Rise extended
Apollo Asia Fund: the manager's report for 3Q2003

The Apollo Asia Fund's NAV rose 49% in the third quarter, to US$334.88; it is up 89% for the year to date. (Performance charts.)

At end-Sept prices, the shares in our portfolio are on an average historic PE of 13.8, and an estimated 'current-year' PE of 10.3. The figure for next year is 8.8: we have rarely given this forward figure, partly because economic uncertainties make forecasting unusually hazardous and we do not rely too much on such estimates, but do so now because (a) the one-year forward projection is that most quoted by brokers and other fund managers, and it is always unwise to compare apples with pears; (b) it illustrates that for what it is worth (not much) we are still forecasting reasonable EPS growth, of the order of 18%.

Recent gains are partly due to higher stock market valuations: the portfolio PE is as high as it has been since inception. Exuberance has returned to many of our markets with unnerving speed, given the magnitude of global imbalances and evident risks; bull markets normally climb a wall of worry but this feels more like pole-vaulting. The small-cap sector feels particularly frothy. (Brokers are putting experienced analysts onto the sector, as a sector, for the first time that I can remember - this makes more sense than traditional practice in analytical terms, and maybe even in business terms since the corporate financiers are usually visible behind, but in investment terms it is definitely a contrary indicator).

However, absolute valuations of our own portfolio suggest that, if one were part-owner of a private company with these characteristics, subject only to manic-depressive daily bids from 'Mr Market', one would not countenance selling, and it is this which has guided our decision to remain fairly fully invested (94% at end-Sept, the 6% being an opportunity cost while we dither as to which opportunities to select). Earnings yield 10% for the current year, dividend yield 3.6% after Asian taxes - Mr Market's bid is improving, but is not high enough to induce us to sell, at current interest rates: the possibility that he may not only reduce his bid but also give us an offer (and thereby allow us to buy back from him) at a lower price is too uncertain.

To put sensations of vertigo into context, rerating accounts for only half of recent portfolio gains. Our estimates of 'current year earnings per share' and of net tangible asset backing for the portfolio have risen by 40-50% over the past twelve months. A fraction of this is because we have again, on balance, sold shares with relatively high ratings to buy more attractive ones⁽¹⁾, but the EPS growth of the shares we now hold is estimated at a remarkable 34% for the current year. This is partly due to a strong recovery in the formerly bombed-out shipping sector and in some commodities. Growth hopes for next year are based not on a recurrence, but on broader consumer trends, and with luck a sustained post-SARS return to normality.

FAQ: (1) the mandate allows us to hedge, both stockmarkets and currencies, but we haven't to date, and have no immediate intentions to do so; (2) we could move heavily into cash if we thought it was the right thing to do; (3) we can invest in Japan but do not currently do so; (4) ditto gold; (5) I am wary of US$, but there is no obvious alternative in which the fund should be denominated.

Personally I think there is a good case for holding a portion of assets in (a) Japanese equities, (b) gold / gold shares, but the fund at present is fully committed to the sorts of companies which people associate with the Asia-ex-Japan growth story. Investors should therefore look after their own Japanese exposure (mine is through Morant Wright Japan Fund⁽²⁾ & Orbis), gold exposure (eg via AIMS' Phoenix Gold Fund, of which I am a director, gold accounts at Hongkong Bank, or an excuse to buy jewellery), and cash reserves. I am more comfortable with most Asian currencies as stores of value than with US$, but that isn't saying much.

Most of our activity for the quarter can be summed up as top-slicing Thailand and adding to Hong Kong, but Thailand has continued to rise more rapidly so (a) performance would have been better if we'd done nothing⁽³⁾, (b) percentage weightings are remarkably little changed - as indeed are the portfolio's top names.

Thanks to all co-investors, especially those who provide ideas and feedback on the companies and the ground realities around Asia - always welcome, but particularly so in times of such rapid change.

Claire Barnes, 4 Oct 2003

1. We have also bought some shares with very high PEs but with reasonable cashflow or growth; and we cap our exposure in Indonesia, which is cheap for good reason: the lack of legal protection (even compared to other Asian markets) makes it high-risk, as the current Ongko suit against BFI Finance and ongoing APP tragi-comedy both demonstrate.
2. Japan and gold have both seen similar surges of investment interest: "We have being saying for some time that our stocks were cheap. We should not therefore be too upset when other investors come to see stocks in this light. Nevertheless it is always slightly disconcerting when every strategist has turned uniformly bullish..." Ian Wright, Sept 03. Contact Morant Wright Management Ltd, tel +44 20 7499 9980, fax 7499 9981.
3. But even higher exposure to Thailand & individual stocks would have taken us out of the comfort zone. Expect similar 'mistakes' to recur.