Apollo Investment Management

The case for long holidays
Apollo Asia Fund: the manager's report for 1Q2007

The Apollo Asia Fund's NAV rose 4.2% in the first quarter, and 14.2% over the twelve months to March, closing at a new high of US$771.07.

The last three months have been relatively peaceful, since the Thai government eased up on market-shaking announcements after mid-January. Political confidence has yet to be restored, but silence sufficed for a clawback of January's losses, and for the quarter as a whole the market value of our Thai holdings rose fractionally.

That Thailand remains our biggest geographical weighting seems anomalous. This is partly because the investment process is bottom-up, so we see no reason to sell out of a well-run business merely because of bad government. (Where then could one invest?) Another factor is that we have been categorising by primary listing. We should perhaps change this to show the location of corporate headquarters, which would reduce the apparent importance of Singapore. 40% of the securities in the portfolio (37% of assets) are in businesses effectively headquartered in Hong Kong and China. (However their registered offices may be on the other side of the planet, and if a single key executive moves... this could all become too subjective. Since the geographical mix of the underlying businesses is even more debatable, we should perhaps let sleeping table-formats lie.)

Geographical breakdown
by listing; 31 Mar07
% of assets
Hong Kong
Other equities
Net cash & receivables

Greater China, with a practical focus on Hong Kong, still seems our most promising hunting ground, and its relative importance to the Fund may frequently be higher than at present. However, China euphoria is unhelpful to valuations. Large inflows to fund managers who keep buying more of their existing holdings have sometimes also driven prices upwards. After some years of capital abundance we are again seeing a number of companies facing stiff competition, significant cost increases, and limited pricing power. Our research coverage is too limited to be representative, but is history rhyming?

We are finally out of Indonesia, where we have had holdings since inception. Being accustomed in that market to a combination of high risk and deep value*, we are not wholly convinced that Indonesian shares should be on comparable PEs to those elsewhere in SouthEast Asia. Brokers tell us that the risks are much diminished, but after seeing a number of companies suffer from apparent deficiencies in the legal system, it would be reassuring to see more improvement on that front.

Our Indonesian holdings had for some time been reduced to one: the nickel miner PT Inco Indonesia. This was a very profitable investment for us, and most of that was pure luck since we had no idea at the time of purchase that the nickel price would rise more than fivefold. Having bought and sold it early on, we reentered in Jan 03, continued buying during that year, and started selling in Jan 04 when the share had risen a mere 9 times, unaware that we would be able to sell the last of our holding in Feb 07 at 30 times the price of that purchase four years ago - or that it would promptly go up another 70% to a nice round 64,000 rupiah, which would have been 50 times the price paid. These figures are without counting dividends. So you would, once again, have been better off if your fund manager had gone on a two month holiday. But this stock is now outside my sphere of competence: valued at a significant premium to the cost-per-tonne of new projects planned elsewhere (although this is operating and they are not) and at a double-digit multiple of earnings which have risen 17-fold in four years. When we bought, we had equally little expertise on the price of nickel, but needed only to hope that it would not fall through the bottom of its previous range to find the cashflow attractive. Few if any brokers then covered the stock.

How things change. We may be guilty of nostalgia, for we are finding few new investments comparably exciting - or of not looking hard enough, but our peers report the same. When bargains are fewer, our priority is to try not to lose too much. The historic PE of the Fund's holdings at end-March was 13.6, matching that of PT Inco at Rp 64,000 - but we think that the earnings of our current portfolio may hold lower risk.

The portfolio PE figure we usually quote is our estimate for the current year, and at end-March that was 13.2, much the same as a year ago. (For a small percentage of portfolio companies, and a larger percentage of those we monitor, our earnings figures may differ significantly from those reported, as we tend to strip out exceptional profits and take a conservative approach to dilution.) Underlying EPS, DPS and book value of the portfolio roughly kept pace with the growth in net asset value, even though that of individual companies was often pedestrian: the difference may be explained by portfolio rebalancing. For the year ahead, our individual company estimates now add up to suggest low-single-digit EPS growth.

So good ideas from our well-placed investors would, as always, be very welcome. Thanks to you all.

Claire Barnes, 13 April 2007

* This started with our first acquisition, which had fallen 85% before our purchase, and promptly fell another 85%. This took it to 2% of its original price. It ultimately proved a rewarding investment for us, and a significantly better one for the braver souls who stayed in longer.

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