Witan Pacific Investment Trust — Diversified exposure to pan-Asian equities

Exhibit 2 (LHS) highlights the significant underperformance of Asian equities compared to global shares in recent months. Emerging market equities (including Asian), have been particularly affected by negative investor sentiment; concerns include US dollar strength and risks to global trade due to President Trump’s protectionist policies. Looking at forward P/E valuations (Exhibit 2, RHS), in absolute terms, Asian equities are currently trading on a multiple of 11.7x, which is c 11% cheaper than the 13.2x five-year average. In relative terms, Asian equities are trading at a 12.8% discount to the world market, which is c 2pp wider than the 10.7% five-year average discount.

In its October 2018 World Economic Outlook, the International Monetary Fund continues to forecast above-average growth in the emerging and developing Asian region compared with the global economy (6.5% versus 3.7% respectively for 2018, and 6.3% versus 3.7% in 2019). Factors supporting higher growth in Asia include rising disposable income, improving workforce education levels and robust infrastructure spending. Investors seeking exposure to the region may view the recent relative pullback in Asian equities as an attractive buying opportunity.

WPC is a well-established fund with a long history (launched in 1907). It aims to generate capital and income growth from a diversified portfolio of Asian equities. Given its focus on Japan, alongside other countries in the region, WPC could be considered as a ‘one-stop-shop’ for investment in Asia. The trust aims to outperform the MSCI AC Asia Pacific Free index (in sterling terms) over the long term, while growing the annual dividend at a higher rate than UK inflation (the dividend has increased in each of the last 13 consecutive financial years, compounding at an annual rate of 13.6%). WPC’s board also aims to control costs; aiming to keep ongoing charges (excluding the performance fee) below 1.0% pa.

The trust has employed a multi-manager investment approach since 31 May 2005, when Witan Investment Services (WIS) was appointed as executive manager, reporting directly to the WPC board. There are currently four external managers: Aberdeen Asset Management (c 25% of assets), Dalton Investments (c 9%), Matthews International (c 41%) and Robeco Institutional Asset Management (c 25%). Dalton and Robeco were added to the line-up in September 2017 with the aim of improving investment returns and increase exposure to smaller or lesser-known companies.

We met with WIS’s investment director James Hart, who says that 2018 has been a difficult year for stock markets and particularly for emerging markets (including Asia), where investor concerns have centred on a strong US dollar, rising bond yields and trade disputes. However, Hart believes that inflation remains in check, and bond yields have not yet reached a level that puts equity valuations under pressure. The investment director comments that while the US is ahead of the rest of the world in terms of normalising its monetary policy, the Federal Reserve should be mindful that the US economy needs to be robust enough to withstand higher interest rates; and if higher rates are impeding economic progress, the central bank will adopt a more dovish stance. He says that although global economic growth as a whole is mediocre, it is still positive, and this is reinforced by the fact that interest rates are rising.

Ongoing trade concerns have affected investor sentiment towards Asian equities in particular. Hart says that President Trump’s boorish tactics appear to be an unorthodox negotiating strategy, which has tended to produce an agreed settlement, such as the recently resolved trade deals between the US and Canada and Mexico. There is no signal yet as to whether these positive outcomes will extend to a trade deal with China, which is a cause of investor uncertainty. Hart notes that there is a poison pill in the new North American treaties, aimed at restricting the parties’ ability to enter unilateral negotiations with countries such as China. The investment director also says that Asian economies have suffered from higher energy prices. Yet again, President Trump has had an influence, as the US’s U-turn on a nuclear deal/sanctions with Iran is leading to a supply constraint and, as a consequence, higher oil prices.

Hart says that, on a more positive note, corporate earnings continue to grow, although there are fewer positive estimate revisions compared with those experienced over the last 12 to 24 months. He notes that 12-month forward consensus earnings estimates are in high single-digit territory, which is “still pretty healthy compared to history” and compares favourably with the very low government bond yields prevailing in Japan and Europe. Hart also says that Asian equities are attractively valued compared with those in other regions, especially the US, and barring a further step up in the oil price or the imposition of draconian tariffs on Chinese exports, the Asian stock market has potential to perform relatively well.

WPC is the only UK investment trust offering exposure across the whole Asia Pacific region. Hart explains the benefits of investing in Japan, as well as in the rest of the Asia. For example, some Japanese companies operate in high-growth areas, which are under-represented elsewhere in the region and may play into the theme of increasing productivity. These include WPC holdings Fanuc (robotics) and ROHM Semiconductor (specialist manufacturer, supplying markets such as high-end audio/visual products and semi-autonomous driving). The investment director says that over the last five years the Japanese stock market has generated similar returns to the Asia ex-Japan index, but the Asia (including-Japan) benchmark has experienced lower levels of annualised volatility (11.3% versus 13.5% respectively – source: WIS). Hart also highlights economic reforms in Japan and a higher focus on corporate governance.

The board is responsible for hiring and monitoring WPC’s external managers, as well as allocating capital between them. It aims to generate long-term growth in capital and income from a diverse portfolio of Asian equities; the multi-manager strategy aims to maximise total returns from a broad opportunity set, while diversifying risk. WPC’s directors travel to Asia every two years to meet with existing and potential new managers; the last trip was in early-2017, with the next planned for February 2019.

WPC’s current four multi-manager line-up is highlighted in Exhibit 3. They all run high-conviction, benchmark-agnostic portfolios, with a bottom-up approach to stock selection. Their individual portfolios have high active shares (a measure of how a fund deviates from an index – 0% is full index replication, while 100% is zero commonality) ranging from c 80% to c 100%, which combine to a 73% active share for WPC. A maximum 10% of WPC’s portfolio may be held in a single company, although in practice the trust’s top 10 holdings will tend to be much smaller (Exhibit 1).

WPC’s current portfolio breakdowns by geography and sector are shown in Exhibits 4 and 5; these are the result of the bottom-up stock selection process. At end-September 2018, the trust’s top 10 holdings made up 16.3% of the portfolio. This was a modest decrease in concentration from 17.4% a year earlier, with seven positions common to both periods. WPC has just over 200 holdings spread across its four managers, who each hold between c 25 and c 70 stocks in their respective portfolios.

Hart says that there have been marginal increases in exposure to frontier countries such as Vietnam, which he says is very well positioned to take advantage of the trade issues between the US and China. The trust currently has three holdings in Vietnamese companies (Vinamilk, the country’s largest dairy company; Vinh Hoan, an industrial fish farmer; and Thien Long, a stationery manufacturer that is benefiting from a growing level of education and a rising middle class in Vietnam).

In H119 (ending 31 July 2018), WPC’s NAV and share price total returns of -0.6% and -4.0% respectively, lagged the benchmark’s -0.1% total return. The relative performance of each individual manager was as follows: Matthews +1.3pp, Robeco -0.3pp, Aberdeen -1.4pp and Dalton -2.6pp. Positive contributors to WPC’s results in H119 included Chinese companies Shenzhou International (textile manufacturer) and Hua Hong Semiconductor, and Japanese companies Pigeon (baby products) and Anritsu (electronics and communications). Detractors included Chinese auto-parts manufacturer Minth group and Japanese semiconductor company ROHM.

WPC’s relative returns are shown in Exhibit 7. The trust has outperformed the benchmark in NAV and share price terms over the last 10 years, while lagging over shorter periods, when growth rather than value stocks have led the market. While acknowledging that performance has been disappointing, Hart believes that given the changes in the multi-manager line-up in September 2017, WPC’s relative investment performance will improve over time. For UK investors, it is worth noting the trust’s outperformance versus the FTSE All-Share index in NAV and share price terms over three, five and 10 years.

WPC is currently trading at a 15.1% discount to cum-income NAV. This is wider than the historical average discounts of the last one, three, five and 10 years (range of 13.4% to 14.8%). The board repurchases shares when they are trading at a substantial and anomalous discount. So far in FY19, 1.2% of the end FY18 share count has been repurchased (0.7m shares at a cost of £2.3m – see Exhibit 1). Global stock markets are currently experiencing a period of weakness due to heightened investor risk aversion, suggesting that there is scope for WPC’s discount to narrow when risk appetite improves. As shown in Exhibit 9, over the last three years there have been periods when WPC has traded at a discount approaching 10%.

WPC is a conventional investment trust with one class of share in issue; there are currently 62.5m ordinary shares outstanding. The trust is registered with the FCA as a small UK AIFM under the Alternative Investment Directive, and as a result it does not employ gearing (at end-September 2018, it held 3.1% of the portfolio in cash). WPC’s board periodically reviews the trust’s status to assess the costs versus the potential benefit that gearing could add. It also aims to control costs, seeking to maintain ongoing charges below 1% (excluding performance fees). In FY18, ongoing charges were 0.99% of net assets, which was 4bp lower than 1.03% in FY17. Management fees paid to the external managers and WIS totalled 0.63% of net assets compared with 0.65% in FY17 (external managers are paid a management fee between 0.20% and 0.85% of assets under management). Aberdeen charges a lower base fee, but is eligible for a performance fee, based on performance relative to the benchmark (none have been paid since FY15). Effective 1 February 2017, management fees are charged 75:25 to the capital and revenue accounts respectively (historically 100% to the revenue account) reflecting the board’s expectation for the long-term split of WPC’s returns between capital and income.

Distributions are paid twice a year, in June and October, and WPC’s board aims to grow the annual dividend at a rate higher than UK inflation; the regular dividend has increased for the last 13 consecutive years (above inflation). The 5.50p total dividend paid out in respect of FY18 was 15.8% higher than 4.75p in the prior financial year (and was more than covered by income). The c 16% increase is considerably higher than the 5.1% compound annual growth rate over the last five years, due to higher dividend receipts from portfolio companies as well as the change in the allocation of management fees. In H119 (to July 2018), revenue earnings were 4.71p per share, +36.1% year-on-year, and at the period end, the revenue reserve was £12.7m (equivalent to more than 3.5x the last annual dividend) providing considerable scope to smooth dividend payments in years when income is lower. Based on its current share price, WPC offers a dividend yield of 1.9%.

WPC is the sole trust in the AIC Asia Pacific – Including Japan sector, so to enable a comparison, in Exhibit 10, we show the averages of the AIC Asia Pacific – Excluding Japan sector, along with the open-ended funds in the IA Asia Pacific Including Japan sector. The trust’s NAV total return is above the average of the closed-ended Asia Pacific ex-Japan funds over one year, while lagging over three, five and 10 years. WPC’s NAV total returns are below the average total returns of the open-ended funds over all periods shown; generally ranking between the Aberdeen and Matthews funds. WPC has a competitive ongoing charge, although a performance fee could become payable. Its dividend yield is lower than the average of the closed-end funds, but is nearly double the average of the open-ended funds.

WPC has five board directors; all of whom are non-executive and independent of the manager. The chairman is Susan Platts-Martin, who was appointed as a director in July 2014 and assumed her current role in June 2017, following the retirement of Sarah Bates. Dermot McMeekin is senior independent director and chairman of the nomination and remuneration committee; he joined the board in May 2012. Andrew Robson is chairman of the audit committee; he was appointed as a director in July 2014. The other two directors and their dates of appointment are: Diane Seymour Williams (June 2010) and Chris Ralph (July 2017).