The Apollo Asia Fund's NAV rose 7.1% in the third quarter, and 29.7% over the twelve months to September, closing at a new high of US$880.16.
As in the second quarter, the regional index rose faster. Price charts of the racier stocks induce vertigo: we own none of Asia's highest fliers, and many of our holdings have failed to participate at all. A few have, and we have started selling into the strength. Of our holdings, three have hit a current-year PE of 28. They are much better companies than some of those at PEs of 40, 80 and above, but nevertheless these three are amongst those we've been trimming. Most stocks we sell go on to new highs, so this activity has reinforced the 1Q report's case for long holidays - and in accordance with one shareholder's request I shall be taking another fortnight soon.
The 2Q report came from a fully-invested bear, worrying about the consequences of extraordinary risk-taking but uncertain as to the timing & speed of adjustment. Credit market conditions changed dramatically in the third quarter, and the adjustments over the next few years will in my view be far-reaching; the equity market merely dipped and rebounded, but I believe that the risk-reward ratio has deteriorated significantly. We were selective buyers in mid-August, but have been sellers since: cash is now 17% of assets.
by listing; 28 Sep 07
% of assets
|Net cash & receivables|
The credit market troubles appear remote to many Asian investors, distracted by bull markets in many areas and helped by a lack of news on significant local casualties. This may be a matter of time. One Hong Kong company we visited on 7 Sept, after a month in which risk awareness might be assumed to have risen, surprised us by explaining cheerfully that its management of cash reserves, hitherto conservative, had just been "outsourced to a financial advisor" with a view to generating 1-2% over LIBOR. Cash-rich Asian companies and individuals must now be prime targets of investment bankers seeking to place paper unwanted elsewhere; some can be seduced by the supposed glamour of having graduated to the client list of a US or European bank.*
My assumption is that the housing markets and credit bubble in the US, UK & several other major consumer markets have passed a tipping point and that past rates of credit creation cannot continue; that this will affect spending in those economies and hence Asian exports; that Asian economies are not decoupled (indeed, they are more export-dependent than ever); and that Asian earnings may disappoint. Inflationary pressures (labour, energy, freight, food and other commodities, environmental costs) are rising; pricing power is far from universal; and earnings quality is deteriorating with a growing contribution from stockmarket and property gains and/or dependence on highly-priced equity issues. Rating contraction from today's heights could be savage. The fund is therefore cautiously positioned.
Bulls are arguing that emerging markets are the next bubble. Chris Wood of CLSA, for example, says "rising local investor participation is what is needed to turn Asia from a fundamental-driven rerating story to a red-blooded bull market where greed increasingly drives sentiment" (Greed & Fear, 4 Oct). But are we not there already? New-era cases have been honed to rhetorical perfection, as always after a long bull run, when newcomers are key to momentum, cautionary tales are receding into history, and a price-earnings spiral has been set in motion (issue of highly-priced shares generates EPS growth which "justifies" a higher PE, allowing more issuance...). I am a secular bull, but in the past it has been a mistake to forget the cycles: investors focussed only on the far horizon may fall into the ha-ha. Timing is another matter, but present euphoria is already unnerving, as are company-specific valuations. (Overall market PEs sound reasonable, but may be misleading due to cyclicals and accounting issues.)
I remain convinced of the long-term merits of our Asian holdings, but unconvinced that we could at present add any value by hedging; individual investors may wish to hedge, but the Fund is unhedged, as is my own holding in the Fund. If the bull market continues without significant intervening disruption, investors should not expect us to keep pace: our steadily-managed consumer plays are not preferred bull fodder. We hope they are safer, but that is a judgment on intrinsic value, riskiness, and risk-control of the underlying businesses, and not on short-term share price movements. If havoc resumes, NAV of the Fund may decline as fast as others; but we'll happily resume our preferred activity of purchasing good companies at prices with which we are comfortable.
Constructive feedback and ideas will, as ever, be much appreciated.
Claire Barnes, 8 Oct 2007
* Accounting note from the following day: A personal request to HSBC to place a time deposit was countered with the recommendation to choose a 'structured deposit' at a few basis points more; the bank officer said that the only difference was the lack of a break clause. A request for a term sheet was apparently unusual, but a one-pager was found. The product terms were unclear, leaving details to be found on a website, but the tiniest of small print (so small that many people would be physically unable to read it) mentioned that capital might not be recovered. The bank officer was unaware of this slight drawback. Banks worldwide are now pushing such products, and consumer watchdogs in Asia have few teeth, but if the bank is offering a speculative product gambling on FX or indices and calls it a "deposit", can company accountants reasonably call these "bank deposits"?
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