Interactive Investor

Why this is the best long-term investment opportunity

Edmund Harriss, manager of Guinness Asian Equity Income, explains that having a third of his fund invested in China is possibly the best long-term opportunity in his portfolio.

25th April 2024 09:08

by Kyle Caldwell from interactive investor

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Unlike some of his peers, Edmund Harriss, manager of Guinness Asian Equity Income, is sticking to his guns on China. He outlines the concerns around China, but explains that having a third of his fund invested in the country is possibly the best long-term opportunity in his portfolio at the moment due to valuations for the market being at their lowest level for more than a decade.

He also tells interactive investor’s collectives editor Kyle Caldwell why the fund has some exposure to US-listed businesses, why only a small amount is held in India, and how the way in which he invests seeks to smooth the ride for adventurous investors investing in Asia.

Guinness Asian Equity Income is a member of ii’s Super 60 list of fund ideas.

Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to our latest Insider Interview. In the studio I have with me Edmund Harriss, fund manager of the Guinness Asian Equity income fund. Edmund, thanks for coming in today.

Edmund Harriss, fund manager of the Guinness Asian Equity income fund: Nice to see you.

Kyle Caldwell: Edmund, when I last interviewed you on camera (during the pandemic around three years ago), the fund had around one-third of its assets in China. Today, the fund still has around one-third in China. Could you talk us through the investment case for China, particularly given the fact that its been a poor couple of years for its stock market?

Edmund Harriss: Youre quite right. China allocation remains the same, around a third of the fund. The long-term investment case for China is households growing wealthier, a manufacturing base that is becoming ever more sophisticated and, frankly, low valuations.

The concerns around China at the moment are surrounding the move from property sector-driven growth into longer-term industrial growth in areas such as sustainable energy, telecommunications technology, electric vehicles and the like.

There have been concerns that as the debt associated with the property sector unwinds, the financial system may come under strain and may, in fact, be a fundamental risk. That has caused valuations to drop significantly. So, Chinas long-term valuations are trading at multi-year lows. They havent been this low for over 10 years.

So, what we are doing is looking for businesses in China that are still operating and producing superior returns. They are still able to successfully grow profits in an environment where valuations are still low. We can see that theyre doing well because the dividends are still coming through and the dividends are still growing. So, we see no reason to change that. It is possibly the best long-term investment opportunity in that portfolio at the moment.

Kyle Caldwell: One thing that stood out for me is that you have 10% in the US. Some investors may be surprised to see that, given that youre investing in the Asia-Pacific region. Why do you have exposure to a developed market, and how much can you have in the US?

Edmund Harriss: We have the opportunity to invest in companies that generate more than 50% of their revenues from within the region, but are listed and traded elsewhere. There are about 25 such companies in our investable universe as we define it, and so we can pick one or two of those.

Weve got three names, two of them technology names, one is an insurer. In the technology area weve got Broadcom Inc (NASDAQ:AVGO), a chip design software service; Qualcomm Inc (NASDAQ:QCOM), a chip designer particularly focused on the smartphone area; and we also have Aflac Inc (NYSE:AFL), a healthcare insurer with a very large business in Japan.

These just add an extra opportunity to the portfolio. We have 10% because we have three names, 2.75% in each. Theyve done well, so they now account for around 10% of the portfolio. We dont have a hard limit on how many companies we can have, with 25 names traded outside the region versus another 600 or so that are traded in the region. We would expect the majority of holdings [to] be Asian companies listed and traded in Asia, but there are some interesting opportunities out there.

Qualcomm is a big provider for the Chinese smartphone providers, but also to Apple, which is manufactured in China. About 65% of their revenues are coming through from Chinese facilities. Something like Broadcom, which is a big beneficiary of the AI theme as well, but they are generating revenues from around the region, from Taiwan, from Korea, from China. Its a Singaporean company originally, but weve headquartered in the United States.

Were still looking to generate Asian exposure, but were not going to be too dogmatic about where were going to find it.

Kyle Caldwell: I wanted to ask you about India. It comprises only a very small part of the portfolio. Why are you not finding opportunities?

Edmund Harriss: It certainly is [a small part] at the moment in terms of the weighting. There are a lot of good companies in India,[but] they trade very expensively. When I say good companies, I think in terms of their returns on capital theyre good, but the corporate governance is not so good. So, its quite a tricky area to invest in and weve had a few false starts in that market.

Weve got one name at the moment in the form of Tech Mahindra in the IT services area. There are one or two other names that I am interested in, but they are relatively more expensive than opportunities I found elsewhere. So, for the present, we just have one name. The Indian market has done very well over the past couple of years or so. Primarily driven by domestic Indian investors. I dont think foreign ownership levels have increased significantly over the last couple of years or so. So its been quite an interesting dynamic there.

If we just look at relative valuations, and we express these valuations in terms of multiples of earnings, India at the moment is trading on around 18 times annual earnings, whereas China is trading on around 10 times annual earnings. And if we look at the growth between the two, the growth there is faster than we see in China. Both of them are over 10% growth, but China is trading at much lower multiples. So, I tend to tilt that way.

But India is a market that is included in our universe. Were always looking for ideas there. I think good ideas are quite hard to find. A good idea means youve got to have a good company. The profits are going to be there, the dividends have got to be there. But then it has to be priced at a level that doesnt fully reflect that, and thats where the sticking point is for me right now.

Kyle Caldwell: Investing in Asia Pacific, its more of an adventurous investment area, so its important for investors to take a long-term view. Are there any particular risks at the moment that are concerning you for your strategy?

Edmund Harriss:It is an interesting question because what were seeking to do is take the adventure out of investing in Asia by looking at companies that, for the last 10 years or so, have a track record of superior performance on a global comparison basis, never mind a domestic one.

Our focus, therefore, is on companies that have access to international marketplaces for their products, but also have a lively domestic marketplace for their goods. When Im thinking about risks associated with that, it is risks to those businesses. Will that be taken away from them? We have geopolitical risks that are often talked about, so we have to think about that. We have local politics, economic policies and industrial policies to think about, plus regulatory evolution, whether [those things] are going forwards or backwards, whether the regulation is helpful, providing clarity and structure to a market and order, or whether it is disruptive and playing to vested interests. All these need to go into the mix.

From our perspective, your research and the questions have to distil down to two. At a business level, will the returns of the past persist? And does the current market price reflect that? So, two questions to think about, and the first one is: will the returns persist? Is the operating environment for that business stable? Is it a fair playing field? Is there a market for this business? Is it growing? Is there cash associated with it? Does it have investment opportunities? All of which are designed to decide whether the cash flows and the dividends we see from them are coming.

Then we have the market question. The market question is a function of what we think about the business. But it also [means we must] think about inflation, interest rates and what the Federal Reserve is going to do. It also comes down to whether the political environment is stable, whether there is going to be some other sort of factor that throws out valuations. But it is about building blocks.

The approach of buying quality businesses has been tested quite thoroughly over the last 10 years or so. Weve had a couple of China slowdowns thrown in there. Weve had Brexit, which caused questions over the European financial system. Weve had a pandemic. Weve had major disruptions, therefore, to business. Were our companies able to survive and thrive in that environment? The answer is yes. They have produced a steady set of returns that is consistent with 6% average annual earnings growth over that period and around a 3% to 4% dividend yield. And the returns from the portfolio have reflected that.

But youre right, its a long-term view that youve got to take. As an example, through that Covid period, the market took a very dim view of Asian companies and sold them off hard. Yet during that period, the companies themselves continued to perform very well operationally. It took two years for the markets assessment of that profitability and the underlying performance to come back into line. If you were able to have confidence in those businesses, setting aside what the market thought about it at any given moment, you would have done fine.

Kyle Caldwell: Finally, Edmund, do you have skin in the game?

Edmund Harriss: Yes, I do.

Kyle Caldwell: Edmund, thanks for your time today.

Edmund Harriss: Thank you.

Kyle Caldwell: Thats it for our latest Insider Interview. I hope youve enjoyed it. You can let us know what you think. You can give us a like, you can subscribe, you can comment, and hopefully Ill see you again next time.

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