Schroder AsiaPacific Fund (SDP) has announced its annual report for the year ended 30 September 2023. NAV total return for the period was 2.9%, ahead of the benchmark MSCI All Country Asia ex Japan index which rose by 1.5% over the same period. Shares were up 2.3%. This continues the company’s commendable long term record of NAV total return outperformance of the benchmark which sits at an annualised 2.4% over 10 years.

Commenting on the performance, chairman James Williams noted that there was a significant divergence of returns across Asian markets. Larger markets especially China and Hong Kong, were very volatile during the financial year, impacted by economic headwinds and geopolitical risks. Elsewhere, markets such as Korea and Taiwan performed better. However, Asian currency weakness was a significant drag on performance.

Regarding the outlook, the investment manager commented:

“The euphoria seen in markets at the beginning of 2023 over China’s move away from its “zero COVID” policy feels like a distant memory, as China’s long awaited post-COVID recovery has proved weaker than expected. Economic data out of China, and a lack of forceful policy response, has been disappointing, reigniting concerns over local government debts and the wider residential property sector. This has overshadowed more positive global developments stemming from more favourable US inflation data, its knock-on to the US interest rate cycle, and potential for a soft landing in the US. There have also been some signs that the inventory cycle has started to bottom, potentially pointing to a more favourable demand outlook. This in turn could support demand for Asian manufactured product, which historically has been supportive of Asian markets. However, as already highlighted, geopolitics remains an overhang to the region with areas of tension including US-China relations, Taiwan and Ukraine, notwithstanding the recent developments in the Middle East. The electoral cycle is a likely point of focus with both the US and Taiwan having elections next year.

“Overall earnings have continued to be revised down following a reset to China and global growth expectations, leaving aggregate valuations broadly in line with their longer-term averages. However, this masks a large variation across individual markets where Singapore and Hong Kong, amongst others, look relatively cheap versus history, and India more expensive.

“Although we did not have an optimistic view on the growth outlook for China, it has still managed to disappoint. This has brought renewed focus back on to the residential property sector, where private sector developers have seen a liquidity squeeze, as sales have continued to disappoint, impacting cashflow for the whole sector. The recent negative headlines around Chinese property developers such as Country Garden could cause further deterioration in homebuyers’ sentiment and financing capabilities for other private-sector developers, indirectly raising the risk of more defaults in the industry going forward. Therefore we expect policy easing, both on the demand and supply side, in the property sector to intensify to avoid more defaults and any wider impact on the financial sector. Our long-term concerns around the structural headwinds for the residential sector remain – property is likely to be less of a driver for the economy than in the past, given the already high levels of residential investment combined with an ageing demographic. It should be said we do not own any of the Chinese private sector developers in the portfolio.

“Near term, we believe it is a lack of consumer confidence that is the problem rather than an inability to spend due to high borrowings. In fact, household balance sheets have only strengthened over the last two years, due to high levels of precautionary savings. It is measures to address this, such as progress on reforms, rather than a massive fiscal stimulus which is needed to give the consumer greater confidence to spend more. Nevertheless, in our view it is likely we will see further government stimulus, on top of the piecemeal measures we have seen so far, to boost growth given the fragility of the property sector. More positively, the regulatory backdrop does not appear to be getting worse and there are even tentative signs of reengagement between the US and China. Despite this, we remain very underweight combined Hong Kong and China, albeit we have been tentatively looking to add to holdings in both markets where valuations have come back. We are more positive on Hong Kong, where valuations are lower, and the SAR should see a recovery now that the border with the mainland has re-opened. Although visitor numbers to Hong Kong and Macau have picked-up materially, one needs to remain cognisant of the potential for tighter capital controls by the Chinese government should external balances become too wide.

“India continues to be a market that offers highly attractive long-term opportunities but is currently being priced for that in many cases, which leaves the market looking relatively fully-valued and relatively expensive versus both its history and other regional markets. Despite this, it has benefitted from the uncertainty around the outlook for the Chinese market, together with the local demand driver of strong domestic inflows which have pushed the small and mid cap names up dramatically. We continue to favour the IT services names together with the banks but also have exposure to the fast-growing healthcare sector via Apollo Hospitals.

“In the smaller ASEAN markets, we favour Singapore which is benefitting from its increasing status as a regional wealth management hub, as well as the growth of its ASEAN neighbours. We also have exposure to Vietnam, Indonesia and have recently added to our holdings in the Philippines.

“Sector-wise, IT stocks, where we have been overweight, have been the bright spot. The potential for additional demand being generated by increased AI has seen many companies, however loosely affiliated with the theme, perform well. Whilst this has seen several companies, in our view, move into more speculative territory, we believe that a number of our companies are set to benefit from this additional demand driver over the medium to long term. We therefore remain overweight – albeit the recent rally has seen us selectively pare back holdings that we believe have got ahead of themselves. The IT names remain sensitive to the global economy and the Korean names, such as Samsung Electronics, are still trading at relatively attractive levels from a valuation perspective, in our view. While the visibility of demand remains low, the supply side adjustment is starting to take place as announcements on production and capex cuts have started to be seen and inventories appear to be peaking. Otherwise, we remain overweight to financials – a diverse sector spanning not only banks, but also insurers and exchange companies. Although we saw concern over banks earlier in the year following the Silicon Valley Bank and Credit Suisse collapses, the banks we own are generally well-capitalised with strong deposit franchises and fall into two camps; those that are benefitting from increased credit penetration, such as in India and Indonesia, and the more domestically-focussed retail names in more mature markets, such as Singapore, that in general trade at attractive valuations and decent dividend yields.

“Underweights remain in those areas of the market generally perceived as more defensive, including consumer staples, health care and utilities, where valuations, in our view, still remain relatively full. More recently, however, the market’s correction in Chinese healthcare stocks has seen us add to a name there as described above.

“Near term, it is likely that we will see further downward revisions to earnings as global growth slows, and an ongoing period of inventory adjustment amongst companies to reflect this slower growth, which will hopefully put them in a position to start to grow earnings once more when demand recovers. Positively, we are starting to see early indicators of a potential bottoming in the global goods cycle with PMIs showing tentative signs of improvement in inventories and new orders which historically, with a lag, have been a good lead indicator of exports. The distortion in the goods cycle from COVID was significant, with goods demand collapsing, post its surge in 2020, as services recovered, meaning that the goods cycle is much progressed when compared to that of services. Given overall aggregate valuations for the region are now trading at or below long-term averages, this does set up a more constructive backdrop for Asian markets in the coming year, barring a global hard landing or a more extreme geopolitical risk event.

“To conclude, it is worth remembering that as investors we buy companies, not countries. We are mindful of the impact political and macroeconomic factors can have on equities and returns, but we are bottom-up stock-pickers first and foremost, focusing on the company’s return prospects and valuation. We do not try to pick companies which will do well based purely on a particular macro environment which we have forecast; rather we try to pick well-managed companies at attractive valuations, which have structural and sustainable competitive advantages. Therefore, a focus on attractive bottom-up ideas, in our view, remains essential.”

SDP : Another solid year for Schroder AsiaPacific despite challenges