Apollo Asia Fund 2Q15 Manager’s Commentary: Stormy macro, reassuring micro

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Claire Barnes – Apollo Asia Fund manager’s commentary for the second quarter ended June 30, 2015.

H/T ValueInvestingWorld

Apollo Asia Fund: Stormy macro, reassuring micro

The Apollo Asia Fund’s NAV rose 1.1% in the second quarter, to US$1,957.82. However, at the end of June it was down 6.7% over twelve months. After all the volatility of the last few days, the net decline in the first nine trading days of the third quarter has been approximately 2.2%.

It was a quarter of dramatic headlines and surprises, regionally as globally. April brought an unexpected tax panic for foreign investors in India; China’s stock markets made the roundtrip from boom to bust; Malaysia’s small businesses struggled with a botched implementation of GST; and more people started to question secular growth prospects for the emerging economies. China built some impressive structures to project its power in the South China Sea, without any effective pushback from the countries most affected, mostly preoccupied with domestic politics.

For once, however, after several trying quarters, the news from our individual companies was mostly good.

Apollo Asia Fund: Portfolio activity

Two companies that had been reporting poor results for some time, and causing us some concern as to the adequacy of the response, delighted us with improved performance accompanied by a much clearer articulation of effective action taken. The reticence had been due to a preference for action first, acknowledging the problems only after addressing them – admirable in a way, although not conducive to high ratings, or to the investor following which leads to liquidity: we have since been adding modestly to both positions.

Another holding reported much improved results, but we are not yet sure whether the management response is sufficient to combat the newly apparent challenges: meanwhile an upturn is welcome, and we hope it’s sustainable.

Three of our companies reported lousy results that came as no surprise given adverse changes beyond their control. Among these were Steppe Cement as a result of ruble depreciation and an influx of cheap Russian product; and Vard, as a result of the collapse in oil and gas prices and the resultant impact on its deepwater E&P customers. In both cases adverse conditions may persist for some time, but sensible responses increase our confidence in both management teams. I was glad to have the opportunity to visit Vard’s Vietnamese yard. This is its smallest, but the group has been delighted by its operational achievements and progress, and is now working on the development of a regional customer base. Although not yet very significant in group terms, the visit was encouraging evidence of Vietnam’s competitiveness in this rather specific shipbuilding niche (complex enough to be quality sensitive but not too automated), and boosted my confidence in the group processes for decision-making.

Another of our companies recruited an impressive executive for a key role, after a long search. Early feedback gives us hope that he will help the company to overcome various stumbling blocks and become more effective while improving controls, setting it up for a new phase in its evolution from a small company run by its founder to a more resilient professional entity.

On the other hand Aeon Credit Service (Asia), a Hong Kong listed company, startled investors on 12 May by announcing the simultaneous retirement of the managing director and two senior colleagues, three executive directors out of four, to be moved to other roles in the group, with no immediate provision for replacement: it said only that another announcement would be made ‘in due course’. Only six weeks later did it announce the new candidates. They seem well qualified, but this sort of high-handedness, and concerns about the handling of the increasing conflicts of interest within the group, help to explain why this excellent business is trading below book value, with a dividend yield over 6%. Another factor is the lack of geographical reporting on the ongoing investments in China, which might be viewed as an option on the emergence of a viable business model there, valued separately from the mature-but-solid operations in Hong Kong, depending on the willingness to commit further capital in the meantime. We hope that a strategic review may clarify the role of the Hong Kong listed company within the group, recognising its decades of ground-laying effort and investment in China. If this also happens to result in greater scale and liquidity, we would expect a significant rerating.

We have no such confidence in the new management team at Tomypak, and the board has done little to protect the minorities. We were therefore delighted to be able to exit, selling into a strong share price surge ahead of the first quarter results (which were better, against a low base) and the AGM (we may not have been the only people happy that we did not need to attend). The new controlling shareholders bought Tomypak cheaply, and one way or another will probably make a lot of money, but we prefer to coinvest with shareholders who treat minority investors as partners.

Market fundamentalism was roundly criticised by the Pope. His encyclical ‘Laudato Si‘ generated a heated reception. He criticised ‘the myth of progress’ (§60) and ‘a magical conception of the market’ (§190) while noting that ‘the environment… cannot be adequately safeguarded or promoted by market forces’ (§190). He recommended rejection of ‘the false notion that an infinite quantity of energy and resources are available, that it is possible to renew them quickly, and that the negative effects of the exploitation of the natural order can be easily absorbed’ (§106). He called for ‘resistance to the assault of the technocratic paradigm’ (§111), and ‘redefining our notion of progress’ (§194), while noting that ‘a decrease in the pace of production and consumption can at times give rise to another form of progress and development’ (§191). A rethink of development priorities seems overdue worldwide, and especially in Asia where environmental destruction has been rapid: this is a remarkable and very readable contribution to the debate.

We continue to sift new company ideas across a wide range of markets and sectors; the risks seem unusually high so input from fellow investors would remain very welcome. Current market turbulence is also presenting opportunities for some rebalancing.

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