Apollo in wonderland
Apollo Asia Fund: the manager's report for 2Q2003

The Apollo Asia Fund's NAV rose 27.3% in the second quarter, to US$224.66. Over the last twelve months, NAV is up by 32%, which matches the compound growth since inception. (Performance charts.)

At end-June prices, the shares in our portfolio are on an average historic PE of 9.5, and an estimated 'current-year' PE of 7.6. From this you may deduce that portfolio EPS growth is forecast at 25%; this arises from a combination of relatively subdued post-SARS assumptions for many companies with spectacular jumps for a few (eg shippers and some commodity companies, and those benefitting from falling debt or interest rates). Inverting the PE, the earnings yield is estimated at 13% for the current year, with a net dividend yield of 5.6% after Asian taxes. Price-to-book is about 1.5. While economic and business conditions remain very uncertain, and the forecasts accordingly vulnerable to disappointment, such numbers remain attractive in absolute terms, especially as we own companies which we believe to be stronger and better-managed than most of their peers.

However, small-cap stocks around the region have experienced a major rerating, often to valuations at which history gives pause for thought, and on all valuation parameters the portfolio is as expensive as it has been since inception. A sharp setback must be a possibility; as ever, the timing is hard or impossible to predict. Would-be investors are requested to consider their tolerance for markdowns of the order of 50%. We will attempt to avoid major losses in 'intrinsic value', meaning the whole-business valuations of the underlying companies, but that cannot be measured with such precision. Accordingly it will comfort only those investors who understand that this seductive precision of daily market valuation is an illusion.

Reading the world news is becoming ever more surreal, in financial matters as in politics. The hype and spin from the financial industry and mainstream media roll on, blithely disconnected from the evidence of gross macroeconomic excess and imbalance, never mentioning risks and casualties. Most individuals assume, based on longevity and the complacency of others, that the core institutions of both finance and society are sound, ignoring proliferating evidence that many are not. Savers detest today's low interest rates, and are vulnerable to the growing variety of complex structured products being offered in Asia and Europe by mainstream banks, with grossly inadequate explanation of the risks. (Whether banking regulators are keeping up with the risks to the banks themselves would be another interesting subject, but not for this report.) The charge into emerging market debt, including that of some remarkably low-quality Indonesian companies, should be ringing some alarm bells (especially with those who own money market and bond funds), but memories are short. This will end badly; such embracing of risk, and enthusiasm for financial instruments, reflect the tail end of a mania, and one which in many respects was off the scale of all past manias. Bill Fleckenstein observed this week that "... many people fail to understand that we had a bubble, and that it has created long-lasting, unavoidable repercussions. They can say the words, 'We had a bubble', but they never get beyond that to accept the implications."

To sum up that section, I remain very nervous of global macro instability, emanating especially from the US, and of the consequent shock to Asian export demand and financial markets.

In Southeast Asia, the political situation in Burma and Aceh is deeply depressing, and the quick-fix expediency of the present Thai government disconcerting. This is all made much more dangerous by the breakdown in international expectations for the behaviour of civilised countries caused by US military actions and the perception of utter hypocrisy in its civilian disputes. (Take Vietnamese catfish, for one of many regional examples, which individually and cumulatively rankle.)

A report on 2Q03 should, I suppose, mention SARS, an economic and psychological shock not widely imagined beforehand. The disease and the panic have both receded almost as rapidly as they surged, leaving a bad dent in current-year profits and a lingering impact on willingness to travel, along with a more constructive reassessment of domestic spending priorities in countries such as China. Disease specialists fear seasonal recurrence, but if so this will be a global problem, so I see no need to fear it as an Asian risk. The panic was illuminating; as a Hong Kong friend asked, 'What will people do in a real emergency?'

Deutsche Securities hosted an interesting conference this week on Malaysian oil & gas service companies. It was disconcerting to hear fund managers and companies referring to the sector approvingly as 'the new dotcom', and irritating to see newly-listed conglomerates trading on PEs of 25 when we were so recently forced out of our excellent oil-support company Bumi Armada at one quarter of that rating. The distinction between good corporate governance (a culture) and bureaucracy (what regulators impose instead, counterproductively) is relevant in many countries but has been particularly vexing us recently in Malaysia and Hong Kong.

Thai stocks remain by far the largest group in our portfolio, and the percentage has grown over the quarter, even though we have been trimming Thai positions and adding to Hong Kong & China shares. So far we would have been better off to do nothing, since Thailand has been surging in spectacular fashion, but we expect to continue this gradual rebalancing. The process is however driven from the bottom up, as individual shares appreciate beyond fair value or other more attractive ideas are found. The Thai market's rise has been somewhat too rapid for comfort, but it is in a virtuous circle of falling interest rates and rising confidence, and absolute valuations are still justifiable.

A sharp setback in most stockmarkets would be no surprise, but given Asia's economic flexibility and high savings, plus much lower pension and litigation risks than the US & Europe, and the relatively recent elimination of some excesses, the region may have merit as a least-unsafe home for long-term investment. The global stampede from cash into riskier instruments will end, but we hesitate to predict timing. Given the valuation parameters of our specific portfolio, we remain fairly fully invested.

Ideas and feedback are always welcome, and especially so in these complex times. Thanks to all co-investors.

Claire Barnes, 4 Jul 2003