Asia Small Companies: January 2020 Commentary


Sentiment turned sharply negative in January following news of the outbreak of a new coronavirus (2019-nCoV) first identified in Wuhan, Hubei Province, China. Our benchmark index fell by 3.8% in US dollar terms which converted to a small gain in Australian dollar terms of +0.8% due to a sustained decline in the local currency. The Australian dollar dipped below US 67 cents to end the month at lows not seen for eleven years.

All of our investment markets fell during the month in US dollar terms, Singapore -2.4%, Japan -3.1% and China was -3.3% (closed in the final week for Chinese New Year). The biggest impact was felt in Korea -10.9%, Hong Kong -5.7% and Taiwan -4.8%. Markets are likely to remain volatile in coming weeks as investors react to news surrounding the coronavirus. Evidence from past events of this type, especially Severe Acute Respiratory Syndrome (SARS) in 2003 is that the market impact is relatively short-lived. Unlike 2003, the response from the Chinese authorities has been open and proactive, resulting in the rapid identification of the 2019-nCoV genome sequence which will see the development of vaccines for testing in a matter of weeks. Back in 2003, during this phase of SARS the Chinese authorities were in complete denial of the situation. The better communicated and proactive response this time around may have exaggerated some of the stock market volatility, however, we take the view that this isn't a reason to exit companies in the region. Investor selling into this type of volatile environment typically "forget" to re-enter the markets as fear generates too many confusing signals. In terms of long-term investment outcomes, it is always better to be a net buyer in this type of situation.

The Stock Exchange of Hong Kong has taken the first steps towards allowing companies to hold weighted voting rights with a consultation paper published in late January. Weighted voting rights were introduced in 2018 with ownership limited to individuals. If this expansion of weighted voting rights is enacted then Hong Kong will find itself being downgraded in the regional assessments of corporate governance having taken another move away from "one share, one vote".

The "phase one" trade agreement between the United States and China was signed in mid-January, this removes one of the key risk factors that has hindered Asian markets in the past eighteen months. With the deal signed we should have seen the end of pre-emptive tariff increases imposed on China by President Trump until at least the other side of the US Presidential elections. The agreement is more of a "truce" than a long-term solution for the United States trade deficits with China.

In normal circumstances we would have seen a strong response in China to the election results in Taiwan in which the Democratic Progressive Party (DPP) won a second term in a landslide result securing 57.1% of the votes. This was an incredible comeback for President Tsai Ing-wen who recovered from very low approval ratings and major losses in the 2018 mid-term elections. There were two key factors in the DPP success, first, partly due to trade tensions between China and the United States, Taiwan has been the beneficiary. Taiwan's fourth quarter GDP growth of 3.8% was the fastest since mid-2018 helped by a strong electronics sector as factory production switched from China to Taiwan. Second, the protests in Hong Kong has increased pro-independence sentiment which is a key DPP theme while the opposition KMT adopt a much more pro-Beijing stance.

We undertook a number of transactions in January with the aim of reducing our overall number of holdings and exposure to Korea. Three companies (GS Home Shopping, Grand Korea Leisure and COM2US) were sold in Korea to take our country exposure down to 6.5%. We also sold three companies following reviews of the value, momentum and quality scores. Two of the sales were in Japan, automotive parts maker Toyoda Gosei and hardware retail chain Komeri. The final sale was the Taiwanese footwear manufacturer Yue Yuen Industrial which is listed in Hong Kong. All three companies were unable to maintain our requirement for momentum, having sustained earnings downgrades in recent months. The portfolio now holds 60 companies which is the lower end of our 60-80 target range.

We were pleased to see one of the "quiet achievers" Sawai Pharmaceutical emerge as our biggest holding through sustained performance, rising by 34% since early October, to now exceed 3% of the portfolio. Another of our pharmaceutical companies, Sinopharm Group, took the decision in January to issue shares in an after hours placement as permitted under the rules of the Stock Exchange of Hong Kong using a General Mandate, causing a dilution of our shareholding by 4.8%. This action by Sinopharm Group will prompt us to conduct a review of their governance and treatment of minority shareholders.

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.