Apollo Investment Management 
Interesting times ahead!  & hence, opportunity

Apollo 001 Fund: the manager's 3Q99 report

The Fund's NAV fell 6% in September, to US$18.68, resulting in a decline of 5.4% for the third quarter, and reducing the year-to-date gain to 42%, before fees. Judging by today's AWSJ reports of the Lipper mutual fund universe, both the 3Q and year-to-date performance on a fee-adjusted basis would be comfortably above the average, and we are also looking respectable against the most relevant of the MSCI regional indices. However, I keep an eye on these only to make sure that we are not looking stunningly foolish, and to explain the backdrop to short-term valuation movements, as I am much more interested in absolute returns, and the risk/reward balance on the bets which we do decide to take. We take no account of index weightings, and most fund managers would consider our portfolio highly concentrated (15 holdings at present, with 82% of the value represented by the top 8), and decidedly eccentric (they might well use the word "boring"). That's fine by me.

The biggest risk to Asian financial markets comes from Wall Street. I've been nervous about this for so long that I, like other bears, may have little credibility on the subject (the Cassandra syndrome), but with a Dow Theory bear signal in place and an impressive array of technical indicators flashing red, it does now look as if the mania is crumbling. Maybe we will see the dip-buyers return this week with their former bravado, but I would not be surprised to see serious carnage in the weeks ahead. (This would confirm October's short-term place in market legend, although I am inclined to agree with Mark Twain on the subject.)

In this event, I would not be surprised to see serious short-term valuation losses on our portfolio - but the damage to intrinsic value of the businesses we own would be much less. This is because the companies we own have strong balance sheets and very solid business franchises, and are in aggregate extraordinary cash-generators. One can go on to worry about global depression, starting with bleak scenarios of the 1930's and the eventual political fallout, with plenty of flashpoints and political risks on our doorstep to heighten the nightmares - but it would take a disaster of this magnitude to put a serious dent in the cashflows of some of our more recession-resistant companies (such as fast-food operator Cafe de Coral, Hong Kong's major purveyor of hospital meals and school lunches). Meanwhile, (1) it may not be that bad, (2) mere financial depression with the economic fabric intact may present tremendous strategic opportunities to the well-run and cash-rich companies, (3) bear markets are a bargain-hunter's delight.

Market timing being a game at which I claim no prowess, I fall back on fundamental valuations. On my estimates, our portfolio (at the latest NAV of US$18.90) is on a current year earnings yield of 15%, and prospective one year out of almost 18%. The dividend yield, after Asian taxes, is expected to be just under 8% this year, and a touch higher next. Compare these with the deposit rates at your local bank. How accurate are the numbers?  I spend more time thinking about the strategic positioning and broad valuations of our companies than the blips and dips in the earnings figures, but I find this particular group of companies gives me pleasant surprises more often than they disappoint. These valuations, anyway, give more than adequate margin-of-safety from the fundamental investor's perspective. Even if one is nervous about the big picture, value like this is hard to ignore. (I stress as always that we make no concessions on quality, and would never, in Asia, buy stocks just because they "cheap". Nor do we buy only the cheap, as previously discussed. These are good companies - and the list of new ideas which I want to research is as long as it has ever been.)

Meanwhile, there are a number of potential positives from a top-down perspective. Firstly, it is possible to envisage a soft landing for US financial markets and hence the US economy, which would allow investors to rotate into Asian economies offering higher growth and better value. Secondly, Y2K disruption is absurd, and many investors are reportedly staying clear of dodgy-compliance countries. If not too much chaos ensues, the burst of pent-up demand to buy Asia in January could cause a New Year rally fit for - well, fit for the New Millennium. One fund manager friend told me recently that they were under pressure from trustees to move 25% into cash, with a view to reinvesting in the New Year! Thirdly, even without Y2K, there is always a temptation for fund managers to sit back after a strong performance and "lock in gains" for the remainder of the year; for those susceptible (and the reality is that many incentives are based on the calendar year), I suspect that temptation will now be particularly strong.

Chris Wood at ABN-Amro has just published a 106-page blockbuster proclaiming boldly that "Asia remains in a bull market, though Wall Street and Y2K concerns will keep sentiment cautious in the final quarter... Investors should use weakness in America as an opportunity to buy in Asia, not as a risk to run away from... In both [China and Japan] there is growing, albeit still tentative, evidence that deflationary pressures have peaked out... [There is] potential for sustained non-inflationary growth in Asia, along the lines of the US Goldilocks model, [given] the continued absence of credit growth as a result of the continuing hangover from past excesses... The bull theme [in Asia] will switch from deleveraging to info tech. The new economy will serve as a catalyst both to revolutionise the way companies are run and to free up long pent-up consumer demand resulting in a genuine long-term growth story... It is precisely because so many aspects of the traditional Asian business model are so inefficient that the new economy has so much potential... Its catalytic role will actually be greater in Asia than it has been in already lean and mean America... Asia can go forward regardless of any setbacks, violent or otherwise, emanating from the US."

I recommend this report (Asia Maxima - Mission Possible) for a wealth of useful charts, my favourite of which is their established Jack and Bill Index. This shows that the whole of Asia-ex-Japan, including India, was capitalised at end-Sept at only twice the combined market cap of General Electric and Microsoft. The ratio peaked at 12 in December 1993, and the average for the 90's has been about 7 - so US investors taking their chips off the home table could, if they wished, get more than usual for their money. (In practice, of course, most of them are quite disillusioned with overseas investing, whereas "US equities always go up in the long run", so they stack even more chips on the recent winner. Asians have more recent experience of volatility and of markets heading to oblivion, but retain an equally touching faith in the long-run virtues of property.)

I'd also like to recommend Marc Faber's recent essay "Is the recovery in Asia for real?", especially for those at a distance, for Marc as always provides some excellent reality checks. "The Asian countries haven't suffered for long enough to bring about true reforms... Crony capitalism is alive and well; in fact the crisis may actually have led to more - not less - corruption, as everyone is desperate to make back what they lost over the last two years... In most Asian countries the political situation is tense." However, Marc too is struck by the speed with which the Internet is changing the Asian economic landscape. Writing in the first half of September, he concluded that there was then "no urgent need to purchase Asian equities, as the markets are more likely to provide a better entry point towards the end of this year or early next year", but that "Asian economies will offer great investment opportunities in the future; not necessarily in Hong Kong banks and property stocks, but in new industries and in new regions and with new entrepreneurs. Devastating bear markets tend to bring about a change in leadership. New countries, new industries, and new companies will be leading the next secular bull market."

What a great time to be a cherry-picker!

Claire Barnes, 18 October 1999

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