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How this pro weighs up risks and rewards · On The Money

• 0:03
  Kyle Caldwell: Hello, and welcome to On The Money, a weekly look how to get the best out of your savings and investments. In this episode, we're gonna be looking at the outlook for investing in the Asia Pacific region, and in particular, we're gonna be focusing on the prospects for China. Joining me to discuss this topic is Doug Leddingham, fund manager of Pacific Assets and Investment Trust. So Pacific Assets has had a long standing underweight position to China. The Investment Trust is still underweight versus the index, but it
• 0:40
  has been increasing exposure to China over the past year or so. Doug, could you explain why you've turned a bit more positive and where you're finding the opportunities?
• 0:50
  Doug Ledingham: So for us, you know, Pacific assets should always be a reflection of where we're seeing the best opportunities to predict and and grow our clients' trust over the the long term. Now if you look back actually to the trust in twenty ten, twenty eleven when Stewart Investors took over, so China and Hong Kong was roughly 20% of the portfolio versus India, which I think was 10%. So over the last ten, fifteen years, there's been material evolution in the portfolio, and, hopefully, you know, that's a reflection of us evolving the trust to where we we see the opportunities.
• 1:24
  Now in 02/2015, we were given the opportunity to invest in in mainland companies for the first time through the Hong Kong Stock Connect. But for those of us that know Stewart Investors, you know that we we take our time. You know, for us, we're really looking to hand the Pacific Assets Trust Capital to reputable privately owned enterprises with great stewards, you know, very attractive business models, and and long term opportunity for growth. When we first started looking at China, know, a lot of the companies that we were interested in just hadn't been listed for very long. You know, we really are looking at financial history to get an insight into the behavior of our franchise, the behavior of the people that we're handing the the trust precious capital to.
• 2:03
  And so for us, yeah, time was important in the market in terms of understanding the opportunity set and also valuations. You know, I think you could probably spend a whole podcast talking about valuations in China and what that really tells you. But for us, the types of companies that we are interested in, you know, you remove the big state owned banks, the state owned insurance companies, and the types of companies that we were interested in handing our clients' capital to were were not that cheap, and we're actually probably more expensive for the growth opportunity versus where we're being asked elsewhere in the region. Yeah. So for those two two reasons from, say, 2015 through to 2020, you know, we had limited exposure to to China.
• 2:42
  Now as you as you mentioned, there has been a a growing exposure to China over the last kind of eighteen months, two years, and that's really, you know, a function of of three things. So the the first one being a great understanding on our part of the investable universe, you know, the types of companies that we get excited about, spending more time with them. The second point being valuations. I think since the the end of twenty twenty, you've probably seen private enterprises in China lose $4,000,000,000,000 worth of market cap. And finally, a shift in the positioning of privately held or privately owned businesses in China.
• 3:17
  You know, I think in February, you saw Xi Jinping sit down and shake hands with the the large Chinese entrepreneurs. And I think that was probably a a big turning point in in in how Xi and the CCPC, the role of private enterprise. I know that's an important, you know, I think, indication for us in terms of how we think about risk and opportunity in China.
• 3:38
  Kyle Caldwell: So over the past two years, what's the exposure to China gone from, and what is it to today?
• 3:44
  Doug Ledingham: So it's gone from less than than 10% to, I think, 16 or 17% today. And I don't know what that is in the index, but, certainly, it's it's been a for us as truly bottom up investors, you know, we're always looking for opportunities in the region where there's clouds hanging over particular countries or sectors. And and in China, the opportunity over the last couple of years where you've really seen where you saw companies get sold off no matter whether they were state owned or privately helds, you know, what the company did, the balance sheet, the valuations. All these companies were sold off together. And for, you know, bottom up and stock pickers like us, that was the, you know, the perfect market a perfect opportunity to to really get on the road and and and see what's out there.
• 4:31
  Kyle Caldwell: And you mentioned earlier, Stewart Investors, it has a capital preservation focus. Yep. Could you go into more detail about how as a house Stewart Investors invests and how it differs from other fund firms?
• 4:44
  Doug Ledingham: Yeah. So I think I I tried to move away from this idea that we are, you know, defensive or or too risk averse. I think, you know, there's many ways up the investing mountain. And for us, you know, we are really trying to position ourselves as the most attractive, you know, long term stewards of of capital in Asia. And we're kinda working backwards from that, and that really means looking for that combination of capital preservation and growth and, you know, the knowledge that if we want to combine clients' capital over the next ten, twenty years, we've got to be around to do it.
• 5:15
  So, yeah, that capital preservation point is is important to us. And I think if you look back over the performance of the over the last fifteen years of of the trust, You know, we have tended to underperform fast rising markets where you've probably got a little bit more speculation, a little bit more greed, you know, probably a little bit more concentrated performance in regards to the index. And then on the other side of that, the last fifteen years, we have tended to to preserve capital better than the index in in times of stress. Now that is a function of of a few things. So, you know, coming back to how we think about risk.
• 5:55
  You know, risk for us is the the risk of losing clients' capital rather than deviation from a benchmark, and that has been, you know, a fundamental input to how Stewart Investors has invested capital over the last thirty years. And then that leads to a number of of other inputs. So we try to take a, you know, a long term perspective to allocating clients' capital. You know, we're not trying to beat our our peers in in guessing what's gonna happen next quarter. We're looking for, you know, companies that we can allocate for as long as possible and and really benefiting from the growth of of great companies.
• 6:27
  When we're constructing the portfolio, we're I mean, we're we're trying to be as humble as possible. You know, we again, looking back over the last fifteen years, we've never forecast any any macroeconomic events. So we understand we can't do that. So we are looking to build a portfolio robust and and resilient to most macroeconomic events. And I think, actually, this is probably something that doesn't get enough attention in the investment industry is just who are the people you're handing your money to.
• 6:54
  You know, I think we're an industry where everybody wants a a numerical number with probably a couple of decimal places. But for us, we, you know, we spend a lot of time asking ourselves who we're handing Pacific assets trust capital to, and that really leads to I think over 90% of the positions in the the trust at the moment have a a family, a foundation, or a founder behind them. So that has been an important input to the preservation and growth aspect because when you go into that inevitable down cycle, you want businesses with robust balance sheets, resilient cash flows, you know, the ability to think and act differently and and look to maximize the value of a business over ten years rather than ten months, and owners think like that. But, again, if you're in an industry like ours where there's lots of focus on quantification, there's lots of focus on short term time horizons, people don't matter. You know, we can read investment or reports written by investment banks that could run a 100 pages, and there's maybe one paragraph in the people.
• 7:55
  So I think one thing that certainly we are given in terms of our long term approach, our active approach is that ability to think differently about who we're handing money to. And you can you can see that hopefully in that when you are investing, you know, in Pacific Assets, that you have your money alongside individuals and families that have, you know, billions of dollars invested alongside you and also generations worth of reputation at risk. And I think, you know, that's a very, you know, important thing to think about, I think, with Pacific assets.
• 8:22
  Kyle Caldwell: And your process, it involves seeking out predictable businesses that are also sustainable in terms of how they operate. So with China, has the investable universe increased over the past couple
• 8:37
  Doug Ledingham: of years? Are you now seeing more companies come on your investment radar? We are looking for companies, and I think this is important in most markets, but especially in China, is companies where the the management team are focused on quality of growth rather than quantity. You know, we speak out to a lot of Chinese companies, and the ambition is to be the biggest, not the best. And that really, I think, leads to many sectors in China, you know, with very limited pricing power, limited margins, limited returns.
• 9:08
  So when we're talking to management teams, we're looking for companies and management teams that are are focused on value proposition. And and I think this has been a very interesting time to be talking to Chinese companies because you can see what matters and the lessons that are being applied from the current economic downturn. You know, that we've had some really interesting conversations with our companies about lessons they've learned going into this down cycle, what they're doing with their balance sheets, and and how, importantly, how they're benchmarking themselves against global peers. I think there's some really great opportunities in China in the in in the software space, in industrials, especially those industrial companies that are providing a service where price is not number one on the customer's priority list. So that, you know, example would be an industrial company that's providing saving time for for customers.
• 10:00
  So we own a company that provides industrial automation inputs, and part of their value proposition is getting to that getting those products to clients as soon as possible so they don't need to hold that on their balance sheet. And that serves two benefits to the customer. They save money, but, also, they have more time to spend on their core value proposition. So for us, you know, there's a very long opportunity for these kind of industrial companies to evolve in China. And we also really like companies that get stronger at the bottom of the cycle, and, you know, they're and we're seeing that a lot in the industrial companies.
• 10:31
  So, again, getting out there and talking to companies is some of the best ways that we can find opportunities. Think screening companies, you know, it'll tell you what work what's going well in the past or what's not going well, but, really, it's it's it's change, I think, and also meeting the people that will will create those long term opportunities.
• 10:48
  Kyle Caldwell: And you're what is known as a bottom up stock picker. How does the wider macroeconomic backdrop influence your investment decision making, particularly when it comes to deciding to increase exposure to a region such as China?
• 11:02
  Doug Ledingham: Yep. That was a good question. I I you know, we are we appreciate that our companies don't operate in a vacuum, so it'd be naive to completely ignore what's going on in the macro picture. But I think probably, you know, China is a wonderful case in point in regards to the challenges and risks to your capital if you take a purely top down view. Mean, if over the last thirty years, there's been I mean, the GDP has grown many, many multiple times.
• 11:29
  There's been wonderful educational and and health outcomes over the last thirty years, but the I think Chinese market's the same price as it was thirty years ago. So, yeah, that's, I think, a great example of of of why you know, top down, you can sound very smart, but I don't think it's the right it's the right perspective to take when stewarding other people's capital. So for us, we are really trying to understand the opportunity, especially in China, for high quality companies to create value, not only for customers but for their shareholders. And, you know, that throws up a number of questions in regard to China. So we really struggle to to find companies where there is, you know, large presence by state owned players.
• 12:14
  You know, the the the playing field is not is not flat, and it really runs against the idea or our our desire for great companies to inevitably dominate a market and and lead through a better value proposition for their customers. You know, if you're competing in it against the states, it's not a nice place to be. The second point would really be that you're coming back again to that what is it? What are the dynamics that allow a custom you know, a company to win? You know, there's many sectors in in China where where prices is the dominant factor, and you have many companies operating in that space that have no consideration for for for profits.
• 12:53
  It's not a nice place to be. Probably the greatest change and probably you know, we were in Hong Kong recently talking to a number of consumer companies. But post COVID, you've really seen a major shift in the psychology of Chinese consumers. So not only have you had a, you know, major economic downturn with the the tightening of wallets, but you have had the emergence of of of Chinese companies that can produce quality comparable to multinational players at a comparable you know, at a similar price. So for a long time, there was a a perspective that multinationals could sell a trusted brand and, you know, they could just replicate models that have been successful elsewhere.
• 13:30
  And I think that, you know, that has changed materially in a certainly a dangerous place to be if you've got very high margins and consumers have have changed their their their purchasing decisions.
• 13:40
  Kyle Caldwell: And how much of a factor is political risk in your investment thinking when you're deciding whether to invest in a company in a particular region such as China?
• 13:51
  Doug Ledingham: Yep. That's a I mean, the political risk is a major concern for us. And, again, coming back to that point on us being truly active. So if we can't get comfortable with a particular company, sector, or country, we'll have 0% of the portfolio invested there, which is, you know, the freedom that doesn't you you don't have if you are constrained by the benchmark. So, you know, political risk is a major concern for us and especially that alignment question.
• 14:21
  You know, I think for a long time, we've really looked to find great opportunities in the health care space in China. You know, they have some health care burdens, whether it be diabetes or or cancer that's in line with what you see in The US from an absolute numbers perspective, but spell you spend a fraction of of their GDP on health care. So you need you they need to develop a a low cost, high quality health care system. What we've really struggled is finding that alignment with with the states because what we've seen is when penetration for a particular product reaches, you know, in line with the global west, you know, pricing changes overnight. So you saw that with orthopedic products.
• 15:04
  We you know, you get an email one day saying the the regulators decided to cut prices by 70% and share prices go with them. So for us, it's very much understanding how our companies are aligned with where the CCP wants to take China and then also questioning and this is a heavily, I suppose, qualitative question is an allowable return. Certainly, we get nervous looking at companies that are extremely profitable in China because, likely, they will fall under, you know, the the the lens of of the state, which I think that qualitative and holistic view of risk is is important in China. I think if you were a, you know, a quality manager purely focused on defining quality and quantitative terms, you you probably have missed those those risks in the past. So for us, yeah, keeping a close eye on on that alignment with our companies.
• 15:52
  Again, if you if we were to see a shift in the the CCP's positioning in regard to the importance of of privately owned companies in in in China and a shift back towards the dominance of The states, you know, I wouldn't you shouldn't be surprised if you see Pacific assets have a lot lower weight within within China.
• 16:10
  Kyle Caldwell: And would US tariffs also come into your investment thinking, particularly if it's a company that you're examining or own that is being hit by paying higher tariffs to The US?
• 16:20
  Doug Ledingham: Yep. As I said, we're trying to work backwards from all the ways that we can lose clients' capital, and certainly tariffs and a and a changing of the competitive environment is something that get we get increasingly nervous about. I think what's important is come back and ask ourselves how much of the particular franchise and the investment cases is at risk here. And I think, you know, a lot of the headlines probably overemphasize the the dependence of of many Chinese companies on The US. You know, I think post Trump one point zero, lots of companies realized that they needed to diversify revenue streams, and you've seen a lot of Chinese companies, especially in regards to overseas growth, emphasize, you know, Latin America, Africa, ASEAN rather than just selling into The US.
• 17:02
  So I think the underlying risk to cash flows for for many Chinese companies are probably not as not as high as as people assume. And then, you know, we have material positions in the trust in India, and, you know, we have at least a number of industrial companies that are glow globally aspirational in their in their in their targets over the next ten, twenty years. And I think for us, when we are looking at industrial companies in India, we're looking for companies that are not competing purely on on coming back to that point on what you're competing with you're competing on. You know, we're looking for companies that are offering high quality. You know, they're looking to build trust with customer bases over time, and they they increasingly understand, especially when we talk to these companies, that you can't build a world class company in India if you're just leaning into kind of labor arbitrage and competing on price.
• 17:53
  Kyle Caldwell: Let's move on to India. So as you mentioned earlier, fifteen years ago, it was a relatively small waiting in the investment trust. It's now your top country waiting, although you've been taking some exposure off. Is that all down to valuations or all the other factors at play? And for a couple of years now, India has had a premium valuation compared to other regions.
• 18:15
  Is that justified?
• 18:17
  Doug Ledingham: So as you said, yes. So for the last ten years, India has been the the material exposure to the of the trust. I think what's important to highlight about the investable universe in India is the breadth of the opportunity set. We have the ability to to own a number of world class companies with wonderful long term opportunities with exposure to, you know, a number of really exciting trends. It's not, you know, like some, perhaps, Asian or emerging market right there where you're forced to either own a bank or a telecom company.
• 18:49
  So if you were to look at the underlying exposure that we've had in India, it has evolved materially over the last ten years despite that weights being consistent. So we have well, the material shift is seeing a reduction in our exposure to consumer staples, which for those of you who who know Stuart Investors well, you know, consumer staples have historically been a a wonderful place to provide the the outcomes that we're looking for in terms of resilience at the bottom of the cycle and nice long term growth opportunities. But today, you're really we're being asked to pay very, very high multiples for for growth that isn't as certain as it was in the past, and that's due to, you know, rising competition and evolving distribution channels. So, yeah, we've we've we've reduced consumer staples. And then coming back to that point on industrials in India, that's certainly something where you're seeing an emerging set of aspirational companies with very ambitious long term owners at the helm.
• 19:45
  And I get really excited anyway about the when you hear them talking about taking on global industrials in their backyard. And when you look at some of them in the European industrial companies that are now very large, very bureaucratic, gonna do a bit of everything, You know, these are the types of companies that our Indian owners are are very excited about taking on. Yeah. That that's certainly been one evolution I'd, you know, highlight over in regards to the what's been going on in India. In regards to valuation, you know, we own companies, not countries.
• 20:15
  And I think, you know, coming back to comparing China and India, which is inevitable, I think, in in Asia is the the divergence in the the cut the largest companies in both indexes, divergence in the ownership structures. And then on that, just highlighting that, you know, our the companies we own look and behave very differently to the index. So I think of the 100 largest companies in India, we throw 75% of them out for governance, franchise, or sustainability, you know, positioning question marks. You know? So we we're not owning the index.
• 20:51
  What we would say is that when it comes to valuations, we try to take a step back from looking purely at short term price to earnings ratios and kinda lean into the advantage that we have of of taking a ten year time horizon and and asking different questions and asking, you know, what is this company worth to us over the next ten years rather than, oh, it's at 10%, you know, price to earnings premium. And I think that's something that we, you know, we we we try to utilize as as much as possible and not get sucked into the the short term game of just, you know, comparing price to earnings ratios.
• 21:23
  Kyle Caldwell: You mentioned that you invest in companies, not countries. However, when looking at the portfolio outside of both India and China, which countries do you have the most exposure to and why? So we've got material weights in in Taiwan, which, again, is
• 21:41
  Doug Ledingham: the result of finding truly world class industrial companies largely run by long term competent stewards. Probably I mean, one one country, but I think that's worth touching on is is The Philippines, and that it's now, I think, 7% of of the trust. You know, you've seen you've seen the trust increase exposure to The Philippines for for a couple of reasons. Firstly, you know, valuations are are very enticing, and, you know, coming back to that point on finding parts of the market where there's clouds hanging over them, I mean, The Philippines is kind of the land that the foreign investors, you know, forgotten. We were we were there a couple of months ago, and, you know, the brokers that took us around, they really it was like them seeing aliens.
• 22:28
  You know, they were they were they were so surprised to see a foreign investor rock up. So I think, you know, that's certainly something you you don't see at the top of a market. And then from a company perspective, there are a number of very well governed companies in The Philippines.
• 22:43
  Kyle Caldwell: As you've explained, you invest very differently from the index. You have a capital preservation focus, and I know that you have a long term investment approach. But if you look at shorter periods, say, over the past one year, the trust has made a small loss in both net asset value and share price total returns. Could you explain why that's been the case?
• 23:05
  Doug Ledingham: Yep. The performance has not been helped by the lack of exposure in the trust to Chinese mega caps, Chinese banks, and the very strong performance of of of TSMC. And then also on the other side within the portfolio, the larger Indian holdings that we have, you know, they've seen relatively muted performance over the last twelve months. So, certainly, that combination is has not been not been pretty for for relative performance over the last twelve months. But I think, you know, for us, as you said, we're we're focused on on creating, you know, long term value for for underlying shareholders, and that really means focusing on, you know, ten years, seven years.
• 23:46
  That's where that focus on capital preservation and the focus on people really contributes to compounding. You know, over any twelve month period, it's largely multiples and noise that drive earnings or share prices. Sorry. And I think any philosophy has to have a trade off and a cost. You know?
• 24:05
  And for us, the cost is not being drawn into attempting to outperform every twelve month period, and the cost is explaining why we have underperformed. And, you know, I I I hope that when clients look at the relative performance of last twelve months, they can they can understand that underperformance. And if we were to have outperformed over that period, I think it would have required material shift in the investment philosophy. So it would require less of a focus on governance, less of a focus on on leverage, and and and a shift to how we see position sizes. So TSMC is a, you know, it's a wonderful company.
• 24:43
  We've owned it, I think, since 02/2010, 2011 when we took over the trust. It's currently a 2% position in the trust, and it's a I don't know. I think it's 10 or at least very close to 10% in the index. We wouldn't have 10% in our highest conviction name, partly coming back to that view of of risk and and humility and not wanting the portfolio to be overly exposed to to a particular name or or sector. So, yeah, I mean, TSMC is a wonder wonderful name and a, you know, a a wonderful company, but that position size for us is really a reflection of of how we see risk and and and valuations.
• 25:18
  Kyle Caldwell: And looking ahead, what would you say is the main reason for optimism and also the biggest risk for investing in the Asia Pacific region?
• 25:27
  Doug Ledingham: I think the the biggest risk is with Asia, given the diversity of the markets, the number of very large domestic democracies, the number of nuclear arms borders in the region, I think there's always something to worry about. There's always gonna be a headline or two that's that's picked up and and, you know, has a risk of forcing you out of of your Asian exposure. You know, Asia really does offer some wonderful long term structural opportunities, whether that be, you know, financial inclusion, the rise of billions of middle class, the rise of manufacturing powerhouses in in in, say, Vietnam or or or India. And then coming back to that that point on on what it is that Pacific Assets offers underlying clients is that, you know, those long term opportunities have have always been there. But what does Pacific Assets offer?
• 26:19
  It offers you to, you know, align your capital with owners that are willing, I think, and able to to benefit from from those those trends. They've got their money invested alongside you. And like I said, I think they're trying to build a better business in the next ten years rather than the the the next ten months. Valuations are very attractive in our view for for that growth opportunity. The some of the the portfolio metrics for the trust, I think if you were to look at free cash flow yield, it's it's near, you know, all time highs, which and you combine that with the number of opportunities that we're coming across in the region, and it it tends to indicate, you know, a pretty attractive opportunity longer term.
• 26:59
  And I know that and, obviously, The US has done very well. I think when we talk to some of our clients, they've got the lowest exposure to Asia that they've ever had. I think diversification is, you know, is important and getting exposure to to Asia Asia over the next ten, twenty years through a, you know, through a trust that is allocating to to outperform over those periods and not being dissuaded from that due to, you know, political headlines or the the performance of The US, I think is I think the probably greatest risk is is is not having exposure to the to the region over the next ten years.
• 27:34
  Kyle Caldwell: Well, thanks to talk, and thank you for listening this episode of On the Money. If you enjoyed it, please follow the show in your podcast app and do tell a friend about it. And if you get a chance, leave us a review or a rating in your podcast app too. We love to hear from you. You can get in touch by emailing otm@ii.co.uk.
• 27:54
  And in the meantime, you can find more information and practical pointers on how to get the most out of your investments on the Interactive Investor website, ii.co.uk. And I'll see you next week.