World in upheaval
Apollo Asia Fund: the manager's report for 1Q2011

The Apollo Asia Fund's NAV fell 3.8% in the first quarter, to US$1,222.46: over the last twelve months it was up 24.4%. charts.

Activity during the quarter was light: we added modestly to three holdings, trimmed four, and completely sold out of one very small stake. Our additions were mainly in Japan; our sales mainly in Southeast Asia. In the short term this has done nothing for performance. Had we done nothing, the combination of share price and currency losses post-tsunami would have reduced the dollar value of our Japanese holdings by 8% at the end of the quarter, and we started with a 10% Japanese weighting. Since we increased our holdings, the headwind was a bit more; and both prices and currency have declined further in the first days of April. Nevertheless we have continued to make modest additions. The Japanese business environment is hard to predict in any detail - will government spending on healthcare rise or fall? - but it still seems a good hunting ground for companies of high quality. Valuations seem reasonable in relation to assets, and go far to offset the heightened risks.

At the end of March, our portfolio was on an estimated current-year PE of 13.2, with a dividend yield of 3.1% after Asian taxes. Over the three years since March 2008, through the global economic crisis and immediate rebound, portfolio EPS have grown by 30-34% (30% for the "historic" figure, 34% for the estimated "current year" figure, at each date), representing compound growth of 9-10% per annum. If we could achieve such growth in future we would be more than happy, so investors hoping that we might repeat the much higher growth figures of earlier years should look elsewhere. This is partly a function of size (there are always cheap micro-caps, which we can no longer enter and exit in meaningful size), but more a reflection of the opportunities and the increasingly-large business risks which we see. Part of the early growth came from market re-rating: we would not count on that for the future.

Energy and resource constraints, political consequences, and environmental disasters dominated the headlines in a quarter which started with the Queensland floods and Aflockalypse, and ended with the Tohoku earthquake, tsunami and nuclear emergency, after an Arab Spring set convulsions in motion through much of North Africa and the Middle East. Limitations for coal, oil, and nuclear all became clearer; strategic imperatives and dilemmas came into focus; efficiency suddenly seemed less important than resilience. The number of people thinking about resource limitations and the conflict with business-as-usual growth projections increased dramatically.

In looking at the impact of higher energy prices and supply hiccoughs, I decided to look at production / consumption of all forms of primary energy (rather than just oil), and related the net exports / imports to domestic consumption (as a measure of the impact relative to the current size of each economy) and to population (to measure per capita impact). The results can be seen in the table on the left, showing key Asian economies along with other big winners and losers, and some reference figures for comparison. From this perspective, Norway is by far the biggest winner: much of its own energy usage comes from hydro, and it has only a small population to share its large energy endowment. Russia is by far the largest exporter of energy, but the windfall for Kazakhstan and Australia is much bigger per capita. The benefits for Indonesia and Malaysia are spread over larger populations, but are very substantial in relation to their domestic economies.

Overlooked in such a table is the distribution of the wealth, and the calibre of resultant investments. Restless populations in Saudi Arabia and Egypt feel that they shared little of the energy windfall. Much has been frittered. Only Norway looks wise, with its petroleum fund, but energy revenues doubtless trickle down more equitably in Canada and Australia than in Indonesia and Malaysia.

Taiwan, Korea and Japan import essentially all of their fossil fuels, with nuclear and hydro contributing 10-20% of consumption. Thailand and India, too, are now very dependent on imports, having reduced their fossil fuel endowments more recently. China, until recently self-sufficient in coal, is much less vulnerable in relative terms, and is the main manufacturing competitor of all five of these economies. The richer, higher-technology exporters in North Asia may be better able to absorb and pass on price increases than Thailand and India.

To talk of oil-equivalents is to simplify, of course: gas is typically priced on long-term contracts; oil is indispensable for now in the transport sector; coal remains relatively abundant; oil reserves are the hardest to replace. Yet the mix can vary significantly over time, and from country to country, whereas energy usage remains strongly correlated with GDP growth. Energy constraints imply growth constraints. Few countries are yet thinking rationally about national objectives to replace the idiotic obsession with GDP, and few have coherent energy policies.

Emerging economies can do more than developed economies with each unit of energy. Consider the motorised trishaw delivery model, compared to that of Los Angeles. So Asia may continue to outbid the west for supplies, as it has since 2005* - provided that this remains a question of price. The assumption that supply will always be forthcoming at the right price has been commonly taken for granted, but it is probably time to make it explicit, and to start to ponder other possibilities.

With so many emergencies simmering quietly around the world, generally untreated due to the global preference to extend and pretend, it would be foolish to predict which will be next to the fore. However, I believe that the next few decades will be very different from the last few, with resource constraints and environmental limits increasingly pressing, and energy at the heart of the changes. The geographical mix of the portfolio may not appear to take much account of the analysis above, but our risk assessment for sectors and individual companies has been more affected, and our stock selection remains bottom-up. Thoughts from our readers on appropriate positioning would, as ever, be very welcome.

Claire Barnes, 8 Apr 2011