Encounter

Among countries, Andrew Graham is most keen on India.
By Sonita Horvitch | 24/05/17

Andrew Graham, head of the Asia team at Edinburgh-based Martin Currie Investment Management Ltd., says that after their strong showing so far this year, stocks in the higher-growth economies of the Asia-Pacific region are no longer that cheap. "These stocks have been rerated," he says, "but current valuations are still more or less in line with the valuation averages over the past decade."

About the Author
Sonita Horvitch is a Morningstar columnist who specializes in reporting on money managers and their strategies. A veteran financial journalist, she was formerly with the National Post and its predecessor, the Financial Post. At the Post she was best known as the author of the popular Buy & Sell column, which she wrote from its inception in 1994 to December 2008. She holds a master's degree in business economics from the University of the Witwatersrand in Johannesburg, South Africa.

After a fairly modest showing in 2016, the MSCI AC Asia Pacific ex-Japan Index produced a total return in Canadian-dollar terms of 12.2% in the first three months of this year. "This is one of the strongest first quarters for this index in 30 years," says Graham, who has spent almost 30 years in the investment business focusing on the Asia-Pacific region.

Helping to propel the Asia-Pacific index so far this year, he says, is the synchronized global economic recovery, China's move in the first quarter of 2016 to stimulate its economy, and the upgrade in corporate earnings estimates by investment analysts. "Starting in the second quarter of 2016, there has been a strong rebound in the ratio of earnings-estimate upgrades to downgrades." This comes, he says, after "a lengthy earnings-downgrade cycle." Given the index's strong run since the beginning of 2017, there could be some profit-taking, he cautions.

This Asia-Pacific index, which excludes Japan, includes stocks from both developed and emerging economies. There are four developed-markets countries in the index, including Australia and Hong Kong, and eight emerging-market countries, with China and South Korea among the heavyweights. "In all, this index encompasses those countries that provide the broadest growth opportunities in the region," says Graham.

Japan, with the lowest GDP growth rate in the region, at an estimated 1.4% in real terms (adjusted for inflation) for 2017, "has its own dynamics." By contrast, Graham says the Asia-Pacific ex-Japan region is expected to have real GDP growth of 6% for 2017, with China coming in at 6.8% and India at 7%. At the other end of the spectrum is Australia, a more mature economy, which is expected to have GDP growth of less than 3%.

Of China, Graham says that the country's high-profile One Belt, One Road project announced a few years ago and the subject of a recent summit in Beijing, will, if successful, facilitate trade between China and its target countries. For example, it will boost the external demand for China's products such as steel, cement and machinery. These are, he says, being produced at a pace in excess of China's needs, "as China has already had a massive infrastructure-investment program."

Under this One Belt, One Road project, Graham explains that China is looking to foster the building of infrastructure projects in more than 60 countries. "There seems to be a reluctance on the part of many countries to participate in this," says Graham. "To many, it is seen as a way of China extending its geopolitical influence."

Established in 1881, Martin Currie has offices around the globe, including in Singapore and Melbourne. The firm is a sub-advisor to TD Asset Management Inc. At Martin Currie, Graham and his team are responsible for a wide range of mandates including TD Asian Growth. Graham manages this $96-million mutual fund with colleague Paul Danes.

 

Andrew Graham
Andrew Graham

Martin Currie's Asia team targets companies with established franchises, preferably operating in industries where there are high barriers to entry. The companies must generate good returns on capital and have strong balance sheets. Corporate governance is an important factor in the team's analysis, says Graham. Finally, valuation is a key factor. "We will invest in the stock if it is trading at a discount to the team's estimated intrinsic value of the business." The investment horizon is three to four years.

TD Asian Growth is benchmarked against the MSCI AC Asia Pacific ex-Japan Index. The portfolio, which currently has 52 names, has an overweight in China at 31% of the portfolio versus 25% in the index.

"We have had an overweight position in China for more than one year, reflecting value opportunities," says Graham. "We have focused on growth companies in the country, such as in the information-technology sector."

Graham points to the holding in China's Tencent Holdings Ltd., a dominant Internet-services company domestically, as an example of a stock that meets the team's criteria. The company's Tenpay, an online-payment service provider, is "successful and growing market share." This expands the range of services that Tencent provides and captures more of its customers' time. This stock is among the top-10 holdings in TD Asian Growth.

The portfolio has a smaller weighting in China's  Alibaba Group Holding Ltd. (BABA), another online-services company, with a major stake in the country's online commerce. Alibaba is "well run and is rapidly expanding its business," says Graham.

Tencent and Alibaba compete in some of the same areas of online services, he says. "The two are major players in this industry and have a significant lead over other participants." The online sector of China's economy is "likely to grow at a much faster pace than the Chinese economy as a whole." A caveat, he says, is that companies in this sector have to tread carefully to ensure that they do not come into conflict with the Chinese government."

Graham is most enthusiastic about India. "There are so many areas of the economy that are underdeveloped, including the online-services business, and the potential is substantial." India's online-services business "is still early stage and mainly in the hands of unlisted companies," he says. Both Tencent and Alibaba have significant investments in this sector in India, but these investments only represent a small part of their overall business, says Graham.

A play on the huge demand for infrastructure investment in India that is a holding in the portfolio is IRB Infrastructure Developers Ltd., which builds and operates toll roads. The current order backlog is about $2.3 billion. It is a well-managed company, Graham says, and "given the underdeveloped nature of India's road system and the likely growth in vehicle ownership, IRB Infrastructure's growth opportunities will span decades."

Graham and his team are picking their spots carefully in the region's financial-services sector. "The credit cycle in the region has deteriorated and is bumping along the bottom." The portfolio's holdings in Australia illustrate the team's selectivity. "We are underweight Australian banks. The economy is low growth, loan growth is slowing, and it is the only major market in the region currently facing a deteriorating credit situation," says Graham. As the "best-managed full-service bank in Australia," Commonwealth Bank of Australia is among the top-10 holdings in the portfolio and a "long-term holding."

The portfolio has a high weighting relative to the benchmark in Macquarie Group Ltd. This is an investment bank/asset manager with a global reach, he says. "Its revenue is largely fee-based, which means it is less dependent on the lending business."

Martin Currie's Asia team is cautious about the region's insurers. "There have been regulatory changes affecting the industry in countries like Australia, China and South Korea, and it is difficult to assess the full impact on the companies' financials."

The team continues to emphasize consumer-discretionary stocks. Graham cites the example of the global brand-name luggage producer Samsonite International S.A., which is listed on the Hong Kong Stock Exchange. Asia is 37% of total sales and accounts for 47% of EBITDA (earnings before interest, taxation, depreciation and amortization), he says. "Asia has higher growth prospects than Samsonite's more mature markets in Europe and North America."

Graham and his team have taken profits in a number of names that have "worked well." For example, the team trimmed its holdings in Samsung Electronics Co. Ltd. and  Taiwan Semiconductor Manufacturing Co. Ltd., whose American Depository Receipt (TSM) trades in New York. These two stocks remain among the portfolio's top-10 holdings.

Alibaba Group
Holding Ltd.
Taiwan Semiconductor
Manufacturing Co. Ltd.
May 22 close$124.75$35.40
52-week high/low$126.40-$73.30$35.80-$24.21
Market cap$315.6 billion$177.1 billion
Total % return 1Y*58.252.0
Total % return 3Y*-22.1
Total % return 5Y*-21.8
*As of May 22, 2017. All figures are in U.S. dollars.
Source: Morningstar

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