A second-half rebound has put Invesco Asia (IAT ) ahead of its benchmark with the managers hoping to maintain their outperformance by partly tapping into over-sold Chinese companies that have suffered from its faltering economic recovery.

In recent annual results the £229m portfolio reported net asset value (NAV) including half-yearly dividends grew 1.3% over the year to 30 April. That may not look much but was a lot better than 6% total decline in the MSCI All Companies Asia ex-Japan index.

The full-year outcome was also the product of a 16.6% recovery in NAV in the six months to April 2023, which more than made up for a steep 13.1% fall in the first half to October last year.

That was a good result for a fund three years into a five-year performance review which will determine whether the company has to return a quarter of its assets to investors in a tender offer in late 2025, and could influence whether shareholders vote to continue the trust for another five years.

For the moment, that’s a long way off but for the record, up to 30 April IAT is well ahead of its benchmark which it needs to beat by at least 0.5% a year to avoid tendering its shares back to investors. At the financial year-end NAV was up by 13.9% a year over three years while the index managed just 3.3% a year.

Despite China’s troubled economy, the wheels haven’t come off performance since the financial year-end either, with NAV essentially flat offering a current three-year total return of 23.2% compared to the MSCI index’s modest 1.6% gain in sterling.

Nothwithstanding a discount that has widened close to 10%, the point at which the board may have to buy back shares, total returns to shareholders are ahead of the underlying NAV return, up 32.4%, and yielding 4.5% from dividends largely paid from capital.

China conviction

Ian Hargreaves (above), who manages IAT with Fiona Yang (below), said the ‘small positive return’ felt like a good result given the volatility over the year and the short-lived optimism around the world’s second largest economy.

Chinese consumer companies were contributors to performance over the year, as the reopening acted as a ‘positive catalyst’ for the likes of Gree Electrical Appliances, Beijing Capital International Airport and Samsonite International.

The property sector in China is, however, still under pressure and China Overseas Land and Investment and A-Living Smart City Services both lagged the broader market.

‘Dongfeng Motor also disappointed, although we have now sold this position, with the car company’s outlook challenged by the strength of competition in China’s electric vehicle market, an area of the market they are losing ground in with joint venture partners Nissan and Honda,’ the managers said.

Economic data coming out of China has been mixed and expansion in the services sector has failed to feed through into other areas, and subsequently concerns about the strength of the recovery is feeding back into markets, not helped by persistent tensions between the US and China.

‘We believe the current mix of macro, regulatory, and geopolitical concerns leave valuations at overly discounted levels, providing attractive opportunities to add exposure to quality growth names that appear cheap,’ the co-managers said.

They added dairy producer Yili, saying it had an ‘improving branding and consumer service capability that is likely to drive sales growth and support a recovery in earnings over the medium term’.

Will Semiconductor is also a new addition. The group, which designs and sells semiconductor devices, was ‘impacted by a downturn in the Chinese smartphone cycle, but has a more positive growth outlook further out which is supported by drivers such as auto contact image sensor, where it has 40% share’.

Korea discount

The managers have also increased exposure to South Korea, which they said is the cheapest market in Asia even after a strong start to the year.

‘We increasingly feel that the “Korea discount” overstates corporate governance concerns, geopolitical risk, and the cyclical nature of its economy,’ said Hargreaves.

‘We believe that this is an opportunity to own operationally solid companies, with good balance sheets, and an ability and desire to improve shareholder returns over time.’

The trust added to its position in Taiwan Semiconductor Manufacturing, which will benefit from the ‘excitement’ around artificial intelligence (AI) as the main fabricator of AI chips.

LG Chemical, the largest electric vehicle maker outside of China, and consumer goods company LG Household & Health Care were both added to.

Region over-sold

Chinese markets have scope to re-rate given there is ‘fundamental improvement in the outlook for corporate earnings’ that has not yet been priced in, and this should provide a boost for the rest of Asia.

‘Asian markets continue to trade at a significant discount to developed markets, particularly in the US,’ said Hargreaves.

‘We believe there is scope for this to narrow, with US dollar strength challenged by a potential recession in the US as the Federal Reserve seeks to root out inflation.’

Inflation is less of a concern in Asia, which therefore has greater policy flexibility that should be supportive for markets.

‘Looking further ahead, US inflation might be stickier than expected but it is declining from a high base which could lead to an easing of financial conditions at a time when Asia is enjoying a favourable growth differential,’ he said.