How I flex the portfolio to capture growth without sacrificing income

Sat Duhra of Henderson Far East Income discusses the investment trust’s performance, under-the-radar shares, the risks and opportunities he’s seeing in Asia, and how he’s currently invested in China.

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Dave Baxter, senior fund content specialist at interactive investor: Hello and a very warm welcome back to our Insider Interviews series. 

I’m Dave Baxter here at ii and today our guest is Sat Duhra, portfolio manager on Henderson Far East Income Ord (LSE:HFEL) Investment Trust. Sat, many thanks for joining today.

Sat Duhra, portfolio manager of Henderson Far East Income: Thank you.

Dave Baxter: So, turning to performance to start, it has been, I would argue, a mixed bag. On an absolute basis, it does look very strong, particularly in the last year, but the trust is lagging its rivals and even the markets. How would you explain that? 

Sat Duhra: Yes, if you look at our positioning, it’s more broad-based than our peers. I mentioned some of the themes earlier. We talked about financial inclusion, infrastructure, those kinds of things. We think there’s some great stories emerging outside technology.

However, the index has had a very narrow move. Three or four stocks have been driving the index forward. The likes of Samsung Electronics Co Ltd DR (LSE:SMSN), SK hynix Inc ADR (NASDAQ:SKHY), Taiwan Semiconductor Manufacturing Co Ltd ADR (NYSE:TSM), and they’ve become a much bigger part of the benchmark than even a year ago, and the rally seems to be getting narrower and narrower. The risk for that is that we’re buying names that are becoming more expensive and also have a lot of risk around monetisation of AI and so on.

We like the broader story that’s emerging in Asia and we want to stick to that. In the last 12 to 18 months, those names have performed exceptionally well and we still own those names. So, we do have Hynix, Samsung and TSMC, we have all those names and they’ve done very well for us. However, we do have to manage that exposure because, ultimately, we are a value and income fund.

If you look at periods, for example, when we did that repositioning at the end of 2023, there was a period then of six to nine months where we outperformed the index and all our peers because there was a broad market move, so we benefited from our value names in South Korea and India, and that worked really well for us.

But when the market really narrows down to just a few technology names…income and growth funds are very similar now, and people seem to have the same TSMC, Samsung and whatever in really big sizes. I think that’s a risk going into the second half of this year, where we [fore]see a lot more volatility.

If you look at the volatility recently, that’s actually worked quite well for us. We have been more defensive than all our peers. We have been performing better because of that. So that broad-based exposure to Asia, I think over the long term, is the best place to be. But obviously, when you have periods where you have a very narrow market leadership, that will be negative for us.

Dave Baxter: You talk about being more defensive. Are there any particular companies in the fund that stand out as serving that purpose? 

Sat Duhra: Recently, I would say the telecommunications sector and financials have been rather defensive. It’s not that we’re stuck in these names because we think they will just not lose capital, there’s actually a great story there. 

For example, Taiwanese financials and Singapore financials have been doing really well. Even Chinese financials over the last couple of years have performed well. These things actually have their own story.

Energy is doing well and we have energy exposure. They have very high yield in those particular exposures that we have, but also they’re performing well, obviously on the back of the rising oil price, but also increasing dividends and so on. 

There are a bunch of other areas, telecommunications is also a beneficiary of AI. These data centres get built, but they have to be connected up. So these are the people who are doing that, and they’re also paying very high dividends. The capex of yesteryear, some of these crazy spectrum auctions, which really put a lot of pressure on the balance sheets, that’s over. Now we see high free cash flow, balance sheets getting stronger, and that’s been a good area as well.

So, there’s a number of areas that are really performing in a resilient manner, which are things that appeal to us. They have value, they have income, they have strong balance sheets. So, alongside that we try and manage that balance. 

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Dave Baxter: We could talk all day, if we wanted to, about the TSMCs and so on, the big beasts of the index. Which promising, lesser-known shares sit in the portfolio at the minute? 

Sat Duhra: There’s a layer below these big technology companies. Of course, these are the direct beneficiaries of AI, but there are some more indirect beneficiaries, so the second-order effect. That’s something like Keppel Ltd (SGX:BN4) in Singapore. It’s a company we’ve owned for a little while now. It has transformed itself from being an oil and gas company, offshore marine and so on, and property development in China and other places. It’s selling down those exposures and using the cash to reinvent itself as an infrastructure company. 

For example, it does subsea cables, it has power generation, it does data centres. It’s really in the mix when it comes to AI, but it’s making real money. There’s real exposure there for things that are going to last for years and years to come. 

The market is rewarding that repositioning, but it is also leading to higher dividends. We think that dividends will increase as the years go by and as they sell down some of those property assets, they will continue to reposition the business. So, we think that’s an interesting story and also a beneficiary of AI. 

Dave Baxter: Is there much in the way of those picks and shovels plays at the minute relating to the AI boom and all of that?

Sat Duhra: There’s a whole bunch of them and they are something we’ve been looking at. We’re taking some of our exposure down from the large-cap, more obvious names and adding to these kind of names. 

For example, Contemporary Amperex Technology Co Ltd Ordinary Shares - Class H (SEHK:3750) in China, the largest lithium battery player in the world, which provides batteries for Teslas and BMWs and so on, but also energy storage. So, energy storage is a really key theme when you think about infrastructure, and that’s something we really like. 

We really want to broaden out the base of exposure for our portfolio. We don’t just want to be sitting there with about 30% in three names and just have the benefit of this narrow move. What happens after that? We’ve seen volatility in recent times, and that’s been beneficial for us in a relative point of view. We’ve been more defensive because of these kinds of things. They produce real cash flow, they are still cheap, they have strong balance sheets, and they are not really well covered and people don’t really talk about Keppel or CATL as much as they do about some high-tech Taiwanese and Korean names.

So, there’s a whole bunch of the market that’s been ignored. Thailand, for example, has done very well. We’ve been adding to Thailand in recent months, so there’s a whole bunch of things that have been ignored in this whole AI rush. 

Dave Baxter: If we gaze out now to the next 12 months or so, what would you say are the biggest risks and the biggest opportunities for Asian equities? 

Sat Duhra: The risks really are currency, geopolitical, and those things that we talk about affecting South Asia, government policy risk. 

South Asia still faces those risks in terms of inflation and so on. Inflation will create some dislocation in some of those markets, and that’s something to watch out for. Now, the way we mitigate that is obviously our exposure is more North Asia. So, we have less to be worried about when that happens and, actually, it’s happening now.

The opportunities really are very significant because some of these trends that have been emerging for a number of years now, when we talk about some of these consumer companies, for example, China going overseas, we talk about technology supply chains, infrastructure, but also corporate reform. These things are here to stay. So, the corporate reform we’re seeing outside Japan is some of the most compelling initiatives from regulators to boost dividends, boost buybacks and simplify corporate structures.

That’s happening in Korea because obviously that was the first player that took a leaf out of Japan’s book. China is doing that and people don’t realise how much China is pushing companies to explain why they’re trading below one times price to book, getting state-owned enterprises (SOEs) to pay more dividends and buybacks, and so on.

It’s happening in Singapore. There’s an equity programme going on from the Monetary Authority of Singapore (MAS) where they are encouraging more investment into the market. See more dividends, more buybacks, that’s very positive.

Even in Indonesia, there’s a sovereign wealth fund that’s taken charge of the SOEs, and some of the yields there can be 8%, 9%, 10% for companies. So, there’s whole bunch of things going on across Asia that are very positive, and that will survive any kind of meltdown in AI, if that happens. 

Dave Baxter: Let’s return to China. That’s always been a source of quite a lot of debate in the last five, six years. It did rally quite hard last year, but it’s lagged some of those more AI-focused markets like Korea. What’s your view on China, and how are you invested there? 

Sat Duhra: Ithad a really poor period of three or four years and then reasonable more recently, partly because of AI. There’s some very strong AI players in China, some of them are not as well known, but a lot of IPOs with these names, that has driven the market in the right direction because they have just performed so well and people are scrambling to buy these names.

That’s an interesting area, but it’s not really for us because we look for companies that are actually generating good free cash flow, that have strong balance sheets and are a bit more established, where we feel there’s less risk, certainly from a management point of view as well.

But the one area that’s really being kind of ignored by foreign investors is the high-yield names in China. If you look at, for example, some of our best performers over the last 12 to 18 months, they have been China financials. Insurance has done very well in China, aluminium, China Hongqiao Group Ltd (SEHK:1378), which is the largest aluminium manufacturer in the world, had an 11% yield when we bought that, and then it doubled.

So, there’s a whole bunch of names there, and with some very high-yield exposures in China. The trend is quite positive for that because interest rates are falling in China, bond yields are falling, and domestic insurance companies are being told to buy more domestic equities. This is why these high-yield companies are still performing very well. They’re also very defensive. 

So, on days when you see a bit of a shock to AI names, these kind of names outperform. So, we think that’s a good part of the market. 

Having said that, we don’t really like the macro in China. We think there’s a lot of risks, property is still very weak and until that recovers consumer sentiment just won’t recover. I think it’s a real drag on overall growth as well. That’s something I don’t think is going to happen in the next few months. I think the macro will be under a lot pressure.

So, it will keep us probably underweight in terms of the overall China position. But within that, those high-yield names are very attractive. Batteries, CATL are very attractive. There are a few other things in technology that are emerging as very key exposures as well. 

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Dave Baxter: How much of a black swan is the regulatory risk and so on in China? We saw people get pretty blindsided by a regulatory crackdown back in 2020, 2021. 

Sat Duhra: Yeah.

Dave Baxter: How is that looking now?

Sat Duhra: It seemed to have died down for a while. Then recently we’ve seen some more of that regulation. It is a risk, and if you invest in China, that’s something you have to be wary of. 

In terms of our exposure in China, most of it is probably more state-owned enterprise exposed. The risk there is much less because the government has a share in those businesses and what they are focusing on is really boosting dividends and simplifying structures and making them more efficient. So, there’s a lot of that going on.

They want to boost the return on equity (ROE) of these companies the same way Korea and Japan are doing. There’s a drive under way to boost performance of these SOEs. I think that’s a good place to be because they are paying very high yields, and they have resilient balance sheets. 

I think some of those risks around local government financing vehicles, around the property market are starting to dissipate to a degree. I mean, they’re still there, but they’re certainly not as bad as they were three years ago, and that created an opportunity for us a couple of years back to go into those names, and they’ve done well since.

So, it’s not a great exposure for us, but it’s something that is ignored and creates potentially some great opportunities. 

Dave Baxter: We have covered this to an extent, but Asia and the emerging markets recently have gathered some of their own concerns around market concentration and the concentration of returns. What’s your view here and how are you dealing with that as a fund manager? 

Sat Duhra: We used to look at the US and the concentration risk, and now our markets are even more concentrated. So, I think it is always a risk. Because, as you said, there is a lot of retail participation, for example, in Korea. There are two times, three times leveraged ETFs on single-stock names.

There are some orange flags coming up on some of these things, and we just want to be a bit wary of that. The index is very much dominated by these big technology companies, which are actually really high-quality, high growth companies. So, it’s great and we have exposure to that, but we have to manage that risk.

Again, as I say, we want a broad balance in terms of country and sector. We think that when there’s a bit of a shake-up in some of these names, then that will be good for us from a relative point of view in terms of relative performance.

We’re seeing that on some of the days when there is a bit of a shake-up in some of those AI names. So, I think that it is a risk to our markets, because if the AI story does fall over, then obviously a market like Korea will be very severely impacted.

So, we have been managing down some of those exposures and moving into some of these second derivatives of AI. Also, these other stories that are going on outside that in the financial space, for example, or infrastructure or whatever it may be.

So, it’s something that one has to be wary of, and we don’t look at the benchmark in that respect. We don’t have an official benchmark, but our objective is very clear, to grow our income. So, income is a key focus.

But what we’ve shifted since the end of 2023 is the income and, alongside that, exposure to these great themes. Some of that sometimes has been India, currently it’s technology, but we will move the portfolio where we see appropriate to capture that growth, but not compromise on the income. That’s really the key thing that we do. 

Dave Baxter: Finally, our usual question, do you have skin in the game? 

Sat Duhra: Yes, so I invest in the fund. It’s important to do that. I go around speaking to clients and telling them about the fund, so I should be invested too. That’s a very important thing and I will continue to do that in the years ahead as well. 

Dave Baxter: Sat, thanks for your time.

Sat Duhra: Thank you very much. 

Dave Baxter: And thank you for watching. As ever, do let us know what you think in the comments. And if you’re a big fan of this series, hit the like button and the subscribe button. Thanks and take care.