Invesco Asia Trust — Conviction pays off

Following a volatile 2022, IAT’s team started 2023 on an upbeat note. Although Asia ex-Japan equity markets have rebounded strongly from their 2022 lows, valuation measures for the region remain below their long-term historic averages. In this environment, Invesco’s portfolio management team (Invesco is the investment manager of IAT) sees multiple attractive investment opportunities, particularly given the continued divergence between Asia-Pacific countries and sectors.

The team was optimistic about Asian economies and financial markets at the start of 2022, but the war in Ukraine (which started on 24 February 2022) increased other geopolitical risks (particularly relations between China and Taiwan) and changed Invesco’s outlook for 2022 to a more cautious one. Caution remained until the Chinese government implemented several significant policy changes during Q422 and into the start of 2023. Specifically, the country abandoned its zero-COVID-19 policy, supported the property sector and registered a pick-up in pro-growth policies, with what Invesco views as signs of a more benign regulatory environment for large internet companies.

Consensus earnings growth estimates for 2023 have been downgraded to what Invesco believes are more reasonable levels. Although there is a risk that developed market demand for Asian exports declines, the investment team considers domestic consumption from China’s reopening to be a potential offset. Invesco states that for China, a fundamental improvement in the outlook for corporate earnings means that there is scope for positive surprises, which would validate a re-rating of the still deeply discounted equity market. The rest of Asia should be a greater relative beneficiary of China’s reopening compared to other regions and may see less earnings vulnerability from the global slowdown, relative to expectations and what is being implied by Chinese companies’ valuations.

Exhibit 1 illustrates that Asia continues to trade at a significant discount to the MSCI World Index, which is still dominated by developed markets (c 85% of the index), particularly the United States (c 68% of the index). Invesco believes there is scope for this to narrow, with the strength of the US dollar challenged by a likely recession in the United States as the Federal Reserve seeks to root out inflation. The team observes that inflationary pressures in Asia are less of a concern, suggesting greater policy flexibility, which should also be supportive for economic growth in the region and its financial markets. Overall, Invesco currently considers Asia a more attractive place to invest than developed markets.

Despite ongoing concerns about US/China tensions, particularly over Taiwan, the managers believe that China will be doing everything it can to avoid targeted sanctions from the United States and Europe. According to Invesco, China’s chief priority remains GDP growth support and the country remains dependent on Taiwan for high-end technology and semiconductors and will continue to do so for the foreseeable future.

At end-January 2023, the portfolio had 58 holdings, in line with its 50–60 target range (56 at end-February 2022). Exhibit 2 shows the fund’s exposures by country at end-January 2023 and illustrates its differentiation from the benchmark MSCI AC Asia ex-Japan Index.

The largest weighting in the portfolio at 49.3% (at end-January 2023) is to Hong Kong and China. The previously underweight position (of c 8.0pp) the company had two years ago has gradually been reduced to a mid-single-digit overweight position, +5.1pp over the index (44.2%), reflecting the managers’ view that investment risk now appears to be better rewarded. They are comfortable with their current positioning in China given that the recent period of regulatory tightening appears to be over, while China is at the start of an easing cycle, in contrast to developed markets where policy is being tightened. Given IAT’s strategy to populate the portfolio with undervalued companies, the shift in exposure towards China also reflects the managers’ confidence in the valuation opportunity in selected Chinese equities. The appetite to increase the overweight position in China further is limited by the geopolitical risks that remain within the region.

The other three notable overweight positions are Indonesia, Australia and South Korea. The largest underweights are in India and Taiwan. The managers have reduced the exposure to Taiwan given the holdings’ strong performance, particularly within the technology sector, and reinvested profits elsewhere, notably into China, Indonesia, South Korea and Australia.

Over the past 12 months the managers exploited the volatility of the Chinese stock market by adding to selected companies when the market was down, including Ming Yang Smart Energy, JD.com and Sands China, then taking some profits following a period of strong performance.

The team bought Inner Mongolia Yili, a China-listed dairy producer with an improving branding and consumer service capability, which is likely to drive sales growth and support a recovery in earnings over the medium term. The managers consider the company’s valuation to be attractive, with the stock trading on a 2023 P/E of around 14x, below its long-term average.

Another recent addition to the portfolio is Will Semiconductor (Will Semi), a Chinese company that engages in the R&D and design of semiconductor devices. The stock has performed poorly recently due to the downturn in the Chinese smartphone cycle. While the managers believe that earnings may continue to face headwinds in the near term, the longer-term outlook is more positive with the company expected to benefit from growth drivers such as auto contact image sensors, where Will Semi has a 40% market share.

The team also bought China MeiDong Auto, an auto dealership that is benefiting from China’s reopening. Despite potential disruption from the transition to electric vehicles (EVs; it has more exposure to internal combustion engine than EVs), the managers remain comfortable given the tilt of its business towards luxury cars, where brand remains essential and foreign brands like Porsche are still competitive. China MeiDong is actively exploring and formulating a strategy to operate dealerships in a future of EVs, with its first Tesla aftersales centre opening around Chinese New Year 2023. Although the shares have risen by c 90% since November 2022, the managers believe that trading on a 2023 P/E of 16x, they still provide an attractive risk-reward versus a five-year historical average of 20x.

The managers reduced their position in Sands China, the Macau casino operator, as the share price rebounded strongly following the country’s reopening, and the managers took some profits.

The managers sold holdings in Dongfeng Motor, Hon Hai Precision Industry and Samsonite, a luggage manufacturer. Samsonite is sensitive to the reopening in China, but also to developed markets, where demand is likely to stall, so the managers decided to exit the position.

The team reduced its exposure to India, as shares of holdings (such as Mahindra & Mahindra and ICICI Bank) performed strongly, but India is an area where the managers remain positive.

The managers maintain selected, sizable positions in the technology sector, notably in South Korean and Taiwanese companies, and are optimistic about their prospects, favouring companies within the semiconductor and specialised parts space (TSMC and Samsung Electronics are both top 10 holdings, Exhibit 3). In Q322 the team added to the position in SK Hynix, a South Korean memory chip manufacturer, at what they believe is an attractive price, as the Korean stock market remained depressed during that period, due to general macroeconomic concerns.

IAT has consistently outperformed the benchmark over the longer term, including three, five and 10 years, as shown in Exhibit 4. Despite a difficult year for financial markets thus far, IAT’s NAV TR has outperformed the MSCI AC Asia ex-Japan benchmark.

Stock selection in China was a key positive contributor to the last six months’ TR (to end-February 2023). As the Chinese market rebounded, IAT’s internet, property and auto related stocks performed strongly. Financial sector holdings were big contributors to the performance over the last 12 months. These included banks (Indian ICICI Bank, Singaporean United Overseas Bank and PT Bank Negara Indonesia (Persero)), and insurance companies, such as Hong Kong listed AIA Group, Australian QBE Insurance and Ping An Insurance in China, also performed strongly.

Stock selection in India also added value. Mahindra & Mahindra’s share price hit record highs as market share gains in sport utility vehicles and a cyclical recovery in light commercial vehicles helped drive profit growth, with its tractor business also expected to enjoy a recovery in 2023. The portfolio’s exposure to Indonesia contributed positively to performance, with PT Bank Negara Indonesia (Persero) the biggest single contributor, and Astra International and Telkom Indonesia also performing strongly.

IAT’s underweight position in the technology sector benefited performance relative to the benchmark. The five-year discrete performance data in Exhibit 5 illustrate the visible relative performance advantage over the 12 months to end February 2022, when during sell offs of companies listed in China the portfolio’s avoidance of highly valued, high-growth stocks meant it was more defensive than the MSCI AC Asia ex-Japan Index and also the MSCI China All Shares Index.

In Exhibits 6 and 7 we present performance and other metrics relative to peers. IAT exhibits a strong relative performance against its Asia Pacific equity income sector peer group of five funds and also country specialist funds within Asia. This strong relative performance is complemented by a competitive yield of c 4.4%.

2022 was a challenging year for global equities, and in Asia, for Chinese equities in particular. By the start of 2022 the managers had repositioned the portfolio more towards Chinese equities, which had fallen out of favour during 2021, eliminating the China underweight position. Although during the volatile months of September and October 2022 holding an overweight position in China was uncomfortable, the managers kept to their conviction and were rewarded when Chinese equities rallied between December 2022 and January 2023. As shown in Exhibit 7, IAT ranks second over one year on an NAV TR basis, following Pacific Assets, which has typically had a large overweight position in India, the market that has outperformed in the past couple years within Asia. IAT also ranks third over 10 years, following Pacific Assets and Pacific Horizon, which has performed very strongly over the long term, with exposure to high-growth names. Despite the volatility of Chinese markets over the past 12 months, IAT’s balanced positioning, gradual building of its slightly overweight position in Chinese names versus the benchmark, and the market rotation from growth to value have all been reflected in IAT’s robust performance relative to peers.

Over five years IAT ranks fourth by NAV TR, in its Asia Pacific country specialist peer group, lagging its growth-focused peers. We believe this is to be expected, given that growth names were outperforming for a number of years prior to 2021, when the market switched more into value names, while IAT’s balanced approach between growth and value meant it did not participate as fully on a relative basis in the growth stock momentum over that period.

The Association of Investment Companies moved IAT from the Asia Pacific sector into the Asia Pacific equity income sector in 2020. Considering the board’s initiative in August 2020 to introduce a regular six-monthly dividend equivalent to 2% of NAV, we believe the reclassification is justified.

Launched in 1995, IAT aims to provide long-term capital growth through investing in a well-diversified portfolio of companies listed in Asia. Invesco has managed IAT since its first day of trading on 11 July 1995, as IAT became one of two successor companies to Drayton Far Eastern investment trust. The benchmark is the MSCI AC Asia ex-Japan Index (the MSCI Asia Pacific ex-Japan Index prior to 2015), reflecting the trust’s primary focus on Asia and persistently low exposure to Australasia. The approach is team based, bottom up and valuation focused. The portfolio of c 50–60 stocks represent the manager’s highest-conviction investment ideas.

The fund managers, Ian Hargreaves and Fiona Yang, aim to outperform the market over three- to five-year rolling periods, following a bottom-up, contrarian approach. They look to buy companies with strong fundamentals, but that are ‘unloved’ by the market and trading at a significant discount, and the team targets a double-digit annualised return from each portfolio stock. IAT enhanced its dividend policy in 2020 and income will continue to contribute materially to NAV and share price TRs. The board targets a dividend yield of 4% of NAV per year. Gearing is permitted up to 25% of net assets.

The board is chaired by Neil Rogan and consists of four directors. Vanessa Donegan is the senior independent director and chairman of the remuneration committee. The board appointed Sonya Huen Rogerson as a non-executive director on 26 July 2022 with immediate effect. As indicated in November 2021, Fleur Meijs stepped down from the board on 2 August 2022. Myriam Madden, who joined the board on 4 November 2021, took over from Fleur as audit chair. Owen Jonathan, the senior independent director, retired at the annual general meeting (AGM) in September 2022 after serving nine full years.