The NAV fell
4.2% in November giving up much of the late October bounce.
It was at least encouraging that markets tested the low
without breaking down further. From a chart perspective, the
next major support level, the March 2003 SARS low, lies a
vertiginous 30% further down.
With dividend yields in many Asian markets now at over twice
ten year government bond yields (the ratio is 1:1 in the
USA) there is no doubting the value in equities. That said,
if the world does slip into a prolonged deflationary spiral,
as some commentators predict, then all bets are off.
Certainly the pace and magnitude of wealth destruction have
been breathtaking. Whether the trillions of dollars being
thrown at banks and economies stop the rot remains to be
seen. Unlike governments in the West, the Chinese at least,
own the dollars that they are throwing, which presumably has
implications for the relative value of currencies going
forward.
The end game in the West must, in our view, be full scale
nationalisation of banking systems as being the only way to
cancel out the myriad derivative obligations that are said
to account for 1000% of global GDP (traditional bank loans
measure only about 80%). If this is the final outcome, the
mandarins in Beijing may start to think that the West has
finally come to accept the case for “capitalism with Chinese
characteristics”. |
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Just as,
arguably, this global crisis began in China, it will, in our
view, find its ultimate resolution there too. We trace the
origins of the successive bubbles of the last fifteen years
to the decision by the Chinese to devalue their currency in
1994 by 50% and then to run an artificially depressed
exchange rate ever since.
This, coupled with the never-ending supply of cheap labour
migrating to tax-incentivised coastal cities, resulted in an
export boom and the accumulation of huge trade surpluses in
both China and the neighbouring countries that supply the
raw materials and components to its manufacturing sector.
Hot money, betting on “inevitable” Renminbi appreciation,
augmented the monetary aggregates in China. Indeed we
understand that 75% of all savings since time began have
been accumulated in the past decade - mostly in Asia.
The recycling of these savings back into the developed world
resulted in low inflation and very low interest rates.
During such disinflationary periods investors tend to end up
chasing higher returns on the periphery, usually in
so-called “emerging markets”.
Hence the bubbles (followed inevitably by busts) that have
occurred initially in Asia in the late 1990s, followed by
dotcom exuberance at the turn of the millennium, property
throughout the period and more recently commodities.
The largest bubble of all, of course, took place in the
developed world’s own emerging market back-yard, the
sub-prime sector, with its impact, tragically, both
concealed and magnified many times over by the ingenuity of
investment banks.
China has the economic fire power, and just as importantly,
the political desire, given Communist Party insecurities, to
keep growth bowling along. Hence the dramatic interest rates
cuts and assorted fiscal measures that have been announced
of late with accelerating intensity.
The most significant measure, however, in our view, largely
overlooked in the West, has been the announcement in October
of land reform, allowing the country’s rural population the
right to buy, sell and rent etc. their allotments.
Just as the decision to distribute state-owned apartments to
factory workers for nominal sums from the late 1990s spawned
a property-owning middle class with all the obvious mortgage
multipliers, the new rules on farmland will have the same
impact on the rural community and on the pace of
urbanisation to the advantage of domestic consumption and
therefore our portfolio.
The ultimate test for the Chinese, however, will come, when,
as we anticipate, huge fiscal deficits in the West, put
downward pressure on the US Dollar and Euro. We will then
see whether the Chinese are willing to countenance an
appreciation of the Renminbi in keeping with their goal of
boosting domestic consumption and higher value-added
manufacturing.
Longer term we must all hope that China’s political
structures evolve sufficiently to relinquish the imperative
of growth at all costs, the cost this time round being
extreme pain in the West. |
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We have continued to
rationalise our portfolios removing holdings that are now
too small. This process is more or less complete in all
funds bar India where chronic illiquidity is making this a
challenge.
We expect to be allocating cash mainly to China and ASEAN.
Our dilemma remains that the top quality mid cap consumer
names are not yet that cheap. Like us, investors seem
reluctant to sell businesses that have emerged as long term
sector winners.
That said, we have no doubt that this difficult period will
separate the boys from the goats. Take for example the
decision by the founders of Natural Beauty, a chain
of cosmetic clinics across China, to try, with the help of
private equity backers, to privatise the company at a price
below the current market value. Whilst we are fairly
confident of being able to block this initiative, the
company’s reputation is now tarnished. |
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Lindsay spent a week in Seoul
with Shi Young. Korea is the one country in Asia suffering
from western style debt problems. Bank loan-to-deposit
ratios are at 140% (compare to India where that number is
about 60%). Household debt is now equivalent to 75% of GDP,
up from 35% a few years ago, and pre Asian crisis savings
rates of 16% have fallen to Anglo-Saxon levels of 2.5%.
As we often say, Koreans are incapable of doing anything by
half. For example, the deregulation of corporate pension
scheme rules in 2007 resulted in a wholesale shift of money
from bank deposits into the stockmarket – just at the wrong
time.
And then, to add insult to injury, Korean corporates punted
private pension schemes in weirdly named currency
derivatives (“KIKOs”, “Pivots” and “Snowballs”) with the
inevitable disastrous consequences. Worse still, Korean
banks (who acted as agents for the foreign banks selling
these derivatives) have, apparently, guaranteed the
liabilities of their end customers.
With Korea now representing only 6.9% of the Asia Fund, our
decision to de-emphasise this market appears to have been
the correct one. Our core holdings, AmorePacific,
LGH&H, Woongjin and Ottogi continue to
stand out in terms of business quality, albeit the first two
are still not as cheap as we would like. Meanwhile we are
completing due diligence on a couple of new ideas. |
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Following
one-on-one meetings with our US Endowment and Foundation
clients in New York in November (these account for about 60%
of our invested capital) we wish to update all investors on
the issue of redemption flows and notice terms.
There is no doubt that the Endowments are, as has been much
publicised, facing a degree of liquidity pressure. Gifts
from alumni, which have helped to fund annual commitments to
pay for research, bursaries and new building projects,
appear to have dried up. Meanwhile cash calls from private
equity portfolio managers are no longer being met by cash
distributions from more mature funds.
The reaction to these liquidity constraints has been, for
the most part, to raise cash from holdings in hedge funds,
particularly those with onerous lock-ups.
We came away with the impression that, unless global markets
ratchet significantly downwards again, our US investors are
more inclined to add to their holdings in emerging markets
which have, due to market action, fallen well below target
levels.
The fact that many of our competitors are withdrawing from
the small cap space, resulting in ever more pricing
anomalies, supports the case. Increasingly we find ourselves
as being the first port of call and, invariably, the only
bidders for blocks of stocks that come out of the woodwork.
With respect to redemption notice terms, it would seem that
our relatively “open” redemption provisions (28 days notice
on a daily dealing basis) have, counter-intuitively, helped.
The fact that our investors know that they can file a
redemption instruction on any day of the month has meant
that they have not felt the need to file precautionary
redemptions. We have no plans to change our current
provisions.
Therefore, although the global outlook remains uncertain, we
are minded, following feedback from our meetings in New
York, to slide some of our cash holdings of about USD 90
million back into the markets given the very attractive
prices now available, especially in the small cap space. |
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