AIMS ASSET MANAGEMENT SDN BHD

Recommendations

Info

more efficiently with involvement from professional managers. Vietnam’s stock market valuations were extremely low last year; after a strong rally, multiples have now increased towards average valuations for Asian regional markets. Although certain areas of the Vietnamese market now do look frothy (e.g. real estate and certain small caps), the secular growth outlook remains strong. Given limited market liquidity and availability of stock, it makes sense to retain positions in attractive franchises with good long-term growth potential. New IPOs and SOE divestments will likely mean a reasonably strong supply of new stock hitting the market in 2017, which will require new investors to step up. If handled properly, increased liquidity should attract more international institutional investors, and help move Vietnam from MSCI Frontier status towards the MSCI Emerging Market Index. A virtuous cycle? With around one third of the portfolio in Japan, and another third in Vietnam, investors may be forgiven for asking whether Panah is pursuing a “barbell” strategy of ‘Japan value’ v ‘Vietnam growth’? This might seem a slick description of Panah’s allocations, though in reality this is not an accurate characterisation of portfolio positioning. In Japan, Vietnam, and indeed throughout our investment universe, we prioritise investing in well-managed companies with solid balance sheets, strong cash flows and respectable long-term growth prospects. Low valuations provide a necessary though not sufficient margin of safety, as it is also important to have an appreciation of why such market inefficiencies exist. While we favour ‘compounder’ companies which are able to reinvest their cash flows at a high rate of return over the long-haul, Panah also occasionally makes ‘deep value’ investments in companies with substantial ‘balance sheet protection’ (e.g. when net cash or net-net working capital exceed market cap) and where we are also fairly confident that a catalyst is imminent. We have made such deep value investments in various markets, including Japan, Vietnam, Taiwan, Hong Kong, and Papua New Guinea, and have also invested in compounders throughout the region. (On the Panah Fund Mind Map, dark green circles indicate stock positions with a deep value-catalyst investment thesis, whereas lighter green circles represent the similarly geographically-diversified ‘compounders’. However, note this classification is not always clear-cut!) There are no other major country concentrations in the portfolio; most other holdings are spread fairly evenly across other Asian markets. There is one notable sector allocation towards a selection of precious metal companies (accounting for 7.1% of NAV at end-Sept 2016, in five stocks). Since Panah started investing in the gold sector (in late 2015), we have become increasingly disillusioned with the quality of management in the sector. The managers of many gold-miners apparently find it hard to resist the siren song of avaricious investment bankers, hurrying to issue shares after any significant rally in their stock price, almost regardless of whether this is necessary or advisable from a business perspective. For long-suffering shareholders, all too often this means unnecessary dilution. As one experienced gold investor so memorably commented: “Gold companies issue more paper than the Fed!” Or, for that matter, any of the G3 central banks. We have little patience for weak gold mine managers and their ballooning share counts. Of the seven precious metal companies in which Panah has invested in 2016, the managers of three firms have displayed symptoms of premature issuance. In each case, our response has been to make our displeasure known, and then reduce and eventually divest of each holding, reallocating our profits towards positions in companies with a more attractive outlook, run by managers who demonstrate more restraint (we hope). As always, it helps if management also owns a reasonable amount of stock to give them ‘skin in the game’. Despite recent volatility in real interest rates and gold prices, we believe that there is a strong valuation and macro case for allocating a small part of the fund to precious metal stocks. However, we do not anticipate that the fund’s total allocation towards this sector will exceed the size of a single ‘conviction holding’ within the portfolio (i.e.
China: How I Learned to Stop Worrying and Love the Debt China is currently undergoing a brief cyclical upturn amid a longer-term structural slowdown in the economy. The most salient features of this upturn have been a sharp spike in real estate prices, and aggressive credit growth since the economy bottomed out in Q1 2015. After critical comments from an ‘authoritative person’ in May concerning unsustainable debt accumulation driving investment and growth, 5 foreign investors questioned whether the authorities would move to tighten macro policy, thereby crimping growth and increasing the probability of volatility in financial markets. A few months on, however, it is clear that President Xi Jinping’s ambitious 6.5% GDP growth target is intact. Apparently the most certain way to reach this goal is by keeping the credit taps turned on, regardless of the long-term costs of such a policy. Indeed, credit growth is still running at ~2.5x the pace of GDP growth, and so aggregate debt levels continue to increase. It is now widely accepted that China’s debt-to-GDP ratio has reached ~250%, a rise of more than 100% since 2009. 6 There is no deleveraging in sight. Interest rates are being held at low levels to keep debt service costs under control. In the past we have likened the debt game in China to ‘whack-a-mole’, with the authorities struggling to keep up with the latest innovative forms of credit which pop up everywhere. Over the last two years, there has been a rapid increase in ‘non-loan assets’ on the balance sheets of the city commercial and joint stock banks, and in many cases these now exceed the size of these banks’ loan books. 7 These non-loan assets mostly take the form of ‘investments’ and ‘receivables’, and have often been created with help from Trusts and other Non-Bank Financial Institutions (NBFIs). Although these ‘non-loan assets’ might not be loans by name, by nature they are remarkably similar to loans. Unsurprisingly, the regulatory-mandated levels of disclosure regarding these quasi-loans, as well as recognition of impairments and required provisioning, are much less than for official loans. This presumably explains why China’s lower tier banks have been so keen to reclassify loans as instruments such as ‘Trust Beneficiary Rights’ and ‘Directional Asset Management Plans’. As a result, China’s weaker banks seem to be presenting a flattering view of their own asset quality, which also has implications for system-wide Non-Performing Loan (NPL) numbers. While China’s ‘big four’ state-owned commercial banks do not appear to have significant issues in this regard, many lower tier banks do appear to have problems. We recently identified one small bank with a shrinking loan book and an NPL ratio as low as 0.5%, but which has seen runaway growth of +73% in financial investments over the last year (exposed to real estate and resources in the north-east of China), which now account for ~50% of total assets (i.e. larger than the loan book). At the same time, this city commercial bank is experiencing funding issues and was recently forced to access an emergency liquidity line from the central bank. Despite these red flags, this institution (listed in Hong Kong) was recently trading at a price-to-book ratio of more than 1.0x. No matter what happens to the broader banking sector in China, we expect that it will be necessary for this bank to raise significant equity in the near-term, likely causing a substantial dilution for existing shareholders. The Panah Fund has recently established a short position on the stock. The Market-Cycle Diaries In previous letters to investors, we noted that China’s real estate cycle bottomed out in early 2015. So far this year (to the end of August), a record 875m sq m of property floor space has been sold in China, a year-on-year increase of +25.5% (this growth rate was as high as +36.5% at the end of April). House prices in Tier 1 cities, where supply has been tightest, have been rising at an average pace of ~30% year-on-year (with even more rapid rises in certain cities such as Shenzhen and Shanghai), while house prices in Tier 2 cities have been approaching double-digit average y-o-y 5 This ‘authoritative person’ (presumed to be Liu He, an advisor to President Xi) published an article in the People’s Daily on 9 May. For highlights, see: http://www.bloomberg.com/news/articles/2016-05-09/china-sauthoritative-warning-on-debt-people-s-daily-excerpts. 6 The experts differ on the exact numbers, but all of them now seem to agree that there is a problem: http://ftalphaville.ft.com/2016/10/12/2177069/in-search-of-chinas-hidden-credit/. 7 Jason Bedford at UBS has been the most assiduous analyst of such developments within China’s banking system. 5
Page 1 and 2: AIMS ASSET MANAGEMENT SDN BHD (Co.R
Page 3: Portfolio Positioning In the Q1 201
Page 7 and 8: meltdown, but rather a rapid increa
Page 9 and 10: know management better and build co

AIMS ASSET MANAGEMENT SDN BHD

Create successful ePaper yourself

Delete template?

Save as template?