Apollo Investment Management

Slower growth, relative value
Apollo Asia Fund: the manager's report for 4Q2005

The Apollo Asia Fund's NAV rose 5.0% in the fourth quarter, closing at a new high of US$572.53. For the year 2005, the NAV grew by 14.8%, lagging the 17.9% rise in the regional index (MSCI FE-ex-Japan). (Performance charts.)

The lag could have been worse, as the fund had no exposure to any of the region's best-performing markets, such as Korea (+54%), Japan (+44%) and India (+42%). Instead we remained invested mainly in dullards such as Hong Kong (+5%), Singapore (+14%), Thailand (+7%) and Malaysia (-1%). Investors should be warned that we will continue to miss opportunities regularly and cheerfully, preferring to focus on businesses which we think we understand & where we can build up the requisite level of comfort, and buying these only when we like the prices. On my last visit to Korea, earlier last year, I was impressed by the improving macro, but never reached the desired degree of comfort with individual businesses. (For the record, when that market was much lower, Masya was urging that we take more interest. My linguistic limitations don't help.) At least for Japan & India I did recommend relevant funds, as I have in the past for gold, although this would cheer me more if I had taken more of my own advice.

Currencies were no help. Those we held were mostly flat or down against the US$ (S$ -2%, Thai baht -5%). We remain philosophically passive, hedging none of our natural exposure and holding cash balances in Asian currencies which we may wish to invest.

Geographical breakdown
  as at 31 Dec 2005
% of assets
Hong Kong-listed equities
Indonesian equities
Malaysian equities
Philippine equities
Singapore equities
Thai equities
Other equities
Net cash & receivables

Our shares at end-Dec were on an estimated current-year PE of 11.8, with a net dividend yield of 3.9% after Asian taxes. I wrote a couple of days ago on the performance page that "For most of the period since inception the valuations were better, but these seem justifiable, for a portfolio of good businesses with strong balance sheets in one of the world's stronger regions. However, while returns (including cashflow returns) on equity for our companies remain respectable, and long-term growth prospects are commensurate with those of the region, we no longer expect growth in 'portfolio EPS' or dividends for the next couple of years. This is a significant change, after compound annual growth of the order of 35% in the six years to 2004." I was intrigued therefore to read Chris Woods' subsequent comment that "CLSA's universe of 595 Asia-ex-Japan stocks is now trading at 11.5 times forecast 2006 earnings, assuming earnings growth of 7.3%... even if, worst case, earnings declined by 10% in Asia next year...". Some headwinds are clear: overinvestment & consequent lack of pricing power in China, rising interest rates, and perennial concerns over US consumption. One company which we own is having a very bad year: we hope that this is temporary. Other companies have made bumper profits in the past which we do not assume to be necessarily sustainable (eg Inco Indonesia, which depends on nickel prices); another has expanded its capital base dramatically, for good long-term reason but diluting short-term earnings-per-share. Another factor is that we have bought some shares this year on relatively high current PE's, because of growth / recovery prospects. The companies which now make up the portfolio are expected to grow EPS in the current year by 10%; the trend in 'portfolio EPS' has been weaker due to changes in portfolio composition.

To sum up: growth possibilities exist but are not to be taken for granted; risks appear to be greater and reasons for ebullience lesser than has often been the case in the past; but valuations are not excessive, and the case for Asian investment within an absolute-return portfolio remains strong.

We focus on stock selection, and the asset allocation is a by-product, but the present geographical mix leaves me reasonably comfortable.

Our chances of identifying good investments, avoiding unexploded mines, and responding speedily to ideas all improved in the fourth quarter with the analytical assistance of Ines Huang, based in Hong Kong. Welcome, Ines. Thanks to all those who made constructive suggestions in 2005 (please continue), and good wishes to all our investors for the Year of the Dog.

Claire Barnes, 7 January 2006

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