Is poorly-performing Edinburgh Dragon a ‘buy’ on a 13% discount? Supporters of largest Asia Pacific investment think so after review concludes fund manager Aberdeen's investment process remains intact.
Is Edinburgh Dragon (EFM), the largest investment trust in the Asia Pacific ex-Japan sector, a ‘buy’ on a 12.9% discount?
Winterflood Securities, corporate broker to the £705 million fund, thinks the shares’ low rating is ‘attractive’ while analysts at Canaccord Genuity have retained their positive stance, believing the trust offers ‘contrarian value’ with signs the board is taking action.
However, James Burns, an influential fund picker at wealth manager Smith & Williamson is not convinced the time is right yet for the Aberdeen managed fund.
There is no doubt Edinburgh Dragon’s performance has lost its puff, underperforming its MSCI AC Asia ex-Japan index in three of the last five calendar years to give it a total return on assets of 58.4% compared to the benchmark’s 75.6%.
With the discount widening slightly over the period the total return to shareholders has been just 55.3%, the worst performance of the nine Asia larger company growth funds tracked by Numis Securities.
Returns have been held back by fund manager Adrian Lim adhering to the ‘quality’ stock-picking approach of Aberdeen Asset Management’s Asia team, headed by Hugh Young. Wariness of high valuations and corporate governance shortcomings, led Lim to be very underweight the Chinese internet stocks, such as Alibaba (BABA.K) and Tencent (0700.HK), which have powered rivals’ returns.
Thus, while the 21.6% growth in net asset value to the end of August was creditable it lagged the 27.2% rise in the MSCI regional index.
Process not broken
With the trust falling out of favour, the only big buyers of the stock have been discount hunters such as City of London Investment Group, Lazards, Wells Capital and 1607 Capital Partners, which hold over 36% of the shares, according to Thomson Reuters data.
Lim has been under pressure but has kept his job, however, after the board, chaired by Allan McKenzie, commissioned consultants to review his performance.
They concluded that his underperformance was not unexpected and had been caused by Lim being out of step with global markets being pumped artificially high by central bank money printing and ultra-loose interest rates.
‘The board is comfortable therefore that the investment process is not broken, and recognises Aberdeen's enhancements to that process. In addition, given the direction of markets over the past five years it is not surprising that the strategy had underperformed the benchmark to some extent,’ McKenzie wrote in the trust’s annual report.
Lim and Aberdeen remain under scrutiny, however, with the board adding that ‘clear parameters’ have been set to ensure their ‘ongoing suitability’ is monitored.
Another cut in charges
While the underperformance may be understandable, it does not sit well with high charges. For the second time in 18 months, the board of Edinburgh Dragon has cut the fee shareholders pay Aberdeen, with the annual management charge of 0.85% applying to its first £350 million of assets. Above that the fee falls to 0.5%, giving an overall rate of management rate of 0.66%.
Canaccord Genuity estimates that with other costs, total ongoing charges will be 0.83%, down from 1.14% up to April last year when Aberdeen received a flat 1% of assets each year.
Canaccord analyst Alan Brierley approved of the move, noting the trust was once again cheaper than its £1.3 billion open-ended version, Aberdeen Asia Pacific Equity fund. ‘We note that Edinburgh Dragon has outperformed this fund by an annualised 1% per annum over the past five years,’ he said in a note to investors.
Comeback on the cards?
Both Canaccord and Winterflood believe any de-rating in Chinese tech stocks could prove a boon to Edinburgh Dragon.
‘The test for the investment trust will be how well it performs in more difficult market conditions,’ Winterflood said in a monthly review last week.
Maintaining his ‘buy’ stance after the trust’s full-year results earlier this month, Brierley commented: ‘We agree with the [trust’s] chairman that a move away from liquidity-driven markets is a potential catalyst, although the question of timing is always a difficult one.’
This is the point that Burns, who leads the multi-manager team picking funds for Smith & Williamson’s Global Investment, Growth and Balanced funds, focuses on.
‘I am pretty relaxed about the board review, as I don’t think Aberdeen has got a broken process. The style has been out of favour,’ Burns said.
However, he added: ‘We would not recommend that people pile in yet. We want to see a glimmer of performance coming through before we get excited again.’
Burns said Edinburgh Dragon was a ‘hold’ and that it featured in his portfolios alongside other growth-focused Asian investment trusts, such as Schroder Asian Total Return (ATR), Invesco Asia (IAT) and Pacific Assets (PAC).
While he didn’t view Edinburgh Dragon as a screaming buy, Burns thought Asia growth trusts on an average discount of under 10% offered some value.
Schroder Asian Total Return was his top pick in the group. ‘We love the approach and the performance they have managed to rack up,’ he added.
Over the past five years, Schroder Asian Total Return leads the AIC Asia Pacific sector with a 133.5% total return, ahead of the 81.4% average.