Macquarie Asia New Stars No.1 (MAQ0640AU) Report & Performance

Asian markets declined over the month as the expectations of aggressive policy tightening by the Fed and concerns over global economic growth weighed on the risk sentiment. The portfolio underperformed its benchmark in May primarily driven by what we believe to be stock specific short-term sentiment driven factors.

• The source of this month’s underperformance primarily came from China with the tertiary education providers, China Education Group and China New Higher Education, depressed on negative sentiment toward the sector. We remain positive on their long-term outlook and continue to look through the sector-based volatility that has seen their valuations drop to highly attractive levels, in our view.

• More broadly, we saw signs that market sentiment was turning more positive on the Chinese equities due to the government’s efforts to cushion economic growth slowdown, expectations of Shanghai re-opening and Beijing’s easing Omicron cases and reduced mobility restrictions, as well as US President Joe Biden’s statement that he is considering removing some of the tariffs on Chinese imports.

• On the positive side of things, India was the country where the most outperformance was delivered during the month, with a reopening play via our investment in the MakeMyTrip online travel booking website provider delivering the bulk of the outperformance

What happened in April?

• Asia New Stars’ quality growth and value disciplines saw it outperform its benchmark* in a period where global markets absorbed the reality that growth will become scarcer in an environment of higher inflation and with it structurally higher interest rates. The domestic focus of the portfolio added resilience with the obvious tailwind of the opening of many of the Asian economies. This opening and escalation of business activity is undeterred by inflation is the feedback from many quarters of the regions especially in South East Asia, India and South Korea where ‘with-COVID’ policies are in place.
• Consistent to our fundamental investment strategy the outperformance was generated from bottom-up stock selection with key contributors coming from India, South Korea and Taiwan in the Financials, Materials and Information Technology sectors. Specifically key contributors included a long held agricultural-chemical company that is benefiting from food inflation, a leading supplier of high-end golfing equipment and a Korean convenient store operator that are benefiting from the re-opening of global and local economies respectively, and a supplier of data-centre equipment as the growing need for data storage is showing little signs of abatement.
• Countering this there were few detractors in a month of a high stock-picking hit rate with the key detractors being cases of reversion from strong recent performance.
• A key regional and global exception to the ‘with-COVID’ strategy is China, yet despite the strict lock-down of Shanghai and its obvious economic drag, China was not an under-performer for the month rebounding into the month end for several subtle, less headline-grabbing but real reasons.

Asia markets retraced modestly in February due to the tensions resulting from the Russian invasion of Ukraine and fears of inflation rising in a slowing global economy. The Fund underperformed with some of the more export focused companies reverting. Offsetting this was solid delivery in the domestically focused names in India and China.

• The weaker exporting names include two long-term muti-bagger investments for the Fund where we see solid ongoing delivery, these being the South Korean producer of high-end electric vehicle batteries, Samsung SDI and the low-cost innovative India agrichemical company UPL. In both cases the companies operate with superior profitability margins compared to peers and have obvious structural tailwinds being the proliferation of electric vehicles and the higher demand for more productive agriculture in satisfying the expanding appetites and palates of the world’s rapidly growing middle class.

• The offsetting stronger performers for the month shared a common thematic of the emergence of the world from the grasps of COVID-19. These include a rapidly expanding restaurant chain in China, a hospital in India which is now realising fuller occupancy in dealing with a backlog of pent-up elective surgeries and an Indonesian microfinance provider who is extending further finance.

• Although not a focus of the Fund, which has consistently maintained a domestically focused bias, opportunity does nonetheless present itself in the more export focused names where domestically developed competitive advantage is leveraged globally. The more obvious examples of these are in South Korea and Taiwan technology hardware sectors where the Fund is has benefitted from a consistent overweight to electric vehicle batteries for many a year and more recently memory exposures. UPL is a less obvious, but nonetheless an equally compelling example of an exporter with a domestically developed entrenched competitive advantage.

The Fund retraced in December mainly on poor sentiment toward Chinese property services and education companies. The Fund lagged a benchmark that was led higher by cyclicals with Industrial and Materials sectors extending their recent outperformance over the structurally advantaged Consumer and Healthcare sectors.

Both property services and education are respectively supported by trends of increased multi-dwelling living and higher demand for vocational and higher education with a shift toward services and higher technology manufacturing within the Chinese economy, in our view. For the year both sectors witnessed strong earnings growth with high annuity style earnings visibility ahead of them. Nonetheless these highly profitable business models are being overlooked with poor sentiment toward China prevailing.

The discounting of domestic demand names despite the solid earnings delivery saw the portfolio close the year at a material discount to both its own benchmark and global bourses. Despite maintaining superior quality and structural growth prospects, the portfolio has historically tended to trade in line with its more cyclical benchmark which we observe to be a product of the less efficient, under-analysed market. The prevailing discount we see as an exaggerated anomaly

Asian markets retraced (in USD terms) during November with ongoing competitiveness, slowing demand and regulatory concerns amongst large cap e-commerce tickers, as well as some anticipation of lockdowns with the Omicron COVID-19 strain spreading globally.

Although both small and large cap Asian stocks retraced in unison over the month the fall in smaller companies was more muted. Year-to-date the MSCI Asia ex Japan Small Cap benchmark has outperformed its large cap counterpart by 23% benefitting from diversification and valuation support.

The Fund, being overweight domestic demand and consumption exposures, underperformed its benchmark slightly during November. Regional variances saw the technology heavy Taiwan and the defensive Singapore regions outperforming whilst the more COVID-19 vulnerable South East Asian regions were amongst the underperformers. Sector-wise it was the consumer sector that is more exposed to lockdowns that lagged whilst Information Technology and Communication Services showed resilience with the former shaking concerns around supply side constraints and the latter being a beneficiary from lock-downs and home-working.

The Fund lagged the benchmark during the month with reversions in South Korean stocks that have performed well year to date, COVID-19 fears in China and capital flows from China around excessive regulatory oversight being the main drivers of performance detraction.

Offsetting these headwinds, the rapid recovery from the impact of the COVID-19 delta-strain in India and South East Asia saw conviction in these regions pick-up and markets rebound.

Much like we did with our long-held conviction investments in India and South East Asia, we hold our conviction in the face of shortterm issues in China. Our resolute view is that quality companies endure and we look to their fundamental delivery and valuations, ahead of sentiment and trends in capital flows.

Hansol Chemical is a conviction position that saw a modest retracement in October but is well placed to be a beneficiary of the structural trend of electric drive trains displacing internal combustion engines, in our view. Although not a pure play on this trend the bottom-up delivery from Hansol is in three key areas being next generation screens for televisions and other electronic devices, memory and elective vehicles. In each case Hansol enjoys strong and improving margins from research and innovation delivering superior inputs as well as security of supply to their industry leading clients whilst gaining scale economies. Whilst others may have taken profits into the rally which has seen the share price more than double over the past year, we hold this position for the growth potential yet to come and we outline why further below