Witan Pacific Investment Trust — Multi-manager Asia-Pacific/Japan investment

As shown in Exhibit 2 (right-hand side), the valuation of Asian equities remains attractive relative to global equities. The Datastream Asia Index forward P/E multiple of 13.7x is currently at a 12.4% discount to world equities, which is wider than the 9.0% average of the last five years. The IMF’s forecast is for above-average economic growth in Asia over the medium term, driven by factors such as a high standard of education, a rising middle class and relatively low levels of debt. For investors wanting broader exposure to the region, a fund that has an unconstrained, multi-manager approach may be of interest.

WPC was launched in 1907 as General Investors and Trustees, which invested in a broad range of assets. In 1975, it merged with City and Gracechurch Investment Trust, and in 1984 was renamed F&C Pacific Investment Trust, reflecting a new Asia-Pacific investment policy. In 2005, the trust adopted a multi-manager approach, Witan Investment Services (WIS, a subsidiary of Witan Investment Trust) took on an executive manager role reporting directly to the WPC board and the name of the trust was changed to Witan Pacific Investment Trust.

The trust aims to generate long-term growth in capital and income from a broad range of Asian assets (primarily equities). Under the multi-manager strategy, funds were initially allocated equally to Aberdeen Asset Management and Nomura. In April 2012, the Nomura funds were reallocated to Matthews International and GaveKal Capital. WPC is the only UK investment trust with a broad Asia-Pacific mandate that includes Japan and Australia; it is benchmarked against the MSCI AC Asia Pacific Free Index (sterling-adjusted).

We met with manager James Hart from WPC’s executive manager WIS, who shared his views on the current macro environment and key messages that he and the board gleaned from their visit to Asia in February 2017. Hart observes that investors often focus on political events, which can create stock market volatility, especially in Asia, but that long-term returns are driven by economic growth and corporate earnings. He does, however, point to positive political developments in South Korea, where Moon Jae-in was recently elected as president after the impeachment of his predecessor. Moon wants to tackle corruption at the state and government level and address the chaebols’ (family-owned conglomerates) business dominance. He also wishes to implement corporate reforms and protection for the rights of shareholders.

Hart considers that Asian equities are attractively valued and views Asia as a more attractive investment opportunity than many Western equity markets. He notes that Asian corporate earnings are starting to recover after a lean period and that there has been a small increase in positive estimate revisions. If economic growth picks up, Hart believes that it will be positive for equities, unless there is dislocation in the bond market.

Regarding Japan, Hart suggests there are signs of life in the country following unprecedented fiscal stimulus. He says that there are indications of a slight improvement in GDP along with some signs of inflation, which is essential for a sustained recovery. Although there have been false starts in the past, this time round Hart suggests that there is a growing feeling that Japan could be starting to turn the corner after nearly three decades in the wilderness, and is no longer the “sick man of Asia”. He says that investors need to be selective when picking stocks in Japan as no two companies will benefit equally from any economic recovery. Matthews is buying Japanese banks, having not owned them for a while, as it believes that there is normalisation in the economic environment.

WPC employs a multi-manager strategy, seeking to generate capital and income and to diversify risk, while outperforming the benchmark MSCI AC Asia Pacific Free Index. The managers are able to invest across the Asian region including Japan and Australia. The board considers that income growth is very important given WPC’s high percentage of individual shareholders. It is responsible for hiring and monitoring external managers as well as reallocating capital between managers. The board visits Asia regularly (every two to three years) to meet with existing and potential new managers (the most recent trip was February 2017). There have been no manager changes or asset reallocations since 2012, but the line-up is under constant review; any change in manager is more likely to be the result of structural changes, rather than due to a period of underperformance.

All three managers are benchmark agnostic. They have active shares of between 80% and 90%, which combines to 75% for WPC. (Active share is a measure of how far a portfolio deviates from the benchmark, with 0% representing full replication of the index and 100% representing no commonality between the portfolio and the benchmark.) Each manager holds between 5% and 30% of their portfolios in non-index stocks.

At end-April 2017, WPC’s top 10 positions comprised 19.6% of the portfolio (Exhibit 1), a modest increase in concentration versus 18.1% at end-April 2016. The structure of the portfolio on a geographic basis (Exhibit 4) remains similar to our last published note in December 2016. WPC has significant underweight exposure to Japan and Australia, with meaningful overweight exposure to Singapore. Sector weights (Exhibit 5) are also broadly comparable to six months ago. Earnings growth in WPC’s portfolio is modestly higher than in the wider Asian region. Consensus earnings growth for the portfolio is running in the low- to mid-teens, which is higher than in November 2016 (9.5-10.0%). The manager says that forecast dividend growth of 9% is also higher than it has been for some time and is above the market’s dividend growth.

Hart highlights a couple of the major holdings in the portfolio: HSBC and Minth. HSBC (trading on a price-to-book multiple of 1.1x) is the third largest holding and is owned by two of the managers, who view the investment as a way to benefit from a pick-up in regional activity and global growth. WPC’s overall exposure to banks has increased recently as fears of a deflationary environment have diminished. The managers consider that the banking sector is still trading on an attractive valuation despite bank share price recoveries in late 2016.

Minth is WPC’s sixth largest holding. It is a Chinese auto parts manufacturer; core products include trims, decorative parts and body structural parts. More than 60% of Minth’s revenues are generated in the domestic market, although it supplies 80% of global auto manufacturers. In 2016, 24m cars were purchased in China, which was an 18% increase versus the prior year; almost all were produced locally. Consensus estimates for Minth’s 2017 revenue and earnings growth are 18% and 19%, respectively, and it is trading on a forward P/E multiple of c 14x. Its share price pulled back following recent concerns about US protectionism and the board restructuring, but has since rallied.

In FY17 (to end-January 2017), WPC’s NAV total return of 30.7% compared to the benchmark total return of 35.3% (the decline in sterling, particularly following the result of the UK’s European referendum, significantly boosted absolute returns for sterling-based investors). The managers outperformed the benchmark in H117, but H217 performance was affected by major sentiment shifts in global stock markets on the back of macro events, such as the election of US President Trump; cyclical and value stocks led the market, while quality growth stocks underperformed. However, Hart points out that much of this volatility has already subsided and notes that WPC has outperformed the benchmark in eight out of 12 financial years since adopting a multi-manager approach. Its NAV total return over this period is 195.8%, which compares to 183.1% for the benchmark. Hart comments that so far in FY18, all three external managers are outperforming the benchmark.

As shown in Exhibit 7, WPC’s NAV total return is ahead of the benchmark over 10 years, but lower over one, three and five years, while its share price total return is ahead over all periods. Of interest to UK investors, both WPC’s share price and NAV total returns are ahead of the FTSE ALL-Share Index over one, three, five and 10 years.

WPC’s current 12.0% share price discount to cum-income NAV is narrower than the 14.1% average discount of the last 12 months (range of 10.7% to 18.3%). It is also narrower than the averages of the last three, five and 10 years of 13.3%, 13.5% and 14.9%, respectively.

The board considers it is in shareholders’ interest to repurchase shares when they are trading at a substantial and anomalous discount to NAV. During FY17, WPC repurchased 0.7m shares at a cost of £1.8m. Repurchases have since accelerated (see Exhibit 1); in FY18 to date, 1.6m shares have been repurchased at a cost of £4.6m (average price of 299.8p); this represents 2.4% of the shares outstanding at end-FY17. Given WPC’s high absolute NAV return in FY17, which was boosted by the weakness of sterling, the higher pace of share repurchases has not reduced WPC’s asset base to a meaningful extent.

WPC is a conventional investment trust with one class of share in issue. There are currently 63.5m 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. The manager suggests that if employed in the future, gearing should be in a range of 5-10% to be meaningful. He notes that while it is currently possible to borrow money cheaply, this benefit must be considered against the inherent risk of volatility in Asian stock markets and if employed should therefore not be excessive. One of the trust’s objectives is to contain ongoing charges at 1.0% of net assets pa (excluding performance fees). In FY17, ongoing charges were 1.03%, which was a 2bp decrease versus the prior year (no performance fee has been paid since FY15). Management fees paid to the external managers and WIS were 0.65%. Aberdeen charges a lower base fee than the other managers, but is eligible for a performance fee based on performance relative to the benchmark.

The external managers have no specific income targets (although Matthews has a dividend mandate), but WPC pays regular dividends twice a year in June and October. The board aims to grow the annual dividend at a rate higher than the rate of UK inflation. Over the last five years, WPC’s dividend has compounded at an annual rate of 3.5% and ordinary annual dividends have increased for 12 consecutive years. The FY17 annual dividend of 4.75p was a 2.2% increase versus the prior year; it was 93% covered by revenue. The trust has a remaining revenue reserve of £10.7m, which is c 3.5x the FY17 annual dividend payment.

WPC is the only company in the AIC Asia Pacific including Japan sector so in Exhibit 10 we compare it to the weighted average of the AIC Asia Pacific excluding Japan sector. Historical peers such as Martin Currie Asia Unconstrained (formerly Martin Currie Pacific) no longer invest in Japan. WPC’s NAV total returns have lagged over the periods shown; a contributing factor to its weaker longer-term performance has been its significant exposure to Japan, which underperformed the Asia ex-Japan region from 1990 to 2010. WPC has a wider discount than the Asia Pacific ex-Japan sector average, a meaningfully lower ongoing charge and a lower dividend yield. We also compare WPC to open-ended funds in the IA Asia Pacific including Japan sector; its NAV total returns have lagged the sector averages over the periods shown.

There are five members on the board of WPC, all of whom are non-executive and independent of the manager. Chairman Sarah Bates was appointed in January 2004 and assumed her current role in June 2014. She has announced her intention to retire at the June 2017 AGM and will be replaced by Susan Platts-Martin (appointed July 2014), who has a background in investment including several years as head of investment trusts at Fidelity International. Platts-Martin is currently on the board of BlackRock Smaller Companies Trust and the Targeted Return Fund. The other board members are: Dermot McMeekin, senior independent director, appointed in May 2012; Diane Seymour-Williams, appointed in June 2010; and Andrew Robson, appointed in July 2014. The board is in the process of recruiting another director.