Witan Pacific Investment Trust — Board enthusiastic about revised manager line-up

In an environment of robust corporate earnings growth and positive estimate revisions, Asian equities have outperformed world equities since late 2016 (Exhibit 2, LHS). However, while the forward P/E multiple of Asian stocks has increased, on a relative basis they continue to trade at a discount to world equities (Exhibit 2, RHS). The current c 10% discount is broadly in line with the average over the past five years and wider than the c 1% average discount over the past 10 years. Asia Pacific economic growth forecasts continue to outpace estimates for both world and developed markets’ output and there are an increasing number of Asian companies with improving corporate governance track records; these factors may continue to encourage positive fund flows into Asia.

WPC was launched in 1907 and aims to generate capital and income growth from a diversified portfolio of Asian (including Japanese and Australian) equities. The trust is benchmarked against the MSCI AC Asia Pacific Free index (sterling-adjusted). At end-May 2005, WPC adopted a multi-manager strategy and Witan Investment Services (WIS, a subsidiary of Witan Investment Trust) took on an executive manager role, reporting to WPC’s board. From end-May 2005 to end-January 2018, WPC generated NAV and share price average annual total returns of 10.3% and 10.5%, respectively, compared with 10.0% for the benchmark (source: WPC).

The initial external managers were Aberdeen Asset Management (50% of assets) and Nomura (50%). In April 2012, the Nomura assets were reallocated between Matthews International and Gavekal Capital. The line-up was changed in 2017, aiming to improve investment performance and to increase exposure to smaller cap or lesser-known companies. The Gavekal portfolio was liquidated and two new managers, Dalton Investments and Robeco Institutional Asset Management were appointed. At end-January 2018, WPC’s portfolio was split: Aberdeen (25%), Dalton (10%), Matthews (40%) and Robeco (25%). The trust also seeks to increase its dividend in real terms over the long term and to control costs, aiming to maintain ongoing charges below 1%.

WIS’s investment director James Hart remains constructive on the outlook for Asian equity returns. Aggregate corporate earnings growth across Asian markets in 2017 was c 9% and the consensus estimate for 2018 is for growth of a similar magnitude. Dividend increases are running ahead of earnings growth, as Asian companies are returning more cash to shareholders than historically, both as dividends and via share repurchases. While the strong performance of Asian equities over the past two years has closed the valuation gap somewhat, Hart still views them as attractively valued compared to developed market equities. Due to the positive re-rating, he expects that further Asian equity gains will be driven by earnings growth, rather than by earnings multiple expansion. However, he suggests that if there is a further broad-based positive revaluation of global equities, Asian equity multiples could expand by more than other developed markets, given their lower absolute starting point.

Hart explains that there some regional issues to consider. These include the Asian political environment, which has been pretty benign compared to the US and Europe in recent years. In Japan, despite recently winning a snap election, Prime Minister Shinzō Abe’s approval rating has declined and there are calls for him to stand down due to scandal surrounding a heavily-discounted sale of state-owned land to someone with ties to his wife. Hart also notes the construction of WPC’s benchmark with its heavy technology bias. Following a period of strong relative performance, the top four index constituents (Tencent, Samsung Electronics, Alibaba and Taiwan Semiconductor), now make up c 10% of the MSCI Asia Pacific index; hence, if there is a shift in investor focus from growth to value, these large companies could undergo a period of meaningful underperformance.

Hart reports that all of WPC’s external managers are finding attractive investment opportunities in the region. This includes Japan, which remains relatively attractively valued compared to some other Asian countries. He says that there are a lot of innovative Japanese companies with global operations, and the country is improving its corporate governance track record. China is the economic powerhouse in Asia, so it is important that its growth is maintained as the country transitions from a low-cost manufacturer to a provider of higher-quality goods and services.

WPC employs a multi-manager approach, aiming to generate capital and income growth from a portfolio of Asia Pacific equities, while diversifying risk. It is the only UK investment trust focusing on the entire region, which includes Japan, Australia and India.

The board is responsible for hiring and monitoring the external managers, as well as allocating capital between them. WPC’s directors visit Asia every two to three years, meeting existing and potential new managers. As shown in Exhibit 3, since end-September 2017, WPC has employed four managers, adopting a variety of investment styles, which offers a wide set of investment opportunities. Hart comments that the two new managers, Dalton and Robeco, are now fully bedded in. They both have a value bias, with Dalton running a concentrated portfolio of c 20 stocks, while Robeco runs a more diversified portfolio of c 70 stocks. All four managers are benchmark-agnostic and adopt a bottom-up approach to stock selection. Their portfolios have active shares between 80% and 98%, which combines to 72% for WPC. (Active share is a measure of how far a portfolio deviates from the benchmark, with 0% representing full index replication and 100% representing no commonality.) Each manager may hold up to 10% of their portfolio in any one company, while in practice WPC is unlikely to have more than 5% in a single company.

At end-March 2018, WPC’s top 10 holdings made up 17.2% of the portfolio. This was a modest decrease in concentration compared to 20.0% at end-March 2017, and five positions were common to both periods.

Hart highlights a couple of the trust’s top 20 positions: Japanese companies Nitori Holdings and ROHM Semiconductor. Nitori is a manufacturer and retailer of home furnishings with a rapid store expansion policy, which includes China and the US. Its long-term goals are 1,000 stores by 2022 and 3,000 by 2032, which compares with the current c 500. ROHM primarily manufactures high-quality integrated circuits and discrete semiconductor devices. It has a broad customer base including consumer, automotive, technology and industrial end-markets. The company is a potential beneficiary of the development of electric and autonomous vehicles.

Exhibits 4 and 5 show WPC’s geographic and sector exposures, which are a function of bottom-up stock selection, rather than being driven by benchmark allocations. The Qualified Foreign Institutional Investor (QFII) scheme allows overseas institutional investors to purchase shares in China’s ‘A’ share market (those that are traded on the two mainland Chinese stock exchanges in renminbi). Three of WPC’s managers hold a QFII licence, and the fourth is in the process of obtaining one. Over the past 12 months, the three QFII qualified managers have made carefully selected investments in China, while remaining mindful that valuations can be unattractive and there can be uncertainties about the quality of some Chinese companies. WPC also has selected holdings in frontier markets, such as Vietnam, which is developing at a rapid rate; positions include Vinamilk, which is the largest dairy company in the country. The trust has a holding in Canadian-listed mining company Turquoise Hill, whose principal asset is the Oyu Tolgoi project in Mongolia. This position illustrates that the board seeks managers that can provide differentiated investment opportunities that may not be on the radar screens of managers running larger mandates.

In FY18 (ending 31 January 2018), WPC’s NAV total return of 17.3% was narrowly behind the benchmark’s 17.9% total return. Its share price total return was 22.1%, reflected by a narrowing of the discount over the period. Positive contributors to performance were broad based, while the trust suffered from underweight exposure to internet stocks Baidu, Alibaba and Tencent, which performed very strongly. WPC has positions in Tencent and Baidu, but the managers were reluctant to invest heavily in these companies when valuations were high and corporate governance records were poor.

WPC has modestly outperformed the benchmark over 10 years, while lagging over one, three and five years. The board is enthusiastic about the changes to the trust’s multi-manager line-up, and is hopeful that WPC’s investment track record will improve as a result.

WPC’s current 14.1% share price discount to cum-income NAV is towards the high end of the range over the past 12 months (range of 10.0% to 14.8%). It is modestly wider than the averages of the past one, three and five years of 13.0%, 13.5% and 13.0%, respectively. The trust’s board repurchases shares when they are trading at a substantial and anomalous discount. During FY18, 1.8m shares (c 3% of shares outstanding) were repurchased at discounts between 11% and 17%. This added 1.53p per share to NAV.

WPC is a conventional investment trust with one class of share in issue. There are currently 63.2m 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. 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 FY18, ongoing charges were 0.99%, which was a 4bp decrease versus FY17. Management fees paid to the external managers and WIS were 0.63% compared with 0.65% in FY17. External managers are paid a fee ranging 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 (although none have been paid since FY15). With effect from 1 February 2017, management fees are charged 75% to the capital account and 25% to the revenue account, rather than 100% to revenue. This reflects the board’s expectation for the long-term split of WPC’s returns between capital and income.

Although Matthews has a dividend bias, WPC’s external managers have no specific income targets. However, the board aims to grow the annual distribution over the long term at a rate higher than UK inflation. Regular dividends are paid twice a year in June and October. The 5.50p FY18 dividend is 15.8% higher than 4.75p paid out in FY17, and growing much faster than the 5.1% five-year compound annual growth rate. The larger FY18 dividend was due to higher dividend payments from portfolio companies, and was helped by the change in the allocation of management fees highlighted above. In FY18, the dividend was more than covered by income and, at end-January 2018, the trust had a revenue reserve of £11.8m, which is more than three times the FY18 annual dividend payment. WPC’s regular annual dividend has now increased for 13 consecutive years. Its current yield is 1.7%.

WPC is the only trust in the AIC Asia Pacific – Including Japan sector, so in Exhibit 10, we compare it to the AIC Asia Pacific – Excluding Japan sector averages. Its 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. Its NAV total returns are behind the averages shown, which may reflect an underlying value bias. WPC has a competitive cost structure, with ongoing charges now below 1.0%, which is meaningfully lower than the averages of both the closed- and open-ended funds shown.

There are five members on WPC’s board; all are non-executive and independent of the manager. Chairman Susan Platts-Martin was appointed in July 2014 and assumed her current role in June 2017. The other four directors and their dates of appointment are: Diane Seymour-Williams (June 2010), Dermot McMeekin (May 2012), Andrew Robson (July 2014) and Chris Ralph (July 2017).