Apollo Investment Management

Not a normal cycle
Apollo Asia Fund: the manager's report for 3Q2011

The Apollo Asia Fund's NAV fell 6.6% in the third quarter, to US$1,238.60: over the last twelve months it was up 8.2%. charts.

At the end of September, our portfolio was on an estimated current-year PE of 11.8, with a dividend yield of 3.4% after Asian taxes: these numbers appear more attractive than since the spring of 2009.

The outlook, however, seems much trickier now. Too many western economies, having hurled taxpayers' money indiscriminately at the banks without allowing normal bankruptcies and restructuring, have catapulted themselves into a debt trap from which it is hard to see any satisfactory exit route. Debt dynamics alone would now make a return to sustainable growth difficult1-2; resource constraints and rising ecological costs compound the problem3-4.

Geographical breakdown
by listing; 30 Sep 11
% of assets
Hong Kong
Net cash & receivables

Complacency on Asia's prospects seems misplaced. The region remains as export-dependent as ever. Hopes that weakness in US & European demand can be offset by growth in emerging market consumption seem implausible; and after the greatest stimulus money could buy, it is hard to see what China could do for an encore. Asia-ex-Japan may not have the sovereign debt and social security problems of the west, but the region is not debt-problem-free, and may not be able to maintain the levels of growth to which it has become accustomed.

Asian equities are now priced to discount cyclical squalls; they are not priced for an ex-growth global economy. Stock selection is therefore complicated, as we envisage poor secular prospects for a number of formerly strong industries, and relatively subdued growth for others which are priced for perfection.

We continue to find Japan an interesting hunting ground, as the very clear headwinds facing both domestic and export sectors are acknowledged more openly than elsewhere, and seem more likely to be priced in5. We continue to increase our holdings there, albeit at the pace of a snail.

The long decline in our weighting in Hong Kong is quite striking. For the first half of Apollo Asia Fund's life, Hong Kong listings usually represented over 40% of net assets, and sometimes more than 50%. Part of the reduction is explained and mirrored by the rising weighting in Singapore: almost half of our Singapore-listed stocks have Hong Kong alternatives in their history, and a higher proportion is regional enough that they might well have done so. But part reflects the difficulties faced in recent years by the large number of Hong Kong listed companies manufacturing in China for export, and our lack of conviction that China consumption plays will be able to maintain recent levels of growth and justify current valuations.

Over the three years since September 2008, the unsatisfactory 'extend and pretend' response of the western world to fundamental imbalances has caused us to position the portfolio with increasing caution. Despite this, 'historic earnings per share of the portfolio' have grown 41%, its estimated current-year dividends have grown 28%, and its book value has grown 48% (annual growth of 12%, 9%, and 14% respectively). If we can do as well over the next few years, we would be very happy. Expectations for the future should be guided by the current earnings yield of 8.4%. In the past we have been able to improve on this by good fortune in stock selection, offsetting our mistakes and our costs. The future may be very different from the thirty years of our Asian experience, during which Asia has boomed; and as we attempt to pick a route through the minefield, our luck may not hold.

We urge all our investors to reassess their asset allocation, and in particular any assumptions about Asian growth which may have been forged in a different era. The export machine faces headwinds which may be secular, not cyclical. Energy self-sufficiency has given way to constraints, and to growing shortages. Pollution is becoming a huge problem. Climate change is becoming expensive. (Some of our companies suffered in the recent Thai floods.) Destruction of the commons over the last thirty years has been monumental. Mangroves are gone, rainforests are gone, coral has gone, fish are gone: natural resources which seemed infinite have shrunk to tiny, endangered fractions in the space of three decades. The exploitation of these may have boosted GDP in past decades. Replacement activities such as fish farming may boost GDP in the future - but the easy stages of development are in many places behind us, and stored problems are mounting. Despite all this, Asian equities still seem to us a reasonable place to try to preserve real purchasing power - but this is a different proposition from that of the past.

Claire Barnes, 16 October 2011

  1. 'The problem I have with the investment universe is that I find it difficult to envision how the US and Western Europe could return to healthy, sustainable growth without a complete purge of the financial system and a catalytic event that restores some measure of social cohesion among people. This catalytic event could be hyperinflation, a complete credit market collapse (widespread sovereign defaults) and pronounced deflation, civil strife, or a major military confrontation... I'm not sure what this catastrophic event will be (possibly all of the above successively) or when it will happen. But I have a high degree of confidence that another crisis of some sort will occur and completely "reboot" the dysfunctional economic and political system we have at present in Western democracies.' Marc Faber, The Gloom, Boom & Doom Report, 29 Sep 2011. (See also recent comments on CNBC).)
  2. 'Thinking the unthinkable: might there be no way out for Britain?', Dr Tim Morgan, Tullett Prebon, July 2011.
  3. The End of Progress: how modern economics has failed us, Graeme Maxton, John Wiley & Sons (Asia) 2011, ISBN 978-0-470-82998-1.
  4. The Wealth of Nature: economics as if survival mattered, John Michael Greer, New Society Publishers, 2011, ISBN 978-0-86571-673-5.
  5. Arcus Investment recently quoted earnings growth figures for 2000-2010: 11% for Japan's Topix, outpacing Hong Kong, Singapore, Malaysia, and Australia. Investment sentiment seems disproportionately coloured by market performance, perhaps failing to distinguish between fundamentals and rerating. Arcus put Topix PE in late Sept as 10.6, with P/B 0.84.

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