Asia Small Companies: December 2019 Commentary

Portfolio Comments for Asia Small Companies

December 2019

The Asian region recorded a strong gain of 2.84% in December in USD terms which was converted into a loss of 1.04% in AUD terms due to a recovery by the local currency. The fund outperformed in December with a return of +0.36% which was 1.40% ahead of the index. Our strong performance in 2019 of 19.7% gross versus the benchmark return of 13.7% was generated by stock selection in China and Japan and the asset allocation overweight towards Taiwan and China.

The partial (phase one) trade deal between the United States and China was announced as agreed in early December, we await the release of full details and confirmation of a date when documents will be signed. Unlike previous announcements, the tone indicated "equality" instead of a victory for the United States. The deal appears to revolve around an agreement for China to increase their purchases of agricultural produce from the United States. The agreement is said to run to 86 pages and includes wording that recognises the "One-China Policy" in relation to Taiwan. This is an important issue for China ahead of the Presidential election in Taiwan due to take place on 11th January, China views this election as a local matter and a win by the opposition KMT would be taken positively by the authorities in Beijing. Overall, this has the feel of a trade "truce" rather than a solution and phase two is likely to be a much more difficult discussion that could extend well beyond the November 2020 Presidential election in the United States.

The strongest markets in December were China and South Korea, up 7.8% and 7.2% respectively. The gain in China was a response to the phase one trade deal, measures to boost domestic infrastructure spending and an easing of residency restrictions. South Korea was lifted by a dramatic improvement in relations with Japan following high level bilateral discussions and a lifting of the embargo on key technology products from Japan. South Korea remains the only market in our investment universe that recorded a loss in 2019. If the improved relationship with Japan can be maintained into 2020, we should see an ongoing recovery in the South Korean market. Taiwan continued to perform well with a return of 5.1% bringing the full year gain to 30.1%, the best in our region, helped by a very strong technology sector. Singapore increased by 2.7%, Hong Kong by 2.9% and Japan lagged with a gain of 1.6% for the month in USD terms.

Seven of our portfolio holdings increased by double digit percentages during December, the best was China Lesso up 21.8%, the manufacturer of plastic pipes in China is a beneficiary of the increased infrastructure spending noted above. China Lesso was our best performing stock during 2019 with a gain of 145% from our average cost of entry. Our next best company for the month and year was semiconductor test equipment maker Advantest which gained 15.2% during the month and 127% from our initial entry in March of 2019.

We undertook a number of transactions during December, building new positions in Acom Co, Tokyo Century Corporation, NOF Corporation and SCSK Group all of which had far superior value, momentum and quality characteristics versus the companies they replaced in the portfolio; Aeon Financial Services, Heiwado and Nishi Nippon Financial Holdings. Towards the end of the month we also sold our position in Showa Denko KK in response to their decision to bid for Hitachi Chemical. While we like elements of the Showa Denko KK business, we view the Hitachi Chemical business as too big an acquisition requiring too much debt to be safely absorbed by the acquiring company.

We will continue to invest in Asian small to mid-sized companies with strong value, momentum and quality attributes together with accounting, strategy and governance standards that meet our requirements. Long-term returns will be generated by the ability of our companies to deliver growing profits and dividends.