Witan Pacific Investment Trust — Update 16 May 2016

2015 was a volatile year for Asian markets, as can be seen in Exhibit 2 (left-hand side). Between February and June 2015, the Chinese stock market rallied strongly before policy was tightened and the market subsequently staged a significant retreat. Although expectations for Chinese growth have moderated, the sharp moves in the stock market did not reflect the path of the Chinese economy or corporate earnings. Longer term, Asia-Pacific markets have underperformed world markets since early 2012 due to slowing earnings growth and investors’ heightened attitude to risk. Looking at growth forecasts from the International Monetary Fund, although estimates have come down for many developed countries, including Japan, the outlook for economic growth in emerging and developing Asia has increased modestly. Growth estimates for 2016 and 2017 of 6.4% and 6.3% respectively are comfortably ahead of the estimates for world output (3.2% for 2016 and 3.5% for 2017). The rate of descent of the oil price and its impact on corporate earnings has negatively affected stock markets. However, over the long term, a weak oil price is positive for consumers generally and most Asian countries are importers of oil.

As a result of the underperformance of the Asian market, since April 2015 its forward P/E has declined from above 14.0x to c 12.5x (Exhibit 2, right-hand side). On a relative basis it is now at a five-year low versus world markets. For investors wishing to participate in a region where several countries are generating above-average GDP growth, an unconstrained fund providing selected exposure within the broad Asian region may hold some appeal.

WPC is a long-standing trust launched in 1907 as General Investors and Trustees investing in a broad range of assets. In 1975, it merged with City and Gracechurch Investment Trust and in 1984 was renamed F&C Pacific Investment Trust reflecting a new Asia-Pacific investment policy. In 2005, the trust adopted a multi-manager approach, Witan Investment Services (WIS, a subsidiary of Witan Investment Trust), took on an executive manager role reporting straight into the WPC board and the name of the trust was changed to Witan Pacific Investment Trust. Initially, funds were allocated equally to Aberdeen Asset Management and Nomura. In April 2012, the Nomura funds were reallocated to Matthews International and Gavekal Capital. At the end of January 2016, assets were split as follows: Matthews (48%), Aberdeen (41%) and Gavekal (11%). Matthews and Aberdeen employ bottom-up stock selection processes (Matthews has a dividend bias), while Gavekal has a top-down approach allocating assets between equities, bonds and cash. WPC is the only UK investment trust with a broad Asia-Pacific mandate that includes Japan and Australia.

Matthews – the manager has an Asia dividend strategy, focusing on companies with moderate but growing dividends, which are seen as an indication of the quality of a company. Investment is not necessarily in household names and there is a large exposure to China and Japan. The manager sees underlying revenue growth of 10% in the portfolio as supporting forward equity valuations. He suggests that near-term volatility in Asia is likely to continue and central bankers are influencing markets to an even greater degree. However, Asia has always had periods of volatility and it is important to maintain investment discipline. Despite the uncertain backdrop, the manager is still finding attractive investment opportunities.

Aberdeen – the manager has a quality bias and its portfolio has underperformed in recent years due to the team’s focus on value rather than growth. The portfolio is relatively static and the fund has held a number of household names for many years. The team has a focus on investing in companies whose management teams are shareholder friendly; an attribute they say is not always apparent in the region. Portfolio holdings typically have 4-5% revenue growth, a 30-80% payout ratio with growing dividends and yields of 2-4%. Performance has been improving in 2016 and the long-term performance track record has exceeded the benchmark.

Gavekal – the manager has two businesses: a macroeconomic advisory and a fund management business with a macro input. Given the focus on macro views, turnover is higher than for the other managers, for example the manager became more cautious on Japan, trimming exposure from 20% at the end of December 2015 to 3% at the beginning of January. The manager’s cautious view on the region is illustrated by the high exposure to cash and bonds; 45% versus less than 30% 12 months ago. In recent months, the manager’s performance has been very positive during periods of stock market weakness.

WPC employs an active multi-manager strategy, which seeks to outperform the benchmark and diversify risk. The focus is on capital return and income growth; the board considers the income element is very important given the high percentage of individual holders in the trust. The board is responsible for hiring external managers; the current three active managers have established track records with different approaches resulting in three distinctive portfolios. The board regularly monitors the performance of the managers. It would be more likely to consider replacing a manager if portfolio actions deviated from the manager’s mandate or there were structural changes to the manager, rather than as a result of a period of underperformance. As well as being able to rebalance WPC’s portfolio across the existing managers, the board could choose to appoint a fourth manager. Any manager selected would be likely to be a real active manager, who is benchmark unconstrained, ideally running a concentrated portfolio.

Including Japan in the investment remit allows the managers a larger pool of companies from which to select investments. The Japanese stock market had a total return of 11.0% in local currency terms (15.4% in sterling terms) in 2015, and outperformed volatile markets elsewhere in the region. This illustrates the benefit of having a broad investment remit in the Asia-Pacific region. There are question marks surrounding monetary policy in Japan as to whether it is correct or will be successful. However, the managers are buying individual Japanese companies, not the index and so are able to invest in companies with the brightest prospects and/or multinational operations.

The portfolios of all three managers have active shares in excess of 80%, reflecting bottom-up stock selection processes, which leads to the construction of a portfolio providing differentiated exposure to the benchmark index. With the three managers combined, WPC has an active share of 75% due to a modest holdings overlap. The largest position across all three managers is Japan Tobacco; during 2015 the stock was very strong with a total return of 38.0% versus an 11.0% return in the Japanese market and it currently has an attractive c 3.0% dividend yield. However, all managers act independently; as an example over the last 12 months Gavekal has reduced exposure to Japan, while Matthews has increased exposure.

Looking at Exhibit 4, WPC has underweight exposure to Japan and Australia; however, stock selection is key and sector weightings are often considered to exert greater influence than geographic exposure. Matthews has a high weighting to the consumer sectors (both goods and services). This is a result of both stock selection and the strong performance of consumer names in its portfolio.

Since the introduction of the multi-manager strategy on 31 May 2005, WPC has outperformed the benchmark in eight of the 11 individual years. The cumulative NAV total return since then to the end of FY16 (31 January 2016) was 125.7% versus a benchmark return of 109.2%. Over this period the share price total return was 129.1%. All three managers have outperformed the benchmark, both before and after fees, since their respective appointments.

As shown in Exhibit 6, the last 12 months have been a volatile period in the stock markets, with significant weakness between April and August 2015. Following another sharp sell-off in January 2016 as investors shied away from risky assets, markets have staged a recovery. During the 12-month period, WPC’s NAV outperformed the benchmark; it has also outperformed over 10 years, while only marginally underperforming over five years.

The current share price discount to cum-income NAV of 13.3% is roughly in line with the 13.2% average over the last 12 months (range of 7.3% to 18.0%). It is wider than the average over the last three years (12.7%), but narrower than the average over the last five and 10 years (13.9% and 15.0% respectively).

Shares are repurchased, up to 14.99% of the share capital, when the discount is at a substantial and anomalous level. During FY16, 0.22m shares were repurchased (0.3% of issued capital). As shown in Exhibit 1, given the persistently wide discount, the level of share repurchases has accelerated in the current financial year, which would support a narrowing of the discount when combined with improving market sentiment. If the discount remains wide the board may consider other options to address discount management.

WPC is a conventional investment trust, with one class of shares in issue. At 12 May, there were 65.4m shares outstanding. It is registered with the FCA as a small UK AIFM under the Alternative Investment Managers directive, and as a result does not employ gearing. The board periodically reviews the costs and potential benefits of this position.

The board is seeking to achieve ongoing charges (excluding performance fees) of less than 1% per year. For FY16, ongoing charges both including and excluding performance fees were 1.05%, which compares to year-ago levels of 1.06% excluding and 1.12% including performance fees. Management fees paid to WIS and the external managers accounted for 0.62% of the total. Aberdeen charges a lower base fee than the other managers, but is eligible for a performance fee based on performance relative to the benchmark; no performance fee was payable in FY16.

While the managers have no specific yield targets, WPC pays dividends twice a year in June and October and the board aims to increase the annual dividend per share by more than UK inflation rates. Over the last 10 years, dividend growth has compounded at an annual rate of 13.3% versus 3.0% in UK retail price inflation. For FY16, the annual dividend was increased by 2.2% to 4.65p, which was 93% covered by revenue income. In the future, the board aims to have the dividend fully covered as a result of the prospect for long-term portfolio dividend growth. The revenue reserve of £10.9m is equivalent to 3.6x the level of dividends paid in the last financial year.

WPC is unique as it is the only investment trust with a broad Asia-Pacific mandate including both Japan and Australia. Historic peers such as Martin Currie Pacific (now Martin Currie Asia Unconstrained) no longer invest in Japan. Exhibit 10 includes a comparison of WPC with the weighted average of the AIC Asia ex-Japan sector. WPC has outperformed the average over one year and lagged over three, five and 10 years. In terms of risk-adjusted returns as measured by the Sharpe ratio, WPC is in line over both one and three years. WPC has a lower dividend yield than the Asia ex-Japan sector, which contains some funds with a high-yield strategy and which apply a different charging structure. A comparison with the average for open-ended funds investing across the Asia-Pacific region shows that WPC’s NAV total return has lagged over one, three and five years, but modestly outperformed over 10 years; this may reflect a different remit for WPC versus the open-ended funds.

There are five independent directors on the board of WPC. Chairman Sarah Bates was appointed in January 2004 and has been chairman since June 2014. Dermot McMeekin is the senior independent director and chairman of the nomination and remuneration committee; he was appointed in May 2012. Andrew Robson is the chairman of the audit and management engagement committee; he was appointed in July 2014. The other members of the board are Susan Platts-Martin and Diane Seymour-Williams who were appointed in July 2014 and June 2010, respectively. The board members have a broad range of experience including investment management, Asian business, corporate finance and accounting.