AIMS ASSET MANAGEMENT SDN BHD

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Panah’s +3.24% gain in Q3 2016 was achieved while running a net market exposure 1 of ~70-85%. This was slightly higher than has been the case historically, primarily because of a relatively large position in a Papua New Guinea LNG stock which was subject to a takeover bid (the investment case for this stock is described in the Q2 2016 letter to investors). This LNG company contributed around one-third of Q3 gains for the fund, as did the fund’s long-term holding in a Korean semiconductor equipment. Stocks in Vietnam also made a strong contribution to performance in the third quarter. Panah’s positions in Japan in aggregate made no overall contribution to returns over the quarter: smaller gainers were offset by a steep though healthy correction in one of the fund’s larger Japanese holdings (to which we added on weakness). The fund trimmed some of its outperforming gold stock positions earlier in Q3 (reallocating capital to less popular companies), so despite the violent sell-off in many gold stocks over the summer, Panah’s gold losers offset winners almost exactly over the quarter. The fund lost some money in HK-China, where the fund’s long value holdings came under pressure while short positions were squeezed. During the third quarter of the year, we made incremental rather than dramatic adjustments to the fund’s positioning. Early in Q3, Panah exited a modest position in a Hong Kong-listed value stock operating in the China retail sector; our divestment followed the resignation of the CEO and a loss of confidence in the company’s strategy. We also exited a small investment in a Thai financial company where we judged that management had been slow to deliver on turnaround plans, and that it would still take quite some time to set the company back on the right path. Although these stocks seemed cheap, the outlook for both was uncertain nonetheless, and we simply saw other investment opportunities as more compelling. We continued to add to core Vietnamese stock positions as lines of stock became available, increasing our position in a jewellery retailer after a correction in the stock price (this firm is described in our Q2 2016 letter to investors). We also doubled the size of our position in a well-managed Vietnamese conglomerate which operates in several sectors: as a mechanical and electrical engineering contractor, an air-con manufacturer, a real estate developer and landlord, and an investor in power and water infrastructure. In Japan, we continued to trim back the fund’s real estate stock holdings as the property cycle approaches a peak (as set out in our Q1 2016 letter to investors). Instead, we added to a longstanding holding in a Japanese consultancy company which also leverages its business expertise to make early-stage investments in smaller firms. Over the last year we have met several representatives of the company (in Japan and abroad), and are impressed by the ‘strength-indepth’ of this firm’s employees, as well as their planning and execution ability. We also added to the fund’s largest Japanese holding, a power plant service company (described in the Q2 2016 letter to investors); the share price tumbled in August as the scandal-ridden parent company sold down part of its 60% stake in the firm. Although the market reaction was negative, we saw this partial divestment as good news, so added to our position at more attractive valuations. Later in the third quarter, after extremely strong liquidity-driven rallies in Asian and Emerging Markets, which seemed to be driven to a large degree by passive equity flows, 2 Panah increased its short positions in Hong Kong- and Japan-listed stocks. Many of these single stock shorts are on companies which operate in sectors subject to cyclical pressure and increasing competition, or with aggressive accounting policies which distort the economic fundamentals of these firms. (We have shorted several of these stocks before, in 2014 and 2015, before covering the positions in late 2015 and early 2016 as stock markets fell.) As market volatility subsided towards the end of the third quarter, Panah also bought several cheap, out-of-the-money put options on individual stocks and indices with 3-6 months to expiry; this puts at risk ~80bps of NAV in return for substantial downside protection for the portfolio during a period when the market faces numerous risk events. 1 Market exposure is stated in net ‘Equity-Equivalent Exposure’ (EEE) terms, which aggregates equity positions and adjusts non-equity positions (i.e. commodities, bonds, FX) for volatility and correlation to equities, to give a risk measure showing the Panah Fund’s equivalent exposure to equity markets. 2 EM fund inflows hit a 58-week high in August: https://www.ft.com/content/4ff6670a-65c3-11e6-a08ac7ac04ef00aa. 2
Portfolio Positioning In the Q1 2016 letter to investors we introduced the ‘Panah Portfolio Mind Map’, designed to help investors visualise the fund’s portfolio exposures. This received a positive reception, so we have updated the diagram and have appended it to the end of this letter. The fund’s three largest positions (each accounting for 6.5-8.5% of NAV) were described in the fund’s Q2 quarterly letter to investors: a Papua New Guinean LNG explorer; a Vietnamese jewellery retailer; and a Japanese plant service company. The top five holdings for the fund are rounded out by a Vietnamese conglomerate, and by a Japanese home centre retailer. We expect the LNG explorer will exit the portfolio sometime in the next month as a result of a successful takeover bid, although we do not anticipate any other major changes in the fund’s top holdings in the near future. At the end of the third quarter of 2016, there were no significant changes to the Panah Fund’s largest country exposures: Japan (34.2% gross, 26.4% net; consisting of ten stocks long and two stocks short), and Vietnam (33.8% gross + net; consisting of long positions in seven stocks and two closed-end funds). We presented the investment case for Japan in our Q1 2016 letter to investors… In summary, we think that despite an unenviable macro-economic backdrop – exacerbated by unpredictable and experimental monetary policy 3 – Japan has various redeeming features for equity investors. First, Japanese stocks tend to be less-widely covered by the sell-side compared to other countries in Asia, leading to more inefficiencies and thus opportunities for stock-pickers. Second, we think that the most important contribution of Abenomics might well have been the company stewardship and corporate governance codes; while progress has been slower than hoped, there have nonetheless been real improvements. Third, although foreigners have tended to be the swing equity market investors over the last decade, there is now much more involvement from domestic buyers, including the Bank of Japan and pension funds. Going forward, we expect this domestic constituency to provide more of a stabilising influence at times of market weakness, and also to get more involved in corporate governance issues. Finally, equities in Japan are cheap, and positive corporate governance pressure should help to unlock this value in coming years. The macro and investment outlook for Vietnam was set out in our Q2 2016 letter to investors… After runaway inflation, a credit bust followed in the period 2010-12; the bank recapitalisation process is now well underway, and Vietnam’s credit cycle is at a much earlier stage than in larger neighbouring SE Asian countries. Favourable demographics, cheap labour costs, and a good location near well-established trade routes mean that Vietnam is well placed to capture market share in low-end manufacturing. The recent surge in FDI and trade exports underline that over the coming decades, the country is well-placed to pursue the ‘Asian tiger’ export-manufacturing growth and urbanisation model. Vietnam’s recently signed international trade treaties provide a solid base, but it will be necessary for external conditions to remain stable in order for the country to fulfil its potential. Vietnam has been prone to boom-bust cycles in the past, and policymakers will have to work hard to maintain monetary and financial stability in the future. The size of Vietnam’s fiscal deficit is a concern, but the willingness of the new government to embrace reform is encouraging. In particular, we are impressed by the recent government decisions to divest of its 45% Vinamilk stake (shortly after the Foreign Ownership Limit for this stock was lifted), and to sell its stakes in the two SOE beer companies (Sabeco and Habeco) to the highest bidder. 4 This will not only reduce the fiscal deficit, but these brewers should also be run 3 The latest policy initiatives from the Bank of Japan (announced on 21 September) involve: further equity purchases; enhanced ‘yield curve control’ (i.e. holding short rates negative but the 10yr bond at ~0%, presumably to reduce pressure on financial firms); and the removal of a time constraint for hitting a 2% CPI target (the monetary base will keep expanding until such time as the CPI target is exceeded). There has been a fairly subdued market reaction to such a radical announcement, perhaps because these initiatives present an uncertain path for monetary policy. Indeed, one could imagine a scenario of unlimited bond purchases (i.e. if bond yield rise) which might threaten currency stability, or even the tapering of bond purchases (e.g. in a higher inflation environment). 4 http://www.scmp.com/business/companies/article/2012798/vietnam-sell-stake-prized-beer-companiessabeco-and-habeco. 3
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