The Apollo Asia Fund's NAV rose 45% in the second quarter, to US$839.13: down 3% year-on-year, and 7% from the peak of May 2008: charts.
While the four month rally has been impressive, the accompanying 20-year chart of the regional index shows it in context: consistent with a rally in a bear market, and with the old market saying that a bear market rally feels better than the real thing.
During the first quarter we repositioned the portfolio significantly; during the second we made only modest changes. Three months ago we reported an abundance of quality/growth options at attractive prices. Many of the more promising participated fully in the market's surge. By end-June, we had net gains of 36%, 99% and 164% on the three stocks which we added in 1Q. Several leading companies report that they see no signs of green shoots, but have anyway doubled in price. Valuations are now much less compelling. We are back to carefully weighing the relative resilience and prospects of businesses for the long haul, against a backdrop of economic turbulence which we expect to continue, and possibly to intensify.
Governments, disappointingly, have 'wasted a good crisis'. Not only have they thrown away unimaginable amounts of taxpayers' money, postponing necessary adjustments, and impoverishing future generations. Not only have they missed opportunities for intelligent reform and appeared to be victims of 'regulatory capture'. Not only have they flouted the established hierarchy of creditors, imposing unwarranted losses on the prudent, and distorted the allocation of capital. They have also failed to seize the opportunity to reexamine market fundamentalism, to lead intelligent debate on the appropriate goals of societies, and to forge a new consensus on effective moves towards a more sustainable future.
Perhaps such leadership takes longer, and will emerge in due course, as adrenaline-fired weekly panics give way to consideration of the longer-term issues. The 2009 Reith lectures offered a worthy start to a necessary debate.
We mentioned that the economic crisis may intensify. Papering over cracks serves only to obscure the necessity of remedial action while the problem gets worse. The patchwork of quick fixes will have unintended consequences. Crises in pensions, insurance, government finances, housing foreclosures, etc, may be visible long after their worsening becomes inevitable, long after they become impossible to avert - but long before they reach bottom. The same will at some stage prove true of energy resources, and environmental damage. The timetable for these is less forecastable: they could be decades away, but the possibility that they may intensify suddenly should be borne in mind. Planetary and bureaucratic overload, like military blowback, lend themselves to the models of catastrophe theory, and may reach tipping points with little warning.
How to plan for energy and environmental contingencies, we are not at all sure. Fortunately, it seems likely that there will be better times to act. The stampede for inflation hedges may be premature (forced and voluntary deleveraging may outpace the printing presses for a while). Exchange-traded funds have made the establishment of long positions in commodities more convenient for many, and more investors now seem to be viewing commodities as appropriate for large asset allocations, changing historic price relationships. In John Hussman's phrase, it may be 'hard for investors to sustain a durable sense of doom about inflation risk', if we have a period of subdued prices or deflation meanwhile. Likewise for resource shortages: some 1970s analysis still reads well, but many market participants would regard three decades 'too early' (even if intended as a warning) as tantamount to being wrong. However, early warnings are valuable. Investor views on appropriate long-term strategies would be welcome.
Meanwhile, the attempt to recreate the market economy of 2007 seems both doomed and foolhardy. Many industries will not quickly return to 2007 levels: some will never be the same again. We are wary of future predictions for most 'luxury', several types of retail and consumer goods (spending patterns may change for decades), the auto industry, many types of capital machinery, and construction equipment... among others. We nevertheless hold some shares in these sectors, if the risk-reward proposition remains reasonable, but many of our holdings are in other sectors where business is relatively predictable - supermarkets, fast food, consumer finance, aircraft maintenance, basic telecommunications - and life, for the time being, goes on.
by listing; 30 Jun 09
% of assets
|Net cash & receivables|
Our geographic breakdown shows a significant increase in the Singapore weighting, which prompts us to emphasise that the figures in our table are by country of listing. Around half of our Singapore weighting is in companies headquartered there, and even among these, the proportion of earnings generated in Singapore would be quite small, with the balance broadly spread around East and Southeast Asia. The Hong Kong weighting is less diffuse, and does represent businesses operating primarily in Hong Kong & China. 'Other' at present comprises companies which are London-listed but Asia-focussed. A listing by headquarters would be no more helpful; attributing the underlying earnings would be troublesome to calculate; so by listing it is.
At the end of March, the portfolio was on an estimated current-year PE of 12.8, with some crisis-damage to profits already recognised in the historic figures, and some, we assume, still to come. The current-year dividend yield is estimated at 3.4% after local taxes. Price to book is 1.4, with the usual caveats on the reduced utility of IFRS book values. Over the last twelve months, the portfolio's historic EPS (which incorporates changes to the portfolio, and not just the performance of the present holdings) rose 6% (versus 16% in the twelve months to March), and its book value by 44%. Reflecting current uncertainties and reduced payouts, the estimate for current EPS is 3-4% less than twelve months ago, and the estimate for current DPS has fallen 13%.
Given the magnitude of the economic storm, and some shift away from defensives to growth companies, these figures seem surprisingly resilient, and suggest that the confidence we place in the quality of our businesses has in general been justified.
In assessing expected long-term returns, the best starting point is the earnings yield (the inverse of the PE), now a prospective 7.8%. Earnings growth could add to this figure; costs will certainly subtract from it. Whether your fund manager adds or subtracts value is another uncertainty. But overall, the earnings yield is the best starting point to compare with yields on bank deposits, property, or other assets. Relative to the very low interest rates currently available on deposit, Asian equities still appear attractive for the long term.
Claire Barnes, 6 July 2009
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