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Asian income funds in a bubble, warns Hermes' Pines

20 March 2014

The manager of the Hermes Asia ex Japan fund says valuations in this part of the market are sky-high and that it is “exactly where you don’t want to be right now”.

By Jenna Voigt,

Features Editor, FE Trustnet

The type of stocks owned by Asian income funds are in a bubble and investors would be wise to get out of the sector, according to Jonathan Pines, manager of the Hermes Asia ex Japan fund.

Income-oriented funds in Asia have outperformed their growth-focused peers over three years, recording top quartile returns over this time.

However, they are all in the third or fourth quartile over one year, and Pines says this will only get worse.

“I would say that’s exactly where you don’t want to be right now,” he said. “I would be very cautious if I was an investor in an [Asian] income or yield fund.”

“I would take a very close look at the top-10 holdings of the [stocks] that these income and yield funds are invested in to make sure that the valuations relative to the fundamentals are still sound.”

“A lot of these valuations are sky-high and I would say that I’d be very surprised if income funds did not underperform the market as a whole over the next 10 years.”

Pines, who runs the Hermes Asia ex Japan Equity fund, says the stocks that are most at risk are typical fast-moving consumer goods companies that are predictably increasing their earnings.

These companies include non-durable goods such as soft drinks, toiletries, over-the-counter drugs and processed foods.

A number of mobile phone and game systems companies may also be at risk.

“The profile basically all looks the same,” Pines said. “You’ve got steadily increasing earnings, steadily increasing net asset value – which are good things – but you’ve got a share price that has increased by multiples of how much the net asset value per share and earnings per share have improved.”

The manager says the relative outperformance of income-oriented portfolios in Asia was a result of investor willingness to pay over the odds for perceived stability from predictable earnings.

“As a result of this theme, there’s been a wall of money to non-cyclical stocks and companies that have predictably increasing earnings and a lot of the best-performing funds in the last few years have been income or dividend yield funds,” he said.

“The reason for that is not because of the income or the yield that that got. It’s because of this wall of money that has been attracted to a specific kind of stock: non-cyclicals, predictable non-cyclicals. And that’s realised dramatic capital gains.”


Source: FE Analytics

Pines previously told FE Trustnet that investors were paying over the odds for quality, which was fuelling a bubble in Asia.

“The question is in the context of these income funds, are dividends going to increase in Asia? First of all, whether or not dividends are going to increase in Asia wasn’t the reason for these income funds having done well.”

“The reason why these funds have done well is because of the huge capital gains as these funds have attracted inflows from fund managers that price predictability.”

Pines thinks that dividends are generally on the rise throughout Asia.

He highlights countries such as Taiwan, where he says most companies generally have great dividend policies. He adds that China and Hong Kong are basically OK in terms of income as well.

“The one country which is a standout, terrible dividend payer is Korea,” he said. “And they are incredibly stingy. Now I think that things are going to improve and I think that improvement in terms of what that payout is going to be will be led by the likes of Samsung Electronics, which have indicated to investors that they are going to be increasing their dividend yield.”

“In part because I think the opportunity set is a little bit less than it was before in terms of their ability to invest their capital.”

“Whatever their reason, I think the knock-on effect of Samsung Electronics improving their dividend payout ratio is going to result in other Korean companies doing the same thing, which I think is a positive thing.”

“One of the manifestations of poor corporate governance is a low dividend policy, because it basically tells the shareholders that the company is run for management rather than the shareholders.”

“And if dividend payout ratios start to improve and increase, at least there becomes great alignment between what the company’s management is doing and what the wants and needs of the shareholders are.”

Pines’ Hermes Asia ex Japan Equity fund is not an income-oriented strategy, but instead focuses on growth from cheaply valued stocks in the region.

The manager’s bottom-up process has paid off in the current bear market. The fund is up 11.33 per cent over the last 12 months while the IMA Asia Pacific ex Japan sector has lost 7.77 per cent.

The MSCI Asia Pacific ex Japan index fell 6.94 per cent over the period. It is the best-performing fund in the sector over the last year.

The fund is also well ahead since launch in October 2012, returning 27.77 per cent while the sector gained 4.89 per cent and the index picked up 4.16 per cent, according to FE Analytics.

Performance of fund vs sector and index since launch


Source: FE Analytics

Instead of some of the usual names in Asia and emerging markets – such as Taiwan Semiconductor – Pines holds firms such as container terminal operator Cosco Pacific, Hong Kong airline Cathay Pacific and South Korea’s largest retailer E-Mart.

Samsung Electronics is the largest holding in the portfolio, at 5.7 per cent.

Consumer products make up the largest sector weighting in the fund, at just over a quarter, while telecommunications, media and technology stocks are the second largest weighting, at nearly 20 per cent.

Pines currently holds 7.9 per cent of the portfolio in cash.

Hermes Asia ex Japan Equity is available via platforms and has ongoing charges of 0.89 per cent, according to Trustnet Direct.


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