Witan Pacific Investment Trust — Better investment performance or return of cash

Asian equities have underperformed the global market since early 2018 (Exhibit 2, LHS), primarily due to the relative strength of US stocks, which make up more than 60% of the MSCI World index. However, the Asian region has above-average economic growth prospects, as highlighted on the front-page chart, helped by demand from increasingly affluent and better-educated populations. Valuations in the region are also relatively attractive (Exhibit 2, RHS). The Datastream Asia index is trading on a 13.9x forward P/E multiple, which is an 11.6% discount to the Datastream World index; this is broadly in line with the 11.0% average discount over the last five years. Investors seeking exposure to Asia may wish to consider a fund that has a broad geographic spread of high-quality companies across a variety of sectors.

WPC was launched in 1907 and is traded on the main market of the London Stock Exchange. In 2005, it adopted a multi-manager strategy – aiming to add value and diversify risk – and appointed Witan Investment Services (WIS) as executive manager with responsibility for operational matters. The trust aims to generate capital and income growth over the long term from a diversified portfolio of pan-Asian equities. It is the only investment trust with a focus across the entire Asia Pacific region (most peers exclude Japan), and can therefore be considered as a ‘one-stop shop’ for Asian equity exposure. WPC is benchmarked against the MSCI AC Asia Pacific Free index (in sterling terms). It aims to grow its annual dividend in real terms (above the level of UK inflation) over the long term, and to ensure ongoing charges (excluding the performance fee) are 1.0% pa or less. The multi-manager strategy provides exposure to a variety of unconstrained investment styles and offers a broad opportunity set. There are currently four external managers: Aberdeen Standard Investments (since May 2005 and currently c 26% of assets), Dalton Investments (September 2017 and c 9%), Matthews International (April 2012 and c 41%) and Robeco Institutional Asset Management (September 2017 and c 24%).

WPC’s board is committed to future outperformance of the trust versus its benchmark; if this is not achieved in the period from 31 January 2019 to 31 January 2021, proposals will be put forward, including a full cash exit close to NAV. The beginning of February 2021 would mark more than three years since the last change in the manager line-up; the board considers this is an adequate period over which to evaluate the trust’s performance.

Data from WPC show that from the inception of the multi-manager strategy on 31 May 2005 to 31 July 2019 (end-H120), WPC’s annual NAV and share price total returns of 9.3% and 9.5% respectively are marginally ahead of the benchmark’s total return of 9.2% pa.

Offering his perspective on the macro backdrop, WIS’s investment director, James Hart, argues that investor sentiment is changeable. At the start of 2019, the central assumption was that global growth would remain positive but anaemic, and that Asia would grow faster than the rest of the world, albeit by a narrower margin than in recent years. As a result, Hart was positive on the outlook for global equity markets, particularly as valuations looked undemanding, including in Asia.

Over the course of this year, there have been important issues for investors to consider. There is the ongoing trade dispute between the US and China, with sentiment shifting to and fro on the outlook for a resolution. Hart says the situation is unchanged in recent months as President Trump is trying to engineer a situation that ensures the US economy is robust in H120, rather than peaking in 2019, which should help his chances of re-election next November. A strong economy should support the US stock market, which the director says is the leading indicator on Trump’s personal approval rating. The president needs to strike a balance between keeping a lid on the Federal Reserve’s willingness to tighten monetary policy, and encouraging an environment that is as positive as possible for his re-election prospects; Hart argues that US-China trade talks are a central element of this.

The director remains positive on the outlook for global markets in 2020, but he expects heightened risks as the year progresses. In the run-up to the US presidential election, Hart suggests there are risks of a miscalculation by Trump, or by the Federal Reserve in terms of its monetary policy. The director also believes there is a very slim but outside chance of a Democratic win in the election, which he suggests would heighten stock market risk. However, for now, considering the outlook for Asian markets, Hart argues it is ‘steady as she goes’, as valuations are ‘okay’, while corporate governance in the region continues to improve, which is supportive for equity performance. He highlights that environmental, social and governance (ESG) analysis is integrated into WPC’s external managers’ strategies; for example, Dalton requires engagement with company managements to ensure all shareholder interests are aligned. Hart also highlights Aberdeen and Robeco, as specialists in Asian corporate engagement; for example, Robeco offers Japanese companies advice on the important measures that can enhance shareholder returns, such as effective allocation of capital, an optimal balance sheet structure and fair treatment of minority shareholders. The director says that certain countries, such as Japan, South Korea and China, may be viewed by Western investors as lacking in terms of ESG standards, but improvements are certainly being made.

Hart notes the varied performance between Asian markets in 2019; technology-heavy Taiwan has been a standout, having previously suffered following concerns about slowing economic growth. Certain Taiwanese companies have benefited from increased semiconductor demand, such as Taiwan Semiconductor Manufacturing (TSMC) and Hon Hai Precision Industry. The director comments that China ‘A’ shares have also recovered strongly following a ‘dreadful’ period of performance in Q418. However, in general he says that developed markets, including Australia and Japan, have performed better than the emerging markets within the Asia Pacific region. Hart says that there have been modest changes in market leadership on a number of occasions over the last decade, where value investors were hoping for their ‘time in the sun’; he notes that in the summer this year value stocks stopped underperforming, as an improvement in the global growth outlook favoured cyclicals. However, the director says there has not been consistent value leadership; he suggests that for this to happen, investors need more certainty on the US-China trade issue and a stabilisation or upturn in global growth. Hart says that WPC’s portfolio is neutral on value versus growth, but should perform better when market leadership broadens, rather than being led by technology platforms and high-quality defensive growth companies. He suggests that a narrow market does not allow the individual characteristics of stocks to shine through, and that the market is currently factor- rather than fundamentals-driven.

Since 2005, WPC has employed a multi-manager strategy; there are currently four external managers, all of which invest across the Asia Pacific region (Exhibit 3). The trust aims to generate long-term growth in capital and income from a broad opportunity set. Individual managers run high-conviction portfolios, which ensures that WPC’s combined portfolio is not overly diversified. The portfolios’ active shares (this is a measure of how a fund differs from an index – 0% is full index replication, while 100% is no commonality) range between 78% and 99%, which combines to 71% for WPC (as some stocks are held by more than one manager). Shareholders in the trust are afforded access to strategies that may not be available to individual investors. Assets are held in segregated accounts and there is regular detailed monitoring of portfolio risks. Each manager may hold up to 10% of their portfolio in any one company, although in practice the trust is unlikely to have more than 5% in a single stock. At end-November 2019, the largest holding was a 3.5% position in TSMC; it is in the portfolios of three of the four external managers. In aggregate, they provide exposure across the market cap spectrum, including smaller or less well-known companies, and each manager has a dedicated ESG team. Research has shown that companies with high or improving ESG track records can generate above-average investment returns.

To access videos on each of WPC’s external managers please click here.

WPC’s board is responsible for hiring and monitoring the external managers, and allocating capital between them. The directors travel to Asia every two years to meet existing and potential new managers (the most recent visit was in February 2019). Hart highlights the benefits of including Japanese exposure in the trust’s portfolio in terms of lower volatility and potentially higher investment returns. Data from WPC show that the five-year annualised volatility (as at end-September 2019) of its benchmark is 12.0% compared with 13.6% for the MSCI AC Asia Pacific ex-Japan index, while its annualised total return is higher at 10.6% versus 9.9%.

At end-November 2019, WPC’s top 10 holdings made up 17.1% of the portfolio, which was modestly higher than 16.7% a year earlier; four names were common to both periods.

As shown in Exhibit 4, in terms of geographic exposure, the largest deviations versus the index are underweight positions in Japan (-6pp) and Australia (-4pp), and overweight exposures to Singapore (+4pp) and China/Hong Kong (+3pp). Hart considers that WPC’s shareholders benefit from the trust’s broad geographic exposure as selected Japanese companies are global and regional leaders in their fields, such as high-end electronics, baby goods, beauty products and robotics. Looking at WPC’s sector exposures (Exhibit 5), nearly 60% of the fund is invested in three areas: consumer goods, financials and industrials.

Hart highlights that WPC’s portfolio activity has tended to be modest, with annual turnover of less than 25%. At end-2018 and into early-2019 the managers started adding to their Chinese/Hong Kong exposure given the sharp market sell-off in Q418, including high-quality names that are beneficiaries of middle-class consumption growth, such as AIA Group and Ping An Insurance, which are two of the largest financial services providers in China.

In H120 (ending 31 July), WPC’s NAV and share price total returns of 9.4% and 13.8% respectively compared with the benchmark’s 10.5% total return. Hart explains that stock selection was generally positive, but the trust’s performance suffered from an underweight exposure to Australia, which performed strongly, and an overweight position in South Korea, which performed relatively poorly. As shown in Exhibit 3, looking at the individual managers, Aberdeen Standard was the standout performer (+4.8pp versus the index). Dalton was also modestly ahead (+0.6pp), while Robeco and Matthews lagged by 4.4pp and 1.5pp respectively.

WPC’s relative performance is shown in Exhibit 8. Its NAV has lagged the MSCI AC Asia Pacific Free index benchmark over the periods shown. However, its share price has outperformed over three and six months and one and 10 years, while it is in line over three years. The trust has fared better versus the FTSE All-Share index, particularly over the last five and 10 years, but has lagged the performance of the MSCI World index over the majority of periods shown. This index is dominated by the US (c 63%), which has performed relatively well in recent years.

Hart is confident that when stock market leadership broadens out, WPC’s relative performance will improve. He highlights some of the trust’s positive contributors to performance this year – Breville (small home appliances), Kao (chemicals and cosmetics), MediaTek (semiconductors), Pigeon (baby products), Shin-Etsu Chemical, Shin Zu Shing (metal stamping) and TSMC (semiconductors). Holdings that have fared less well this year have tended to be in the energy, financials (particularly banks), materials and utilities sectors.

WPC’s shares are currently trading at a 9.1% discount to cum-income NAV, which is at the narrower end of the 7.9% to 17.0% range of discounts over the last 12 months. The discount has continued to narrow following the February 2019 announcement that either relative NAV performance improves by the end of January 2021, or cash will be returned to shareholders. Over the last one, three, five and 10 years, WPC’s discount has averaged 11.3%, 13.0%, 13.1% and 14.1% respectively. The board repurchases shares when they are trading at a substantial and anomalous discount to NAV. During H120, c 0.7m shares were bought back at an average discount of 10.9%, which added c £0.3m (0.44p per share) for shareholders. So far in H220, an additional 0.4m shares have been repurchased at a cost of £1.3m.

WPC is a conventional investment trust with one class of share. There are 61.3m ordinary shares in issue. Since 1 April 2014, WPC has been registered as a Small Registered UK Alternative Investment Fund Manager under the Alternative Investment Fund Managers Directive and is therefore unable to employ gearing. At end-November 2019, the trust had a net cash position of 2.9%. WPC’s board regularly reviews the trust’s status in terms of costs versus the potential benefits of gearing. The external managers are not permitted to borrow within their portfolios but may hold cash if deemed appropriate.

External managers are paid a fee between 0.20% and 0.85% of assets under management. Aberdeen Standard charges a lower base fee, but is eligible for a performance fee for outperformance of the benchmark. Management fees are charged 75% to the capital account and 25% to the revenue account, reflecting the board’s expectation for the long-term split of returns between capital and income. In FY19, ongoing charges were 1.03% (FY18: 0.99%), while management fees paid to the external managers and WIS were 0.69% (FY18: 0.63%). For H120, WPC’s six-month (not annualised) ongoing charges were 0.54%, in line with H119, while including performance fees they were 0.57% (in H119, no performance fees were payable).

WPC pays regular dividends twice a year, in October and June. They are funded from revenue and revenue reserves if necessary. Payments may be made from capital if required, but this is not envisaged by the board. The external managers do not have specific income targets, although Matthews’ investment approach does have a dividend bias. In H120, WPC’s revenue return per share of 4.21p was 10.6% lower year-on-year, while the declared interim dividend of 2.55p was 2.0% higher. Lower dividend receipts were due to the sale of a small number of higher-yielding stocks. At the end of the period, the trust’s revenue reserve was 21p per share (3x the FY19 annual dividend).

WPC’s annual dividends have increased for the last 14 consecutive financial years, compounding at an annual rate of more than 14.5%. Over the last five years, the trust’s dividend has compounded at a more modest, but nevertheless competitive, rate of 9.5% pa. WPC currently offers a 2.1% dividend yield.

WPC is now included in the AIC Asia Pacific sector, but is the only peer with a significant weighting in Japan (31% at end-November 2019). It is one of the smaller funds in the group. The trust’s NAV total returns are below the Asia Pacific sector averages over the periods shown. To enable a broader comparison, we also highlight the seven open-ended vehicles in the IA Asia Pacific including Japan sector. WPC’s NAV total returns are also behind the averages of these funds; its relative performance may have been hampered by its modest exposure to high-growth internet stocks. While the trust’s discount has narrowed in recent months, it remains wider than average, ranking fifth; it has an ongoing charge in line with the mean, and is one of three funds that are ungeared. WPC offers a competitive dividend yield, ranking equal third out of the nine closed-ended funds (0.5pp above average) and 0.9pp above the mean of the seven open-ended funds.

Following the retirement of Diane Seymour-Williams at the June 2019 AGM, WPC’s board has four directors, all of whom are non-executive and independent of the manager. The board members are: Susan Platts-Martin (appointed in July 2014, chairman since June 2017); senior independent director Dermot McMeekin (appointed in May 2012); Andrew Robson (appointed in July 2014); and Chris Ralph (appointed in July 2017).