Inevitably there have been some individual disappointments, but overall our companies have been doing fine - and because we have occasionally sold shares which become temporarily expensive to reinvest in others which seem more attractive, the look-through numbers for intrinsic business performance of the portfolio have been even better. The decline in the market valuation is more than entirely explained by derating, with the current-year PE of the Fund's ordinary shares at year-end 5.7, the lowest for over two years. The dividend yield, after Asian taxes, is 7.9%.
"Current-year PE" is based on the expected results of each company for the next full financial year to be reported, which for all but one of our companies now means for a year ending between Dec 2000 and Mar 2001. This figure is representative of recent and current trading, neither insisting on final statistics which are Old History, nor attempting to guess conditions too far into the future. Usually our current-year earnings estimate is not too different from the outcome. (We have an order-of-magnitude less confidence in the forecasts for each year further out.) Over the last two years, the portfolio NAV has risen by 80%, the end-year estimate for "current portfolio earnings" by 97%, and that for "after-tax portfolio dividend" by 132%.
2001: A Space Odyssey? Fasten your seat belts
Complacency in the US is gradually giving way to concern, and even to consternation. Volatility was rising during the latter part of 2000, and the record-breaking whipsaws and trading volumes of the first two trading days of 2001 justify labelling the US as the greatest emerging market of all time - as does the prevalence of poor corporate and fiduciary governance, abysmally low analytical standards, and extremely creative accounting. I remain acutely nervous about the systemic risks emanating from the US, where the excesses of an 18-year bull market are now just beginning to unravel. So far this has been a "water-bed market", where confidence in equities as an asset class has remained remarkably strong; the response to the devastation of technology stocks has been to bid up the old-economy staples, often to valuations exceeding those of the "nifty fifty" of early-70's notoriety. My assumption is that the US market may have reached "the end of the beginning" of a primary bear market, and that the so-far-resilient S&P500 may be about to embark on a significant decline.
This in turn could have momentous implications for the US economy and financial system, which might be capable of sending tidal waves around the world. This is an outcome for which Asian investors have been bracing for some months. This is partly because many Asian economies are significantly dependent on exports, especially to the US, and with electronic items figuring prominently in the mix. (For Taiwan, Singapore and Malaysia, read "predominantly".) Probably a larger factor is that Asian residents and Asian investors tend to be well aware, due to frequent and recent reminders, of global interdependence, of political risk at both macro and micro level, and of markets as roller-coasters prone to stomach-churning downward lurches. As Andy Xie of Morgan Stanley pointed out a couple of days ago: "Typically, Americans are optimistic, at least they were until recently, and consume everything in sight; East Asians are pessimistic and want to save every penny possible. The two economies are about the same size, but their savings behavior could not be more different. Since 1989 the US has accumulated a trade deficit of US$2 trillion and 73% of this is with East Asia." In any event, a major degree of risk is already priced into Asian markets.
While the hues and promises of wafting bubbles can be enticing and distracting, and bursting bubbles can be as fascinating as a good horror story, experience suggests that the precise twists and turns are hard to predict, and the timing for practical purposes impossible. Where we have been able to do well, historically, is in analysing individual companies, and attempting to buy sound businesses with good growth prospects at valuations which are proportionately attractive and allow for a margin of safety. (The margin of safety is necessary: no matter how much we ponder possible risks, we are all too often confronted by the unpondered - but occasionally surprises do also come on the upside.)
If you have identified this as "School of Buffett", you are absolutely right - which has the advantage that we can suggest Buffett's long-term track record as vindication of the approach. Reductio ad: implementation risk - will we take the right micro-decisions? (Talent available: almost certainly less than in Omaha. Asian market inefficiency, and hence opportunity: almost certainly greater.)
As evidence of the futility of market prognostications: when I returned from India in early 1997, I was possibly as nervous about macro risks as I am now - but I expected a US decline to drag down the Asian markets, and never forecast the outcome in which Asian markets collapsed first, leading to a series of falling dominos culminating - thanks to LTCM - in an infusion of liquidity which arguably led directly to the final record-breaking blowoff in the Nasdaq. A cautionary tale of how at the macro-level one can get so much right, and the implications diametrically wrong! (Maybe the Nobel prize winners have already proved this adequately.)
However, throughout 1997 and 1998 it was evident that daily life went on, that we and other Asian consumers needed to eat, etc, and we spotted various companies which we knew well whose share prices temporarily offered such extraordinary value (including a margin of safety) that purchase was quite irresistible. Lesson one was that buying a share after it had fallen by 85% provided no defence against the next 85% (true story, our first purchase, to 2% of the starting price), but eventually the decisions were vindicated - not only by the markets (see historic performance of the fund), but also and more importantly by the business results of the companies into which we bought. Had we sat on the sidelines meanwhile, we would have missed out on the tremendous earnings growth mentioned above, and my future guesstimates are not so bleak that I would now have been happy with that decision.
Certainly the Rubin-Greenspan liquidity injections and the 1999-2000 buoyancy of the US economy helped. Did we foresee these events during 1998? No. Given the quality of the companies that we now own, their cash-generating qualities and balance-sheet strength, and a current-year earnings yield of 18% (compare that with the current and prospective rate on HK or US bank deposits), would I personally be a buyer now? Yes... hence my 3Q commitment to the Fund of the proceeds of a London flat. The timing of that latest purchase has yet to be vindicated (unlike that of the long-delayed sale, which may have been fortuitous), but the risk-reward ratio seems to me highly attractive.
Our top ten holdings are mentioned below: other holdings over 1% are Bangkok Insurance, BAT Indonesia, Glorious Sun, Jusco (HK), Kingboard Copper Foil, United Tractors, and Vitasoy.
The bond holding, as this time last year, remains unusually large at just over 20%, but the bond involved has changed, and is different in nature, although it remains true that we are likely to buy bonds only when they offer prospects of an equity-like return. The Land & General bond is in default and is owned in expectation of a swift and satisfactory workout - although unanticipated factors have come into play and this is one of many examples where the margin of safety may come in useful. These bonds are even more illiquid than any of our equities, and consequently valuation is frequently subjective. The present carrying value has been unchanged for several months and is below cost. Until the last trading day of the year, we thought there was a possibility of an early exit, which would have given your fund a positive rather than a negative US$ return for the year. We remain cautiously optimistic, on this as on other holdings. Once again I have written mostly about macro issues, but am delighted to discuss the investment merits and risks of specific securities with our investors and friendly competitors: please call or e-mail.
The Year of the Dragon has lived up to its reputation for turbulence (caused, so I am told, by the dragons' movements in their subterranean lairs). We are about to enter the Year of the Snake. Since we have forecast tidal waves, it seems appropriate to mention that the sea snakes I have encountered in this part of the world are capable of impressively fast and sustained straight-line motion, suggesting both stamina and single-mindedness. I can't claim to have met one during a typhoon, but these capabilities must surely come in useful!
Best wishes to all co-investors for 2001.
Claire Barnes, 5 Jan 2001
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