The investment opportunities offered by Asian companies with strong balance sheets is not being recognised by markets, according to Invesco Perpetual’s William Lam, who is increasingly focusing on these stocks in his £1.2bn fund.
Lam has worked on the Invesco Perpetual Asian fund since April 2015, over which time it has generated a 55.76 per cent total return. This makes it the best performing member of the IA Asia Pacific Excluding Japan sector, where the average fund has made a 31.11 per cent return, over this time frame; it is also higher than the MSCI AC Asia Pacific ex Japan index’s 31.61 per cent gain.
Furthermore, the five FE Crown-rated fund sits in its peer group’s top decile over one-, three- and five-year periods, as well as over shorter time frames. Lam was promoted to sole manager of the fund in May 2017, having previously worked with Invesco Perpetual head of Asian equities Stuart Parks.
Performance of fund vs sector and index under Lam
Source: FE Analytics
Lam has a number of themes – or ‘buckets’ of exposure – running though his portfolio. Two longstanding examples are Chinese internet, which accounts for around 20 per cent of assets and includes companies such as Baidu and NetEase, and South Korea, which makes up about 22 per cent through names such as Samsung Electronics, the fund’s largest holding.
In a recent update, the manager said: “In the first half of last year there was a discernible third bucket in the form of Australian commodity-related stocks, but over the last few months that bucket has gradually been emptied as the stocks have performed well (or been taken over) and we have reduced the exposure.
“A new bucket that has grown over time, and is now as important as Chinese internet and South Korea, is the ‘strong balance sheet’ bucket.”
While stock indices are touching record highs in many parts of the developed world, fuelled in large part by central banks’ ultra-low interest rates and quantitative easing programmes, emerging markets have lagged them over recent years.
Lam noted that Asian businesses tend to be more reasonably valued on a headline price/earnings (P/E) basis. In addition, the fact that many of them often run conservative balance sheets is not captured by the P/E ratio.
Research by CLSA, illustrated in the chat below, shows that the net debt on the balance sheets of Asian companies on average comprises a smaller percentage of their market cap than in other parts of the world.
MSCI (ex-financials) net cash to market-cap ratio
Source: Factset, CLSA as at 31 May 2017. Note: Net cash-to-market-cap ratio is bottom-up aggregated based on current MSCI universe after float adjustment. Figures for 2016 are forecasts rather than actual figures.
“An additional part of CLSA’s analysis was that 23 per cent of the companies in the S&P 500 have net cash on their balance sheets, while 37 per cent of companies in Asia ex-Japan have net cash on their balance sheets (in both cases financial companies were excluded from the analysis),” Lam continued.
“Perhaps more pertinently, when you do the same analysis on the holdings of the Invesco Perpetual Asian fund, then 53 per cent of them have net cash on the balance sheet.
“We may have to be patient with many of these holdings before the market appreciates their balance sheet strength; but in some cases like Changyou, UGL and Fairfax, we may see others take action to help crystallise the value we have identified.
“Finally, it is also worth pointing out that theoretically, the cash on these companies’ balance sheets means that their share prices should show less volatility in the event of a market sell-off – which would help protect the performance.”
Of course, one consequence of having a strong balance sheet is that firms often become takeover targets. Lam notes that all three of the companies he mentioned as being in this ‘bucket’ – Changyou, UGL and Fairfax Media – have been subject to takeover activity in recent months.
“It is not always good news when we hear that holdings in the fund have received takeover offers. Often it means that the eventual buyers take the upside that we had hoped to take for our clients,” the manager said. “But it does at least indicate that our process of selecting undervalued companies is working, and that our own analysis is being validated by third parties over time.”
Overall, the Invesco Perpetual Asian fund invest in stocks where the share price is substantially below the manager’s estimate of fair value. This often leads Lam to unloved parts of the market and he consider themes such as Chinese internet, South Korea and undervalued balance sheets to be in the process of transitioning from being contrarian to popular.
This approach has won the fund some fans in the analyst community. Square Mile Investment Consulting & Research, which gives it an ‘A’ rating, said: “We think this fund holds plenty of appeal.
“It is managed by an experienced team of individuals who have been following Asian markets and companies for many years, applying a sensible strategy. The team uses the conclusions they have derived at the country, sector and stock level to build a portfolio of stocks that they believe will deliver superior performance across a range of economic conditions.
“However, the fund may lag when the wider market is chasing certain shorter term themes and the team's valuation discipline can also spell periods of underperformance as they are unwilling to chase, for example, high priced defensive type stocks.”
Invesco Perpetual Asian has an ongoing charges figure (OCF) of 0.95 per cent.