Remodelled landscapes
Apollo Asia Fund: the manager's report for 4Q17

Apollo Asia Fund's NAV rose 4.2% in the fourth quarter to US$2,327.60, a new high. For the year, the NAV was up 28.3%, and portfolio turnover was 23%. In 2017, the ADXY basket of Asian currencies rose 6.6%, and stockmarkets also surged. The MSCI All Country Far East ex-Japan index, denominated in US $, rose 39.0% for the year; the fund owned none of its heavyweight outperformers, such as Alibaba and Tencent (up 96% and 114% respectively), and so lagged; our basket of companies may have somewhat lower risk.

Political shocks came thick and fast. Few surprised me more than the detention of the Saudi princes, joining the many prominent clerics, writers, journalists, academics and activists arrested earlier, and the subsequent allegations that the US Treasury provided 'technical assistance' in targeting individuals and locating accounts for shakedown, and that the local version of due process involved torture by American mercenaries. (Academi-formerly-known-as-Blackwater denied any operations in Saudi Arabia at the time, but the new security force of the Crown Prince is reported to have been formed with the involvement of Erik Prince, while the personnel in the earlier operation are now said to include former 'Blackwater' employees.) John Michael Greer notes that 'one of the riskiest maneuvers in all of politics is the attempt by an absolute monarchy to modernize the economic system of its nation and still retain power. That’s what King Louis XVI of France tried to do in the decades before 1789, what Tsar Nicholas of Russia tried to do in the decades before 1917, and what the Shah of Iran tried to do in the decades before 1978... The current crown prince of Saudi Arabia, Mohammed bin Salman, is trying to pull off the same trick right now.'¹ Given Saudi Arabia's importance in both oil and financial markets, and its polarising history in Islamic communities worldwide, the risks of conflagration are hard to ignore. This will be watched with particular concern in Malaysia, given the close ties and frequent visits of Prime Minister Najib.

China appears to have become increasingly assertive on multiple fronts. This became hard to ignore after the party conference in October; Richard McGregor noted that 'under Xi Jinping, China has become more powerful and confident than it perhaps has been for two centuries'... 'In the 1980s, Deng dictated that China should "bide its time and hide its light" in foreign policy while the country gained strength... Xi’s China and party have tossed such restraint aside... the sheer, overwhelming triumphalism in Beijing this week should finally provide a wakeup call to those in the west who have long believed not just that China would fail. Many were convinced that, as an authoritarian state, that it must fail. For the moment, however, China is succeeding.' Rising concern about Chinese influence in Western universities was heightened by spy scares in Australia and New Zealand, and by mid-December the growing alarm on this front was seen in an Economist cover depicting 'Sharp power: the new shape of Chinese influence'. By the end of the year there was little talk of the 'peaceful rise' proclaimed by previous leaders, or of Xi Jinping as the champion of globalisation and open markets at Davos less than a year ago; Luke Patey opined in the New York Times that 'China is pushing its luck with the West'. With Taiwan moving to counter aggressive psychological warfare, the PRC last week emphasised Xi Jinping as military leader and China's combat-readiness.

Meanwhile, the extent of China's strategic additions to the 'String of Pearls' started to receive a lot more attention in western media - some at least partially admiring of the vision and possibilities², some focussing on the potential disadvantages to host countries. Sri Lanka formally signed a 99 year lease on the port of Hambantota and was described by Brahma Chellaney as the latest victim of 'China's debt-trap diplomacy'. Misgivings in Pakistan about the potential loss of employment intensified after reports that China had requested a renminbi zone (refused) and stands to receive 91% of the revenue from Gwadar Port. Reports of a new Chinese naval base in Pakistan were denied and seem plausible. Myanmar may be stalling on both of the major potential port investments in Rakhine state: that of China in Kyaukpyu and of India in Sittwe and the Kaladan river. Thailand is yet to decide on its sections of China's rail link to Southeast Asia, already under way despite particular concern about the potential cost to Laos. These are mega-projects, often significant in relation to each country's total economic activity and debt servicing capability, and in their environmental impact. They will boost GDP in the short term, but whether they lead to prosperity or impoverishment of the host country in the long run may depend on careful negotiation and execution - and transparency is in most cases lacking.

While Chinese companies may reap some benefits, and the Chinese state gains a comparative advantage in case of conflict, the costs of inadequate planning and of possible social / political backlash are hard to quantify. An unpredictable US increases the risks of an escalation in tensions, and the increasingly overt dominance displays have been widely noted. Vietnam faces particularly difficult decisions, given its fast-growing energy demand and increasing encirclement by Chinese infrastructure: we will be interested to see what comes of the discussions with ExxonMobil over the Blue Whale gas field.

Asian markets have been surging, fuelled partly by allocations from investors afar, often apparently assuming that past characteristics hold true. I am not sure that they do. Many Asian countries have moved beyond the easy catch-up/normalisation phase of growth, and are now faced with rising maintenance and cleanup costs as we damage or destroy irreplaceable ecosystems with breathtaking insouciance, and as a growing percentage of activity is channelled into bureaucracy, the surveillance state, or less-satisfactory-substitutes for natural eco-services. Investor enthusiasm for disruptive dominators leaves me wondering how much of each country's economic pie they will be allowed to command - and even if it suits The Powers That Be to allow individual baronies to flourish for now, is it sensible to assume an endgame of maturity resulting in large cash outflows to foreign portfolio investors? We may trust a company's board and managers, but should also consider the attitude of the state: in our new era of tax grabs and asset confiscation, how may the rules change with the tides of capital flows?

Much of the conventional western thinking about investment has developed over seven decades characterised by peace, prosperity, growth, and a rules-based international order of which the US was principal architect. With the US now backing away from that system, and an uncertain protector of its former allies, the incentives for other countries to operate within the system, or to aspire to international acceptance, are rapidly diminishing. All are reassessing their strategies, and their relationship with a belligerent China which may insist on its own rules. Regulatory systems and institutional norms around the world may not continue to evolve at the command of the declining superpower. They may not change, until so required, but the individuals who determine how governments, institutions and listed companies operate often do so on the basis of their own principles, aspirations, and internal codes of behaviour - and we should expect these to evolve over time. We are uncertain how this may affect our investments, but the value of minority shares is not usually commensurate with the value of controlling shares, even in the west.

A new website on Asia's massive infrastructure projects is a work-in-progress, but has beautiful interactive and historical maps which are already interesting to explore: https://reconnectingasia.csis.org/. We have written before on this site about Disappearing Hills, and now highlight Disappearing Beaches due to intensifying conflicts over sand mining³. Professor Bill Laurance argues that many of the big road projects are unnecessary, and that we should instead focus on smaller vehicles, smarter road planning, and tax incentives to change transportation norms - so we close with two persuasive short videos: 'Why roads are like Pandora's box', and 'Why big projects can turn into a giant gamble'.

Best wishes to all fellow-investors for 2018. Constructive thoughts on how best to invest in the new environment, and on any experience from other periods of turbulence, would be very welcome.

Claire Barnes, 12 Jan 2018