Fidelity Asian Values: Last Subscription Share Opportunity Coming Up

Launched in June 1996, FAS is listed on the Main Market of the London Stock Exchange. Since 1 April 2015 the lead manager has been Nitin Bajaj, who aims to achieve long-term capital growth from a diversified portfolio of Asia ex-Japan equities. The manager is able to draw on the broad resources of Fidelity’s Asia Pacific ex-Japan investment team, which includes five dedicated small-cap analysts. He seeks companies that are trading at a discount to their intrinsic value.

Bajaj invests across the market cap spectrum, generally favouring smaller companies, and there are no set limits on geographic and sector exposure, although he restricts single country and sector weightings to 25% and 15% of the fund respectively. Guidelines state that, at the time of investment, up to 10% of gross assets may be invested in a single company, a maximum of 5% may be in companies listed or domiciled outside the Asian region (if they have a high economic exposure to the area) and up to 5% may be unlisted securities (if they are expected to list in the foreseeable future). Derivatives are permitted as a cheaper alternative form of gearing to bank loans (contracts for difference) and to hedge equity market risks, while the manager seeks to improve FAS’s returns by taking short positions. Total derivative exposure is limited to 40% of NAV based on gross assets and 30% of NAV based on net market exposure. In the medium to long term, the board expects net market exposure to be 90–115%. At end-September 2019, net market gearing was 0.1%. FAS’s currency exposure is generally unhedged.

The trust’s performance is benchmarked against the MSCI All Countries Asia ex-Japan index. However, as the manager finds more mispriced securities at the smaller end of the market-cap spectrum, there will be a proposal at the 6 December 2019 AGM to change the benchmark to the MSCI All Countries Asia ex-Japan Small Cap index. If approved, the benchmark change will be effective from the beginning of the second half of FY20 (1 February 2020); there will be no change in the way FAS is managed.

The fund manager: Nitin Bajaj

The manager’s view: Choppy markets likely to continue

Bajaj acknowledges that markets across Asia and the rest of the world have been choppy over the last year. Investors are weighing up the favourable backdrop of low interest rates and fiscal stimulus versus the less palatable slowdown in economic growth and this conflict is leading to stock market volatility. The manager says this environment is not uncommon for the later stages of a business cycle. In 2018, the broad Asian market delivered a below-average total return, while small-caps in aggregate declined. So far in 2019, larger companies, especially growth stocks, have performed better than small caps and value stocks (across the globe, not just in Asia). Bajaj says growth or value leadership in the market is ‘part and parcel of investing’ and although it is difficult to forecast the magnitude of the swings in style, the trends always reverse.

The manager undertakes a quarterly review of the markets and notes there has been no material change in the macro environment; important drivers continue to be the stage of the US economic cycle, the property market and the level of credit in the China, along with unforeseen events such as the dispute between the US and its trading partners. All of these factors are contributing to stock market volatility. Bajaj suggests no one knows where we are in the US economic cycle and although recent Chinese data suggest the economy is stabilising, it is impossible to call the trend.

In terms of corporate earnings estimate reductions, the manager says it is important to determine when company valuations make sense. Global estimates have declined, in aggregate, by around 15% since the peak in May 2018, as economic growth has moderated. Bajaj notes that the shares of good-quality companies are still being dragged down in the market, although there are pockets of relative strength in Asia, such as China A shares. Generally, small caps have suffered multiple compression; the manager says there are plenty of cheap stocks in the polarised market, with many companies trading on forward P/E multiples of less than 10x. He emphasises that FAS’s portfolio continues to hold high-quality stocks, although its aggregate forward P/E multiple of 8.9x is at the low end of the historical range of Bajaj’s tenure. While the fund has a lower valuation versus the index, it also has an above-index return on equity.

The manager says his investment philosophy, which has been built around years of practice and observation, remains unchanged: he buys good companies, run by good people, at a good price. There are c 140 names in FAS’s portfolio and the manager says he has been able to deploy capital into small-cap stocks that are being ignored by investors.

Asset allocation

Investment process: Bottom-up stock selection

Bajaj favours undervalued smaller-cap companies that can grow into ‘the winners of tomorrow’ and have not been recognised by the wider market. There is an intense focus on avoiding large losses in the portfolio; to help achieve this, the manager seeks to invest in good businesses with robust balance sheets, run by competent and honest managers, at a price that provides a margin of safety for errors. There are c 18,000 listed companies in Asia, providing a deep pool of investment opportunities. The manager highlights three elements of the investment process:

The business: Bajaj says this is the first and most critical step. He and his team aim to understand the key drivers of each business, its industry structure, management team, history, a firm’s competitive advantage and durability. The team analyses the last 15–20 years of a company’s financial statements to understand its returns on capital over an economic cycle. This analysis is followed by many meetings with a firm’s management team and other interested parties, including its customers and competitors. The manager is only interested in investing in companies with high-quality management teams.

Valuation: Bajaj says the entry point for a new position is important, as it sets the base price for compounding capital and determines a margin of safety. Valuation metrics employed by the team vary, depending on which are the most logical for each company.

Downside protection: to help mitigate the risk of big losses in FAS’s portfolio, the manager avoids companies with untested business models, or which have high levels of debt. He does not overpay for a good business or pay a reasonable price for a bad business and will not initiate a position during an industry down cycle.

Current portfolio positioning

At end-September 2019, FAS’s top 10 positions made up 22.6% of NAV, which was broadly in line with 22.3% a year earlier; three positions were common to both periods. The fund’s small-cap bias is illustrated in Exhibit 3, with a 54.6pp overweight in smaller companies with market caps up to £1bn and a 48.4pp underweight to larger-cap firms compared with the current benchmark.

Over the 12 months to end-September, the largest geographic change is a higher weighting to India (+7.5pp, Exhibit 4). The manager’s unconstrained approach is illustrated by the fund’s meaningful deviations compared with the benchmark, such as its underweight in China (-17.0pp) and overweights in India (+12.5pp) and Indonesia (+8.1pp).