NAV of the Apollo Asia Fund rose 16.6% in the fourth quarter, and 13.1% for all of 2020. Despite the ravages caused by a virus which came to our attention only in January, and reshaped societies and economies in ways few had imagined, the NAV ended the year at an all-time high of US$2,375.43, fractionally exceeding the previous peak set almost three years ago.
Optimism about vaccines and a return to pre-COVID life fuelled the 4Q surge, along with unprecedented global liquidity, and the resultant unfairness of money flowing mainly to large companies (more likely to be listed) and the well connected. (We often prefer not to own the latter; the wheel of fortune is liable to turn.) Small businesses cannot spare resources for lobbying, and often fail to be heard; we also know that many of the individuals most critical to society are not fairly recognised. Social tensions will be exacerbated in this crisis; the more vociferous manifestations may distract attention from the small, often silent, businesses so essential to the diversity of the enterprise ecosystem.
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It is becoming apparent that vaccine rollout will be slow in many countries, and should be seen as a race against mutations and variants. Managing hopes, fears, risks and social tensions would be challenging even for great leaders; most countries will instead have to muddle through with the leaders that we have. Recent events have at least demonstrated the importance of strong civil and governmental institutions, and wider awareness of function and fragility may lead to more clarity and a determination to support and bolster them. Public-spirited citizens in all countries (democratic, autocratic, and dysfunctional) will be working within their own local constraints to reform institutions that are no longer fit for purpose, and to provide flexible support to people and organisations still working well. Since top-level developments in so many countries appear negative, it will be important to remember that it is sometimes only when an adverse trend has run to an extreme that a sufficient number of people will have become motivated to the effort required for eventual change in a positive direction. I write in a week when a state of emergency has been declared in Malaysia, suspending parliament and constitutional protections, an alarming development on top of the past ten months of political crisis. I shall assume that our investors have also followed the events of the last year in Hong Kong and Thailand, once the major destinations of investment by Apollo Asia Fund: motivation and dedication are not always enough, but they are necessary conditions for maintenance and improvement of the social fabric.
On 23 March 2020, we wrote to investors about emerging stockmarket opportunities, after a sharp selloff. Asia then appeared to have brought the COVID-19 outbreak under control, as it had done with previous threats such as SARS and MERS; disruption had been much greater, but successful public health responses had been demonstrated, and 'normal' life was expected to return after a brief interlude. Chaos in Western countries, and their sluggishness in adopting international best practice was a surprise, but it was assumed that they'd learn, in time; the selloff started in international markets seemed a good opportunity to buy. The portfolio's historic PE was then 8.4, P/B 1.1, and the dividend yield 6%. The news was bleak, but it seemed no time to sell.
Since then the NAV has risen by more than 50%, even as the underlying fundamentals worsened dramatically. The virus has been declared out of control in many countries, and governments that thought they knew how to control it are playing whack-a-mole with new outbreaks and new variants. Infection fatality rates will rise for lack of medical care, and the spread is increasing the chances of more threatening virus mutations. The duration of the crisis, and the lack of exit strategies, is causing unprecedented stress. The few business beneficiaries tend to be bid up excessively, and will be vulnerable when conditions eventually stabilise; many more companies are suffering, although our own portfolio should prove more resilient than average. Share prices are up, but not underpinned by any improvement in fundamentals. The historic PE by the year-end was 12, and P/B 1.5, allowing much less margin of safety than in March. Our 2020 dividend forecast, excluding special dividends, now yields 3.6%. We haven't spent much time guessing at 2020 earnings; our current forecasts suggest an EPS decline of about 15%, but please do not set too much significance on that figure. The wider market will be even harder to forecast, due to the volatility introduced by current accounting standards which insist on valuation models and estimates rather than tamper-resistant historic cost for illiquid assets. The important consideration is the future outlook for earnings and cashflows, also very hard to forecast now; resilient business models and cash management will increase the chances of survival to take advantage of such opportunities as appear. Valuations still appear reasonable, even though not at the bargain levels of March, but our concern is the greatly increased risk to businesses, and the reduction in opportunities for future prosperity.
Had we been confident that the market was going to rise so steeply, we would have been more aggressively positioned; in the event we opted for stability and safety, and stuck mostly with the companies that we know. We were pleasantly surprised by our stress-tests on existing holdings, generally concluding that risks had been overdiscounted and value enhanced - at least by the time that we could think things through; markets often react faster than we can. We trimmed and we added, but introduced only two new names during the year. We eliminated none completely, although Convenience Retail Asia sold its largest business to the franchise owner, with which it may have been hard to negotiate, and distributed dividends in excess of our purchase price. Portfolio turnover was again very low, at just 4%; expect this to rise.
During the early stages of the pandemic, there was talk of resetting economies onto more sustainable paths. I would be happy to hear of governments taking effective action, or adopting appropriate targets to replace the pursuit of GDP growth; real change would require leadership, and in most of the countries I follow closely, ecological understanding and focus are sadly lacking. I am glad to see that the EU has taken some action to restrict export of plastic waste; dismayed to hear that another Brexit promise is being broken with lower environmental protections for the UK and its permitted exports. This article by Karen McVeigh on the UK "loophole" shows a mountain of plastic waste at Kuala Langat, very close to Kuala Lumpur where I live. The photo was taken more than two years ago, which should surely be stated, but the problem has not been solved, domestically or internationally, the huge increase in medical waste for burning has added a new twist, and the damage to public health is cumulative.
The dangers of waste incineration have been documented over the decades by GAIA, an international alliance of NGOs, now extremely concerned about its modern incarnation as chemical recycling. For a helpful quick summary of opposing views on "advanced recycling", important in its own right and illuminating a number of related and complex challenges, see this article by Alex Tullo at C&EN. GAIA is worried that flawed technovisions are seducing politicians around the world, and providing PR cover for planned expansion of the petrochemical industry which would lead to plastic production not just growing but multiplying many-fold over the decades ahead. This does not augur well for beach holidays, in the context of this recent report from Bali. Until proponents can demonstrate recycling technologies that are economically viable at scale and cause no further environmental damage, policymakers would be prudent to adopt the precautionary principle, reorient taxes to achieve a reduction in global usage and production of plastic, and to support the eminently practical Zero Waste initiatives advocated by GAIA - and by the Ellen MacArthur Foundation, which is ably communicating the vital ideas of a circular economy¹ -
The Ellen MacArthur Foundation offers a wide range of stimulating material for different audiences, including ideas for companies in many different sectors; frameworks for company self-assessment as well as for education and policy analysis. The best single starting point for an investor may be their Sept 2020 report 'Financing the Circular Economy: capturing the opportunity' - because all of our investee companies should be thinking about these ideas: they'll appeal to customers and employees alike, and help with the flexibility that guards against obsolescence.
However, the danger is tokenism: many companies making small changes at the margin, without reversing the ongoing secular growth in resource extraction and pollution. More radical changes are possible, but would only be made if regulation and taxation changed to support a whole-of-society shift to a circular economy. Voters in many countries express support for green policies, but few if any governments are showing clear leadership for changes on the scale required. The Ellen MacArthur Foundation suggests 'a transformative Covid-19 recovery strategy' to policymakers, but may not have succeeded in conveying the urgency of firm action. Clarity of purpose, determined leadership, judicious regulations and incentives would be required to mobilise business in new directions, and to unleash the corporate energy necessary for transformation.
Without strong government action, there are many possible changes that businesses will not make. For example: (1) Multinationals wish to develop packaging that they can label "recyclable", to meet the expectations of concerned consumers: they expect that the percentage actually recycled will remain very low, but regard this as PR to enable continued expansion. (2) Some companies will continue to dump pollutants rather than disposing of them properly, if experience suggests that the cost-saving will go unpunished. (3) Manufacturers of rubber gloves know that they could recycle all their water, but will not bother while they can obtain groundwater more cheaply; instead of investing in recycling equipment, they cultivate water officials and obfuscation. Profligate use of water leads to shortages - in a country once covered in rainforest! The cost to society of frequent water cuts goes uncounted - the energy expended on trucking in water, driving around to find water, the lost time and productivity, the risks to public health, the cost of packaged water, and the huge infrastructure expenditure that may later be deemed necessary to pipe in more water over or under the mountains. The additional activity boosts GDP in the short term, but it detracts from prosperity: it is illth and not wealth. Appropriate charging for externalities would result in major changes to the allocation of capital and the balance of enterprise. When JK Galbraith wrote of private affluence and public squalor, his readers were thinking of the urban environment. Extending manmade squalor to forests on the other side of the planet, the most remote islands, and the deepest ocean canyons was not then envisaged - and yet, here we are.
The Ellen MacArthur Foundation "believes that the transition to a circular economy is best achieved through industrial global transformation, with business as the key driver of industry innovation at pace and scale". I share the belief, but think government action necessary to start that driver. The performance of governments in communicating evidence and regulations during the pandemic does not inspire confidence in aptitude to tackle this more complex topic, but one can hope.² A new paper discusses the widespread inability even to grasp the scale of threats to the biosphere, an extraordinary collective blind spot: 'Underestimating the Challenges of Avoiding a Ghastly Future'.
Small steps towards sustainability are all good, unless they delude us that they are enough - or if they are used to delude the public. I don't doubt the 'client demand for investment strategies that seek competitive returns while benefiting society and the environment', but wonder whether all such funds are doing so, or if they are investing in firms conducting business-as-usual while conducting small experiments and honing their PR with the assistance of consultants deploying the new jargon. Some companies may use self-assessment as an opportunity for radical thinking and reinvention; in Asia too many use sustainability reports as an opportunity to deflect attention from major environmental impacts into self-selected goals which are easy to meet. Governments and regulators wishing to maximise efforts towards sustainability might consider authorising ecological specialists to question listed companies on sustainability issues at their AGMs, analogous to representatives of the minority shareholder class who in some countries have helped to raise the level of questions on corporate performance and governance.
To avoid any misunderstanding, we would love to invest our whole fund in businesses that enable us to prosper 'while benefiting society and the environment'. However, we believe that much of current economic activity is very damaging to both, and that overblown claims are either naive or deceptive, but anyway unhelpful. It may be possible to invest in businesses that are less damaging, or in businesses making efforts to achieve meaningful transformation that will reduce their impact over time. It seems easier to identify and support such companies as a consumer than as an investor. (Many companies that I like are small and unlisted, and some are social enterprises.) In any case, I would welcome reader assistance to point out worthy businesses suitable for the fund that we may have overlooked.
Long-term readers of our reports will recall stories of Disappearing Hills. Limestone karst and caves in Asia are iconic: think of the Li River, the caves of Vietnam, the hongs of Thailand, and the 45,000-year-old rock paintings of Sulawesi. In areas accessible for extraction, some views are preserved, for tourism and photo-ops, but others are gone; returning citizens may be distressed to find that the landscape of their childhood is unrecognisable. Many of us know that limestone ecosystems are special; it was only a few years ago that I learned that each outcrop may be unique, the home of species found nowhere else on the planet, an 'imperiled ark of biodiversity'.
Around the same time I was making small repairs to my house, and marvelling at the quantities of sand required for the concrete. A contractor friend pointed to the high-rise buildings proliferating on the skyline, and explained that each may cost us the equivalent of one mountain and one beach - although the marine sand is used for reclamation and infrastructure, and river sand, equally problematic, for buildings. A marine biologist friend explained that seagrass meadows are the nurseries for a huge percentage of coastal & reef fish, but are often unmapped, and that many are being destroyed by dredging and land reclamation for property development.
The trade in sand has been contentious in Asia for years, but tensions are escalating due to the scale of artificial land formation & construction. Availability and increased prices are a concern for my contractor friend, but environmental damage and destroyed livelihoods are a much greater issue, and these externalities are rarely quantified. I have been trying to monitor this for a while, greatly helped by the work of Kiran Pereira, but was still startled to read of the range of sand-related issues in her new book. She goes on to explore new ideas, and directions in which awareness and policy, attitudes and practices could all usefully be nudged. This is a constructive approach in the positive sense, worth emulating for the many interconnected challenges facing society. I highly recommend her book: Sand Stories.
Claire Barnes, 17 January 2021
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