Witan Pacific Investment Trust — Board addressing investment performance

Exhibit 2 (LHS) shows the absolute and relative performance of Asian equities over the last five years. They have underperformed the global market since early 2018, largely due to the outperformance of the US, which constitutes more than 60% of the MSCI World index. However, there are reasons to be optimistic about the prospects for Asian equities. In its April 2019 World Economic Outlook, the International Monetary Fund continues to forecast higher-than-average economic growth in the region (see chart on page 1). Factors contributing to higher growth include a rapidly rising middle class with increasing levels of disposable income.

The valuation backdrop is also supportive (Exhibit 2, RHS). The Datastream Asia index is trading on a 13.4x forward earnings multiple, which is a c 10% discount to the Datastream World index (this is broadly in line with the c 11% average discount over the last five years). With above-average growth prospects and relatively attractive valuations, Asian equities may appeal to investors as part of a diversified global portfolio.

WPC was launched in 1907 as General Investors and Trustees, which invested in a broad range of assets. In 1984, the company was renamed F&C Pacific Investment Trust, reflecting a new Asia-Pacific investment strategy. In 2005 it adopted a new multi-manager strategy and its current name, with the appointment of Witan Investment Services (WIS) as executive manager. The trust aims to generate capital and income growth over the long term from a diversified portfolio of pan-Asian equities, which includes Japan, India and Australia. Given its broad exposure, WPC positions itself as a ‘one-stop-shop’ for investment in Asia. The trust is benchmarked against the MSCI AC Asia Pacific Free index (in sterling terms). It aims to grow the annual dividend at a higher rate than UK inflation, and to ensure ongoing charges (excluding the performance fee) do not exceed 1.0% pa.

The multi-manager line-up has evolved and there are now 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%). The latest change to the line-up occurred in September 2017, when Dalton and Robeco were added and allocations rebalanced, aiming to improve investment returns and increase exposure to smaller or lesser-known companies. WPC’s board is disappointed with the trust’s investment performance in recent years; however, it remains optimistic about the multi-manager structure, believing it is an efficient way to invest across the Asian region. The board has a fiduciary duty to shareholders, so if performance does not improve, it believes investors should be able to realise their holding at a level close to NAV; hence the recent February 2019 announcement. If WPC does not outperform its benchmark in the two years ending 31 January 2021, it would mark more than three years since the last change in the manager line-up; an appropriate period to adequately evaluate the trust’s performance since the appointment of the two most recently appointed managers, Dalton and Robeco.

We met James Hart, WIS’s investment director; he commented on events in 2018, saying that Asia was more negatively affected than the rest of the world by the ongoing trade dispute between the US and China. Last year was also characterised by a strong dollar and higher global interest rates, which were growth headwinds for Asia, while the region was not immune from the sell-off in world markets in Q418, fuelled by concerns of a slowdown in the global economy. Hart suggests that at the beginning of 2018, investors were overoptimistic but soon began to fear tighter monetary policy and rising inflation, followed by subsequent growth concerns and by the end of the year, markets were more than discounting many of the macro risks. This overly pessimistic sentiment has reversed in 2019 and global markets have rebounded strongly. Economic growth has undoubtedly slowed, but corporate earnings growth remains positive (the 2019 consensus for the FTSE All-World index is c +6% versus high-single digit growth in 2018). The investment director says that this backdrop of corporate earnings growth, along with relatively attractive Asian equity valuations means he remains positive on the prospects for Asian markets this year. Hart explains that Asian stock markets bottomed on Christmas Day 2018, with China particularly weak last year on trade concerns and a slowdown in the domestic economy. Investors are now gaining confidence there will be a resolution to the US-China trade dispute, and that government policies will be effective in maintaining the pace of China’s economic growth.

Hart highlights the benefits of investing in Japan alongside other stock markets in Asia. He notes there are certain attractive Japanese business sectors available, such as industrial automation, which are less well represented in the rest of the region, and these should perform strongly regardless of the strength of the Japanese economy. Hart says Japan’s economic performance has improved in recent years and helped generate competitive stock market returns relative to the rest of Asia (although 2018 was a disappointment, in part due to a series of natural disasters). He also notes Japan’s expansionary policies and improving corporate governance culture, which adds to the appeal of Japanese equities. In addition, investment in Asia plus Japan has lower-risk characteristics than Asia ex-Japan – WPC’s benchmark has an 11.9% annual five-year volatility, which is meaningfully lower than the 13.5% annual five-year volatility for the MSCI AC Asia Pacific ex-Japan index.

The investment director says that there is a genuine focus on improving environmental, social and governance (ESG) standards in Asia. He cites China Resources Power, which is predominantly a coal-fuelled power generator and has committed to achieving up to 40% renewables capacity over the next five years, while Huaneng Power International is aiming to cut emissions intensity by 25% by 2020. Hart says that the ‘scale and speed of evolution in China is phenomenal when companies are encouraged to change’.

WPC has employed a multi-manager strategy since 2005; the number of external managers has evolved from two to four. The approach aims to generate long-term growth in capital and income, while allowing access to strategies that may not be available to individual shareholders. WPC’s board is responsible for hiring and monitoring the external managers, as well as 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 this year; the directors spent time with the investment and operations teams at all four external managers. Each has a dedicated ESG team, whose research is considered to be a growing part of the bottom-up stock selection processes (there is an evolving belief that companies going through a positive ESG change can generate above-average returns).

WPC’s multi-manager line-up is shown in Exhibit 3. The managers run high-conviction portfolios with active shares between 81% and 99%, which combine to 73% for WPC – active share is a measure of portfolio deviation from the benchmark, with 0% representing full index replication and 100% no commonality. Each manager may hold up to 10% of their portfolio in any one company, although in practice WPC is unlikely to have more than 5% exposure to a single company.

At end-March 2019, WPC’s top 10 holdings made up 14.8% of the portfolio compared with 17.2% at end-March 2018; six positions were common to both periods (Exhibit 1).

The trust’s geographic and sector weightings, shown in Exhibits 4 and 5, are a result of bottom-up stock selection. WPC has underweight exposure to some of the higher-growth stocks in the region, such as Alibaba, Baidu, Ctrip.com, JD.com and Tencent, as the managers have reservations about the companies’ quality and valuations. The trust’s Indian exposure has increased recently; lacklustre stock market performance in the country in 2018 provided some good investment opportunities for WPC’s specialist managers, particularly in smaller companies that are often overlooked by generalist investors. Vietnamese exposure is now up to 3% (zero weighting in the index), with four holdings, including the most recent purchase of beer producer Sabeco.

In FY19, WPC’s NAV and share price total returns of -7.4% and -10.3% respectively, trailed the benchmark’s -5.4% total return. As highlighted in Exhibit 3, three of the external managers underperformed the benchmark: Aberdeen (-0.8pp), Robeco (-1.8pp) and Dalton (-7.1pp), whereas Matthews was modestly ahead (+0.1pp). Although the newest managers Dalton and Robeco have underperformed since inception, the board has confidence in the potential of their value-based strategies to be successful over the longer term.

WPC’s NAV total return has marginally outperformed the benchmark over the last decade while underperforming over the shorter periods shown in Exhibit 8. However, in absolute terms, the trust has generated solid total returns over three, five and 10 years, with NAV gains between 9.7% and 11.4% pa and share price appreciation between 10.9% and 13.9% pa over these periods.

WPC’s current 11.0% share price discount to cum-income NAV compares with the 10.5% to 18.4% range of discounts over the last 12 months. In February 2019, the discount narrowed in response to the board’s announcement to potentially return cash to shareholders in the event of NAV underperformance versus the benchmark between end-FY19 and end-FY21. The current discount is narrower than the 13.5% to 14.5% range of average discounts over the last one, three, five and 10 years. The board repurchases shares when they are trading at a substantial and anomalous discount. During FY19, 0.9m shares were repurchased (1.3% of the end-FY18 share base) at discounts between 12% and 18%, for a cost of £2.7m; this added 0.2% to NAV.

WPC is a conventional investment trust with one class of share in issue. There are 61.9m ordinary shares outstanding. The trust is registered with the FCA as a small UK AIFM under the Alternative Investment Directive; as a result, it does not employ gearing (at end-March 2019 it held a 2.3% net cash position). WPC’s board regularly reviews this status in terms of costs versus the potential benefits of gearing. It also aims to control costs, containing ongoing charges below 1% (excluding performance fees). In FY19, ongoing charges were 1.03%, 4bp higher than 0.99% in FY18. Management fees paid to the external managers and WIS were 0.69%, 6bp higher year-on-year. External managers are paid a fee between 0.20% and 0.85% of assets under management. Aberdeen charges a lower base fee, but is eligible for an incentive fee based on performance relative to the benchmark (none paid since FY15). Effective from 1 February 2017, 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.

WPC’s external managers have no specific income targets, although Matthews does have a dividend bias to its investment approach. However, the board aims to grow WPC’s annual dividend in real terms (above the rate of UK inflation) over the long term. Regular dividends are paid twice a year in October and June. Typically, dividends are funded from revenue, but since 2013, payments may be made from capital if required. WPC has a high level of revenue reserves (£13.1m at end-FY19, excluding the final dividend, which is equivalent to c 3.0x the proposed FY19 distribution of 7.0p per share).

The 7.0p dividend proposed for FY19 (1.1x covered) is a 27.3% increase compared with the 5.5p distribution in FY18; this is significantly higher than the 1.8% rise in the UK Consumer Price Index over the period. While helped by weakness in sterling over the financial year, WPC’s higher level of revenue in FY19 was primarily due to portfolio companies paying increased dividends (supported by earnings growth), along with higher payout ratios.

WPC’s annual distributions have increased each year for the last 14 consecutive financial years. Over the last five years, WPC’s dividend has compounded at an annual rate of 9.5%. Based on its current share price, the trust offers a 2.1% dividend yield.

WPC is unique in that it is the only trust in the AIC Asia Pacific – Including Japan sector. To enable a comparison, in Exhibit 11 we show the AIC Asia Pacific – Excluding Japan sector averages; WPC’s NAV total returns lag these averages over the periods shown. We also compare WPC to open-ended funds in the IA Asia Pacific including Japan sector. The trust’s NAV total returns are behind the sector averages shown, which may partly reflect its relatively low exposure to high-growth internet stocks. WPC has a competitive dividend yield, in line with the average of the closed-end funds, and more than double the average of the open-ended funds.

WPC has five board directors, all of whom are non-executive and independent of the manager. Susan Platts-Martin joined the board in July 2014 and assumed the role of chairman in June 2017. The other four directors and their dates of appointment are: Dermot McMeekin (senior independent director, May 2012); Diane Seymour-Williams (June 2010); Andrew Robson (July 2014); and Chris Ralph (July 2017). Seymour-Williams will not be seeking re-election at the June 2019 AGM as she will have completed nine years of service. So far, there have been no plans announced regarding the search for a new director.