Risk warnings still in force
Apollo Asia Fund: the manager's report for 1Q2004

The Apollo Asia Fund followed eleven monthly increases with a slight fall in March. Overall, NAV rose 6% in the first quarter, closing at US$455.44. The last twelve months have seen swings of sentiment extraordinary even by Asian standards. A year ago, SARS was causing widespread panic and despondency, and I remember being told in all seriousness that "this is the end of Hong Kong". Since then property, commodity prices and stockmarkets have rebounded vigorously, fuelled by the US printing press, and the Fund's NAV is up 158%. (Performance charts.)

Not all of this has been due to rerating. 'Current-year portfolio earnings per share' are up 39% over the period. 'Portfolio book value per share' is up 57%; 'portfolio dividends per share' are up 86%. (Our terminology has been explained in previous quarterlies.) Portfolio shifts have boosted these figures, which outpace the growth we would have seen in a static portfolio, but it has usually been thus - although there are fewer overlooked backwaters and gems following the markets' rise, and we expect it to be more difficult to generate excess returns in future.

Rerating has certainly played a part. The estimated current-year PE of our ordinary share portfolio is 11.8, the net dividend yield 4.6%, and price/book is 1.9. These sound reasonably attractive - and we believe they are sufficiently so, given the quality and growth potential of the companies - but the figures a year ago were 6.4, 6.4%, and 1.2 respectively. The portfolio PE has rarely been much above 8 since inception, and the average has been 6.6.

Market-average valuations remain more expensive than our portfolio averages, but many of our companies are relatively small and illiquid. A discount is appropriate for such companies because of the difficulty of extrication in the event of a change of view - let alone investor disillusionment, which may cause markets to become one-way. Quality remains paramount, and we do not chase valuation: Korea and China have many shares on low PE's which are cheap for good reason. Management integrity, and forecastable cash flow to shareholders, remain paramount considerations. We do make mistakes (many), but try to recognise them early.

As regards international market conditions, risks and relative safe havens, I can add little to my comments of three months ago. Asian markets continue to look relatively safe, and attractively valued, relative to the US and Europe. Huge fund inflows have been driving the markets, and will continue to do so until halted by either the rapidly-increasing supply of new securities, or some major shock. The critical shock often turns out to be unexpected, but the obvious candidates include US bond, property and stockmarkets and the US dollar.

China's attempts to engineer a soft landing have been widely covered. The deterioration in Asia's terms of trade has been less discussed. Prices of commodities, freight, and euro-priced services have risen dramatically: meanwhile exports have been booming, but mostly through ever-increasing volumes. Pricing power is back in parts of domestic Asia - residential property, some top hotels and resorts, some luxury goods - but there is little evidence of pricing power for most of Asia's manufactured goods.

Shipping shares, which contributed greatly to last year's performance, have all now been sold. Boom conditions continue, but are now widely recognised. It is possible that present prices will be justified, but the risks are harder to justify. We started selling at a fraction of current prices - which was premature not only in the light of subsequent freight rates and investor interest but, for Thoresen Thai, in terms of subsequent enhancements to intrinsic shareholder value achieved through capital raising by alert management. The last holdings were sold at close to peak levels.

CLP Holdings has risen 30% in less than six months. Utilities and perceived 'safe havens' have recently been performing well, as many traditional investors in the region share our concerns as to global risks. This is often a danger sign. CLP is less overlooked than when we first moved into then-deeply-unfashionable stodgies, but on a historic PE of 14 and yield of 4.6% it is not evidently expensive. The present HK scheme of control runs until Sept 2008 and there are concerns that its replacement may be less profitable, but as absolute-return investors we think this still justifies a place in the portfolio.

The views of our well-informed investors on this and other subjects are most welcome, and have in the past been invaluable. My thanks and best wishes.

Claire Barnes, 4 Apr 2004