Apollo Asia Fund

Hoping for alpha
Apollo Asia Fund: the manager's report for 2Q2016

Apollo Asia Fund's NAV rose 0.6% in the quarter, to US$1,880.12, with a stream of depressing economic and political news in mainstream Asian countries and a June plunge due to the far-away Brexit vote offset by a late surge of funds into emerging markets in the challenging search for a safe haven. We have still made no net headway in US$ terms over the last three years, and the NAV at end-June remained 12% below its high set in August 2014.

Geographical breakdown
by listing; 30 Jun 16
% of assets
Hong Kong
20 
India
7 
Japan
20 
Malaysia
8 
Singapore
5 
Thailand
11 
Vietnam, incl funds
4 
Other
11 
Net cash & receivables
14 
 
100 

Looking back at the quarter, it seems to have been dominated by politics, and few of the political developments made me more optimistic. Events in Europe and the US presidential runup commanded a disproportionate share of the headlines, but there was plenty to worry about in Hong Kong and China, Thailand and Malaysia, the South China Sea and the Indian subcontinent. Yet it seems subjectively to have been a constructive period for the fund - not because we can point to spectacular share price surges or great macro insights, but because of a modest collection of new stock selections which we are accumulating, potential candidates which we are working through, and the nitty-gritty of our investment process. It is always stimulating to talk to competent managers and learn about the characteristics of new businesses or specific challenges. This quarter we had a lot of good conversations, and the managers of our holdings rose to a wide variety of challenges in generally sensible ways. (Markets often get excited about temporary changes in business conditions; we frequently consider the quality of the management response more interesting.)

One company that did disappoint us was CSE Global: in response to low interest rates, it invested part of the cash reserves which it had set aside for acquisitions in a variety of Singapore and international bonds which we consider unlikely to prove either safe or liquid. Interest rates near vanishing point are proving very difficult for many savers (not to mention institutions), and we suspect that a new generation of Singapore investors may soon learn the hard way that they should not have believed the assurances of bond salesmen and private bankers.

China's aggressive moves to colonise the South China Sea have been accompanied by a divide-and-rule strategy towards ASEAN. An April obituary for ASEAN explained that it now serves very poorly the Southeast Asian countries in which we invest, which should probably consider its breakup as a political entity - a view that can only have been strengthened by the feeble response this month to the UN's legal ruling. Hopes of Chinese obedience to international law are however undermined by the willingness of other great powers to ignore it when it suits them: the US is another power that has not ratified the UN Convention on the Law of the Sea, and Australia's appalling offshore detention camps are maintained in defiance of international law on human rights.

Corporate governance concerns highlighted some important issues in listed companies that we are glad not to own: the consequent possible responsibility for crimes against humanity in those camps of employees and financiers of Ferrovial (listed in Spain, mkt cap $15bn, Bloomberg ticker FER SM), and unorthodox terms of infrastructure financing allegedly offered by China Communications Construction Company (listed in Shanghai with a mkt cap of US$24bn, Bloomberg ticker 601800 CH).

For the last few decades investors have enjoyed a compelling growth story in Asia-ex-Japan: a leveraged play on global growth (which may no longer exist), abundant natural resources (frequently squandered), cheap and productive labour (increasingly expensive / rare), low tax rates (sometimes enabled by vanished windfalls), a relative lack of bureaucracy (now being replaced by a tangle of international conventions in a foreign language), and adequate prospects of legal protection (never universal, and now under threat). These great advantages were offset by some deficiencies of governance, so overall market returns were frequently less than hoped; but the markets were also inefficient, and disciplined investors could do well. Now the macro story is much less compelling, a huge increase in the numbers of investors-like-us has removed some of the helpful inefficiencies of pricing, and loose monetary policy has ensured that bargains are few. The balance of prospective returns and likely costs / errors is less favourable than before, but there are few alternative safe havens, and it still seems worth trying to achieve positive returns through equity investment. In the absence of better ideas we continue to attempt this in the same way as before, searching for well-managed and sensibly-priced businesses with reasonable cashflows and prospects and rational capital allocation. The political and economic backdrop may be less promising, but company-specifics are everything. Hence our ability to consider that we had a good quarter after researching and sowing a few new types of seed.

The rule of law is essential infrastructure for a modern economy; Malaysian readers now have restricted web access, so may be glad to hear of the many international legal associations expressing support for the independence of the Malaysian bar. We follow the example of Naked Capitalism and introduce an Antidote des Vacances: by way of holiday inspiration, Malaysia's special elephants.

Claire Barnes, 31 July 2016

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