Negative interest rates on the global bond market are implying “asset destruction on an unimaginable level” according to Ewan Markson-Brown (pictured) and Roderick Snell, managers of the Pacific Horizon Investment Trust, who say “embracing the new and going for growth is the only way out”.
Writing in their annual report to shareholders, the managers noted the fallout from Covid-19 has ended a long and positive economic cycle, causing the failure of many businesses that were previously kept alive by freely available cheap money.
In this way, they said the pandemic has done what central banks have been afraid to do: “Create a Schumpeterian capital cycle where the role of the entrepreneur and innovation is paramount at the expense of entrenched, stale incumbents. This economic collapse has freed capital to work better for humanity. That is the good news.
“In the ‘old economy’, especially financial companies, we saw a collapse in share prices and corporate earnings. In the ‘new economy’ throughout the world, transformational technology helped ease the passing of the old ‘normality’.
“With the accelerated growth of the online economy – e-commerce, cloud and gaming – catalysed by Covid-19, the outline of the new order became clearer.”
Aside from digitalisation, another significant component of this “new order” is the movement of global power from West to East.
The managers said that whereas public and private institutions in the developed world were tested and found wanting in the crisis, Asia ex Japan emerged as an economic leader.
As a result, they believe that 2020 could well be an inflection point where the region becomes a favoured asset class for the coming decade.
“For equity investors, the main point is that the East looks better on most metrics than the West – given government debt levels, the price of money or regulation – supported by some of the strongest growth drivers globally,” the managers continued.
“These range from the continued rise of the Asian middle class and consumer, to Asia’s central role in supply chains, world trade and globalisation.
“Clearly, the latter has recently come under pressure, especially with deteriorating US – China relations; however, it is also providing great opportunities for parts of Asia. Vietnam is one of the biggest winners of these trade disputes as it increasingly becomes one of the world’s most important manufacturing centres, capturing much of the manufacturing capacity leaving China.”
Pacific Horizon has a growth-focused strategy, with the managers looking for companies that have the potential to increase their revenue and earnings at around 15 per cent per annum for at least five years, and where this has not been priced in by the market.
They also like to consider what size the company’s industry could become, how this could change and whether there are additional opportunities for growth in adjacent markets. This gives them a rough estimate of the total addressable market for a company, its products and its growth potential.
The approach can lead to concentration in certain areas and the portfolio currently has a significant weighting to ecommerce, software and biotech – a position that helped drive its performance in the rebound from March’s crash.
“Instead of panicking during the decline, we assessed the resilience of the portfolio’s companies and gave further thought as to whether they would still be here in one-, three- or five-years’ time,” added Markson-Brown and Snell.
“We considered whether they could survive current events with products and services that people would want to buy.
“We used Covid-19-induced share price plunges to increase the risk profile of the portfolio and, as managers, we believe that the mass panic and irrationality caused by this virus offers a once in a decade chance to reallocate assets towards Asia ex Japan markets.
“We did not reduce the total of invested borrowings but did take some money from the larger cap names that had outperformed and reinvested it in some smaller names being sold off as they were seen as particularly risky. The key is to invest in specific, researched stocks and be sure that we own the companies that can survive current events.”
This tactic proved to be spectacularly successful: Pacific Horizon is up 122.56 per cent since the MSCI World index bottomed out on 16 March and is the third best-performing mainstream equity trust in the AIC universe in 2020, with gains of 76.36 per cent.
Performance of trust vs sector and index in 2020
Source: FE Analytics
Despite these strong gains, the managers said it is not too late to buy in.
“The start of a new cycle is almost always very positive for business owners,” they explained. “In fact, we would argue that this is possibly one of the best times to be a business owner in Asia: demand for products and services may have collapsed, but many competitors are insolvent, corporate profits are at a very low percentage of GDP, costs can be cut and when growth returns, operating leverage will be significant.
“We believe that the US dollar will probably be weak by historical standards and capital will flow to Asia. Business profits have already bottomed and will rise rapidly from here. Old entrenched businesses may reinvent themselves and embrace the new and begin afresh.”
Yet the managers warned this is not the time to play it safe.
“If we are too cautious because of the risk and uncertainty arising from investment in times of rapid change, we will lose the opportunity to outperform. Hence our continued willingness to seek opportunities for great company returns.
“The risks and opportunities from increased disruption are here to stay. In our view, the market’s focus on geopolitics and capital flows misses the bigger picture and the opportunities created by global digital penetration, technological change and the rise of the Asian middle class.
“These fundamentals will underpin growth in the region for decades to come. The best way to invest in this rapidly-changing growth market is to find the best long-term growth companies; we call it ‘growth squared’.”
Data from FE Analytics shows Pacific Horizon has made 261.14 per cent since Markson-Brown took charge in 2014, compared with gains of 117.87 per cent from the IT Asia Pacific sector and 100.54 per cent from the MSCI AC Asia ex Japan index.
The trust is trading at a premium to net asset value (NAV) of 6.75 per cent compared with average discounts of 2.98 per cent and 2.3 per cent from its one- and three-year averages.
Performance of trust vs sector and index over 10yrs
Source: FE Analytics
It is 5 per cent geared and has ongoing charges of 0.99 per cent.