s FY23 net revenue return increased by 25% y-o-y to £5.6m and covered c 57% of its £14.80 dividend per share (vs 44% of the £15.30 payment for FY22, see Exhibit 16). At the current discount to NAV, IAT’s first interim dividend for FY24 of 7.20p (declared in October, ex-dividend date on 2 November) represents an annualised yield of c 4.9%.

The forward dividend yield across IAT’s portfolio as at end-October 2023 stood at 2.8%, slightly ahead of the benchmark (2.6%) and ahead of MSCI World (2.1%), according to Invesco. This is somewhat down from the 3% previously, but its sustainability is underpinned by solid free cash flow and low leverage across the portfolio, according to IAT’s managers. For illustrative purposes, if we apply the ratio of ongoing charges allocated to income as percentage of NAV of 0.8% in FY23, the 2.8% forward dividend yield translates into a c 50% dividend cover ratio based on income.

Launched in 1995, IAT aims to provide long-term capital growth through investing in a welldiversified portfolio of companies listed in Asia. Invesco has managed IAT since its first day of trading on 11 July 1995, as IAT became one of two successor companies to Drayton Far Eastern investment trust. IAT’s benchmark is the MSCI AC Asia ex-Japan Index (the MSCI Asia Pacific exJapan Index prior to 2015), reflecting the trust’s primary focus on Asia and persistently low exposure to Australasia (ie Australia, New Zealand and some neighbouring islands). The approach is team based, bottom up and valuation focused, with IAT’s portfolio of c 50–70 stocks representing the manager’s highest-conviction investment ideas. The fund managers, Ian Hargreaves and Fiona Yang, aim to outperform the market over three- to five-year rolling periods, and target a less than 10% annualised return from each portfolio stock. Its investable universe of around 1,000 names is defined as companies with a market cap above US$500m and more than US$5m of daily liquidity and aligned with its approach to ESG (see below). IAT enhanced its dividend policy in 2020 and income will continue to contribute materially to NAV and share price TRs (see the dividend section above for details).

IAT is managed by Invesco’s experienced Asian & Emerging Market Equities team (with £10.5bn of assets under management as at September 2023), consisting of Ian Hargreaves and William Lam as co-heads, four fund managers, one deputy fund manager and one analyst. The managers directly responsible for IAT are Ian Hargreaves and Fiona Yang.

Ian Hargreaves, CFA, holds a BA (Honours) in Chinese studies from Durham University and manages several pan-Asian portfolios, including IAT and the Invesco Asian Focus Equity Fund. He also co-manages the Invesco Global Emerging Markets Fund (UK). He has 29 years of experience at Invesco and started his career with Invesco Asia Pacific in Hong Kong in 1994 where he was responsible for managing several pan-Asian institutional client portfolios, covering in particular Indonesia, Korea and the Indian subcontinent. In January 2005, Ian returned to the UK to join the Henley Investment Centre’s Asian Equities Team and was appointed lead manager of IAT (after serving as co-manager since 2012). Subsequently, Ian was appointed co-head of the team in 2018 following the merger of the Asian and Emerging Markets Equities teams at Invesco. He manages more than £4bn of institutional assets within Asian accounts as at end-June 2023. IAT is the only trust available to UK retail investors providing access to his extensive expertise.

Fiona Yang has 11 years of financial industry experience, six of which with Invesco. She started her career with Goldman Sachs in July 2012, initially within their graduate programme, before becoming a member of their Asian Equity sales team, where she was a China product specialist. She joined Invesco in August 2017 and is fund manager of the Asian Equity Income Fund and comanager, alongside Ian Hargreaves, of IAT. Based in Singapore, she covers the wider Asia exJapan region with particular expertise in China’s equity markets as a Mandarin native speaker. She holds a BSc (Honours) in mathematics and economics from the London School of Economics and Political Science and passed the CFA Level II exam in 2018.

Invesco is a signatory to the United Nations Principles for Responsible Investment since 2013 and has been rated ‘A+’ for Strategy and Governance in 2017–2020. Climate change remains high on Invesco’s agenda given its commitment to the Net Zero Asset Managers initiative. IAT highlighted that the carbon intensity of its portfolio (defined as scope 1 and 2 emissions) remains below that of its benchmark and that 33 out of the 57 portfolio companies at the end of FY23 (ie end-April 2023) making up 58% of the portfolio value have already made a commitment to the Net Zero Alignment (vs 28 out of 57 and 49% at end-FY22, respectively). Some of the factors taken into account when evaluating portfolio companies include: 1) historical capital allocation decisions and corporate governance; 2) approach to addressing ESG-related negative externalities; 3) track record of meeting guidance and internal targets; and 4) feedback from competitors, suppliers and clients.

IAT’s managers prefer an active approach to ESG considerations over following a simple exclusion list. Therefore, they are equally interested in top performers in terms of ESG metrics and active engagement and stewardship with companies, which are well positioned to improve their ESG credentials, and in turn create additional value. IAT’s managers look at the ESG profile of an investment through a valuation lens, seeking to quantify the impact of material ESG factors on earnings growth, valuation multiples re-rating potential, as well as dividend payouts. This in turn feeds into the return expectations and positioning of the respective stock within IAT’s portfolio. The above ESG analysis is facilitated by a dedicated ESG team and proprietary ESG ratings tool (ESGintel) at Invesco, which provides data and insights across more than 18,000 companies. On top of regular, day-to-day monitoring, IAT’s portfolio undergoes a formal ESG review twice a year.

As per its investment policy, IAT is permitted to apply gearing of up to 25% of net assets but, under normal circumstances, IAT does not expect this to exceed 15% of net assets. IAT currently has a revolving credit facility with maximum possible gearing of £20m, which is the equivalent of c 8% of total assets at end-September 2023. IAT also has available an uncommitted bank overdraft arrangement with the custodian for settlement purposes, with an end-FY23 balance of £740k. Over the 10 years to end-October 2023, IAT’s net gearing (defined as total assets less cash and equivalents over NAV) remained (except for a few instances) in the range negative 5% to 5% and at end-October 2023 stood at a low 0.7%.

IAT is subject to a management fee of 0.75% on NAV up to £250m and 0.65% on any net assets in excess of £250m (paid quarterly in arrears). There is no performance fee and, therefore, the management fee normally represents the majority of IAT’s ongoing charges ratio (0.99% in FY23 vs 0.97% in FY22).

IAT’s issued capital consists of 66,853,287 shares outstanding, with a further 8,146,594 shares held in treasury. IAT’s major shareholders include City of London Investment Group (19.0%), Lazard (11.5%), Evelyn Partners Investment Management (9.8%), as well as Allspring Global Investments (8.1%).

IAT’s board consists of four directors, all of whom are independent. Neil Rogan (chairman) has more than 30 years of experience as investment manager, ranging from managing Asian portfolios for Flemings and Jardine Fleming to becoming head of global equities at Gartmore. Currently, he is also the chairman of Murray Income Trust, as well as non-executive director of JPMorgan Global Growth & Income.

Vanessa Donegan has 37 years of fund management experience in investing both institutional and retail portfolios in Asian equities, including single country China and India funds. She was head of the Asia Pacific desk at Threadneedle Investments and then head of Asia Pacific equities, EMEA region at Columbia Threadneedle for 21 years in total. At present, she also serves as senior independent director of Fidelity China Special Situations, as well as a non-executive director of Herald Investment Management, JP Morgan Indian Investment Trust and State Street Global Advisors Luxembourg SICAV.

Myriam Madden has board member experience across several regulated sectors, following an international, multi-sector career as a finance executive leading transformation programmes. She is a qualified chartered accountant and was a board member of the International Ethics Standards Board for Accountants, the International Federation of Accountants and the American Institute of Certified Public Accountants. Moreover, she was global president and chairman of The Chartered Institute of Management Accountants. She is currently non-executive director of the Office of Gas and Electricity Markets, Home Group and Golden Charter Trust.

Sonya Rogerson has more than 20 years of experience in legal, governance and compliance across a range of industries (including financial services) and countries in Asia Pacific, Australasia and emerging markets. She led the legal and compliance department at the Bank of China in London and held other senior positions including general counsel Asia Pacific for the British Standards Institution. She is currently head of legal transformation and REFS at Novartis Operations. Sonya is a fellow of The Corporate Governance Institute UK & Ireland and a qualified solicitor in New South Wales, Australia, and England and Wales.