Invesco Asia Trust — Seizing an opportunity

Invesco held an optimistic tone at the start of 2022, but the war in Ukraine (which started on 24 February), increased other geopolitical risks (particularly relations between China and Taiwan) and changed Invesco’s outlook for 2022 to a more cautious one. The outlook for H222 darkened a bit further after the Politburo (the Chinese Communist Party’s top decision-making body) made no new stimulus announcement. It also cut its 2022 estimated gross domestic product (GDP) growth target.

Nevertheless, the manager believes that Asia ought to be on investors’ radars, as economic activity in the region remains stronger than in the developed world, corporate balance sheets are in good shape and, most importantly, equity market valuations are looking increasingly attractive, albeit with some scope for downward revisions to consensus earnings growth expectations for the region. Inflationary pressure across much of Asia is also less than in developed markets due to more modest monetary policy response to the pandemic. Consequently, Invesco expects a less aggressive interest rate tightening cycle across Asia than in many Western economies.

The portfolio managers hold a more optimistic view over China than one year ago. They believe that the country’s macroeconomic situation has room for improvement, as the country adjusts to the authorities’ zero COVID-19 strategy. At the same time, China can implement monetary easing and stimulating fiscal policy to revive its economy and offset the negative effects of prolonged lockdowns.

In addition, the recent period of regulatory tightening for corporates in ‘new economy sectors’ appears to be over. Intended by the Chinese government to promote ‘common prosperity’, inclusive economic growth and exercise more control over the financial system during 2021, these measures resulted in a broad drop in equity valuations (China including Hong Kong accounts for c 47% of the MSCI AC Asia ex-Japan Index). The trailing price-to-book (P/B) ratios of China (the H-share market) stand at c 1.5x and the MSCI AC Asia ex-Japan Index stands at c 1.6x (at end-June 2022), below the 15-year historical averages of c 2.0x and c 1.75x, respectively, and down from 2021 highs (sources: Invesco, Refinitiv). Large differences in valuation between countries remain, with China equities on particularly attractive valuations.

Despite renewed concerns about US/China tensions, particularly over Taiwan, Invesco believes that China will be doing everything it can to avoid targeted sanctions from the US and Europe. According to Invesco, China’s chief concern is trying to contain the spread of the omicron variant and support GDP growth, while also still being dependent on Taiwan for high-end technology and semiconductors, which it will continue to be so for the foreseeable future.

At end-June 2022, the portfolio had 56 holdings in line with its 50–60 range (54 at end-February 2022). Exhibits 2 and 3 show the fund’s exposures by country and sector at end-February 2022 and illustrate its differentiation from the benchmark MSCI AC Asia ex-Japan Index.

The largest weighting in the portfolio at 48.6% (at end-June 2022) is to Hong Kong and China. The previously underweight position (of c 8.0pp), which the company had two years ago, has gradually been reduced to a slight overweight position +1.4pp over the index (47.2%), reflecting the managers’ view that investment risk now appears to be better rewarded. The managers are comfortable with their current positioning in China given that the recent period of regulatory tightening appears to be over, while China is at the start of an easing cycle, in contrast to developed markets where policy is being tightened. The authorities’ zero-COVID strategy is a source of near-term uncertainty, but one which is likely to normalise over time. Given IAT’s strategy to populate the portfolio with undervalued companies, the shift in exposure towards China also reflects the team’s confidence in the valuation opportunity in selected Chinese equities.

The other two notable overweight positions are Indonesia (3.7pp) and Australia (3.9pp). The largest underweight (3.9pp) is in Taiwan. The managers have reduced Taiwanese exposure, given the holdings’ strong performance, particularly within the technology sector, and reinvested profits elsewhere, notably into China, Indonesia and Australia. Taiwan stepped down to the fourth position in IAT’s country having been second at December 2021.

During the highly volatile market for Chinese internet stocks over the past 12 months, the managers seized the opportunity to add to selective companies, where they are optimistic on their medium-term prospects. These included Ming Yang Smart Energy, JD.com and Sands China. The team took some profits from China Overseas Land & Investment (COLI).

The team continues to have an overweight position in Indonesia, even after taking profits from Telkom Indonesia after a period of strong performance. The managers believe that near-term economic uncertainty is starting to lift, and valuations still appear attractive. Over H122, the team invested in Indonesian cement producer Semen Indonesia. The managers believe there is underappreciated long-term growth potential despite near-term headwinds due to higher input costs. In India, where IAT is underweight the benchmark, the team reduced its Mahindra & Mahindra and Larsen & Toubro positions at a profit, and added to Aurobindo Pharma.

The team sold its holdings in Korean Bank KB Financial, Genting Singapore and Taiwanese technology stock Asustek Computer.

Over the six months to end June, the major sector changes were increases in consumer discretionary (3.1pp), industrials (1.3pp), materials and energy (both up 1.2pp) and a decrease in information technology (-6.3pp), see Exhibit 3.

At 24.6%, the consumer discretionary sector weight is the largest. Big online retailers, such as JD.com (top 10 holding, 3.9% of the portfolio) and Alibaba (top 10 holding, 4.8%), form the core of consumer discretionary exposure. Other notable sector holdings include the Indonesian auto-conglomerate Astra and Gree Electric Appliances, a Chinese air conditioner manufacturer.

Within financials, the second largest sector (23.4%), IAT has exposure to banks and insurers, which serve as consumer proxies and are beneficiaries of interest rate normalisation with solid capital levels.

The third largest sector weighting, at 15.5%, is still information technology, reduced as the team trimmed sizeable holdings, such as Hon Hai Precision Industry and Asustek Computer. The managers continue to have selected, sizable positions in the technology sector and are optimistic about their prospects, favouring companies within semiconductor and specialised parts space (TSMC, Samsung Electronics).

Within the energy sector, the managers introduced Worley, an Australian engineering oil and gas company, and within materials LG Chem, a South Korean chemical manufacturer.

IAT has consistently outperformed the benchmark over the longer term, including three, five and 10 years, as shown in Exhibit 5. Despite a difficult year for the financial markets thus far, IAT’s NAV TR has outperformed the MSCI AC Asia ex-Japan benchmark.

Stock selection in China was a key positive contributor to the last six months’ TR (to end-July 2022). A recent easing of lockdown restrictions, some better than-expected macro data and a sense (by IAT’s portfolio management team) that the regulatory crackdown may be over resulted in strong performances for IAT’s internet, property and auto related stocks. COLI was one of the biggest contributors, as it outperformed on signs of policy support for the property sector. Another notable performer was Ming Yang Smart Energy on market expectations that wind turbine manufacturers should benefit from a H222 pick-up in installation projects. The portfolio managers believe that recent commodity price weakness should also help margins recover. Suofeiya also made strong gains, with the custom furniture manufacturer benefiting from signs of a mild recovery in the still challenging property market.

Stock selection in India also added value. Mahindra & Mahindra’s share price hit record highs as market share gains in SUVs and a cyclical recovery in LCVs (light commercial vehicles) helped drive profits growth, with its tractor business also expected to enjoy a recovery in 2023. The portfolio’s exposure to Indonesia contributed positively to performance, with Bank Negara Indonesia the biggest single contributor, and Astra International and Telkom Indonesia also performing strongly.

IAT’s underweight position in the technology sector benefited relative to the benchmark performance. The five-year discrete performance data in Exhibit 6 illustrate the visible relative performance boost over the 12 months to end July 2021. The 12-month data to end July in 2021 and 2022 illustrate that during recent China market sell-offs, the portfolio’s avoidance of highly valued, high growth stocks meant it was more defensive than the MSCI AC Asia ex-Japan Index and also the MSCI China All Shares Index.

In Exhibits 7 and 8 we present performance and other metrics relative to peers.

IAT exhibits a strong relative performance against its Asia Pacific Equity Income peer group of five funds and also country specialist funds within Asia. This strong relative performance is complemented by a competitive yield of c 4.6%.

H122 has been challenging for global equities, and in Asia, for Chinese equities in particular. By the start of 2022 the managers had repositioned the portfolio more towards Chinese equities, which fell out of favour during 2021, eliminating the China underweight position. As shown in Exhibit 8, IAT ranks second over one and three years on an NAV TR basis, following Pacific Assets trust, which has typically had a large overweight position in India, the market that outperformed in the past capital years within Asia. IAT also ranks second over 10 years, following Pacific Horizon, which has performed very strongly over the long term, with exposure to high-growth names. Despite the high volatility of Chinese markets over the past 12 months, IAT’s balanced positioning, gradual building of its slight overweight of Chinese names over the benchmark and the markets’ rotation from growth to value have been reflected in IAT’s robust performance relative to peers.

Over five years IAT ranks fourth by NAV TR, in its Asia Pacific country specialist peer group, lagging its growth-style focused peers. We believe this is to be expected, given that growth names were outperforming for a number of years prior to 2021, when the market switched more into value names, while IAT’s balanced approach between growth and value meant it did not participate as fully on a relative basis in the growth stock momentum over that period.

The Association of Investment Companies moved IAT from the Asia Pacific sector into the Asia Pacific Equity Income sector in 2020. Considering the board’s initiative in August 2020 to introduce a regular six-monthly dividend equivalent to 2% of NAV, we believe the reclassification is justified.

Launched in 1995, IAT aims to provide long-term capital growth through investing in a well-diversified 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. The benchmark is the MSCI AC Asia ex-Japan Index (the MSCI Asia Pacific ex-Japan Index prior to 2015), reflecting the trust’s primary focus on Asia and persistently low exposure to Australasia. The approach is team based, bottom up and valuation focused. The portfolio of c 50–60 stocks represents 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, following a bottom-up, contrarian approach. They look to buy companies with strong fundamentals, but that are ‘unloved’ by the market and trading at a significant discount, and the team targets a double-digit annualised return from each portfolio stock.

IAT enhanced its dividend policy in 2020 and income will continue to contribute materially to NAV and share price TRs. The board targets a dividend yield of 4% of NAV per year. Gearing is permitted up to 25% of net assets.

The board appointed Sonya Huen Rogerson as a non-executive director on 26 July 2022 with immediate effect. She has over 20 years’ experience in legal matters, governance and compliance across a range of industries including financial services and countries in Asia-Pacific. As indicated in November 2021, Fleur Meijs stepped down from the board on 2 August 2022. Myriam Madden, who joined the board on 4 November 2021, took over from Fleur as audit chair. Owen Jonathan, the senior independent director, will retire at the forthcoming annual general meeting (AGM) in September 2022 after serving nine full years. The board is chaired by Neil Rogan and will comprise four directors after Owen Jonathan retires.