Defensive stance pays off against tough backdrop

In the year to 31 January 2024, despite a negative share price total return (-1.9%), Pacific Assets (LSE:PAC) far outstripped the performance of its immediate peers as well as the MSCI AC Asia ex Japan index, which fell more than 10%.

Given the inflationary pressures in the UK, the long-term comparator of UK Consumer Prices Index +6% proved too high a hurdle to surpass. Nonetheless, the team’s navigation of Asia-Pacific markets delivered investors meaningful relative outperformance against a tough backdrop in which US performance continued to eclipse Asian markets.

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Pacific Assets is one of our ACE 40 list of fund ideas and invests in a sustainable manner. The investment trust looks for high-quality companies with sustainable and predictable businesses. It is a concentrated portfolio but, as explained below, it invests in a defensive manner.

The numbers in detail (for financial year to 31 January 2024)

Share Price Return: -1.9%
Net Asset Value Return: -1.3%
Benchmark one: Consumer Prices Index +6%: 10.4%
Benchmark two: MSCI All Country Asia ex Japan: -10.5%
Dividend: 4p (+1.7p vs prior year)
Discount: -9.2% (vs -8.6% in prior year)
Gearing: Nil

Outlook

In spite of most regions underperforming US markets, the investment trust believes in the long-term growth drivers of Asian markets, such as technological and infrastructure advancement, as well as a growing middle class increasing consumer demand.

Portfolio

It is no surprise that Pacific Asset’s portfolio still broadly favours India (42.5% of the portfolio). This is not a macro decision based on demographics or GDP figures, but a product of where management perceive sustainably minded quality companies are most abundant.

In contrast, China has been an area it has not had much exposure to, due to valuations and the corporate structure of Chinese companies. However, a recent development is the manager’s excitement regarding a subset of Chinese companies. A broad de-rating of China’s markets, while painful for many other Asia-Pacific investors, has allowed the team to inch up the allocation to the region – a trend the manager expects to slowly continue.

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The valuation opportunity has led to marginally increasing turnover (18%), as new positions were initiated in Chinese consumer discretionary names (Hangzhou Robam and Midea Real Estate Holding Ltd (SEHK:3990)), as well as across sectors in Indian, Indonesian and South Korean markets.

Dividend

A proposed dividend of 4 pence per share (+1.7 pence) versus last year reflects strong distributions within the portfolio and the trust’s requirement to pay out 85% of earnings. Investors likely won’t buy Pacific Assets for its distributions, but it is a welcome boost to the total return in the year.

Discount

While the current discount of near -9% represents a marginal cheapness compared with the trust’s five-year average, the effects of discount movement during the reported period were minimal as the trust started and ended close to the 9% mark. The discount is similar to peers in its sector.

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In spite of a small negative return, meaning the trust did not beat its long-term UK inflation +6% target over the year, investors should be heartened that Pacific Assets avoided the drawdowns that befell many peers and the MSCI AC Asia ex Japan index. The trust retains its strong track record, outperforming the MSCI All Country Asia ex Japan index by an annualised 2% and 3% over five and 10 years.

What is more, this performance has been achieved with lesser volatility than peers/benchmark and without the propellant of leverage. Stewart Investors are a market leader in the field of sustainable investing, and the bottom-up process looks for companies contributing to sustainable development, believed to be the businesses best posed to deliver long-term returns to investors.

The year’s results are testament to a key attribute of Pacific Asset’s long-term, quality-focused approach – protecting the downside in times of market stress. This is no simple task when investing across naturally higher-risk emerging regions. The concentrated portfolio holds companies boasting careful management, strong franchises, healthy cash positions and minimal debt burden. It is a combination well placed over a longer time horizon to weather storms that have so frequently befallen Asian markets recently.

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The principles of prudence that the team seek in their investments are mirrored in the manager and board’s own stewardship of the trust. The defensive approach includes the board’s decision to not leverage, which could leave returns on the table when markets rise. However, as seen in the reported period, this avoids exacerbating drawdowns when markets are volatile and evades the costs associated with borrowing that eat into returns.

In recent years, the dominant allocation to India has been a tailwind for the trust and is a long-held differentiator of Stewart Investors’ strategies. However, given the run-up in Indian valuations and prior proximity of the trust to its own internal country exposure limits, it is encouraging to see that market conditions are allowing the team to find opportunities that fulfil financial quality and sustainable criteria to increase regional diversification.

Lastly, a strong year of dividend payouts for portfolio companies has grown Pacific Assets’ revenue, thanks largely to strength in the financials sector. While yield is not a goal of the trust, this has translated to growth in the dividend and a healthy addition to the revenue reserve. Investors should not expect this level of distribution to be maintained. Instead, it can be read as an encouraging insight into portfolio companies’ strong earnings and healthy balance sheets, despite a slight softening of valuations across the trust’s holdings in the year.