News and Insights

In praise of avoiding BATs

Investors who stuck with Newton’s Zoe Kan in 2018 may feel vindicated as the Chinese tech merry-go-round begins to slow.

Newton Investment Management’s Zoe Kan has closed the year with a sense of vindication having stuck to her strategy’s investment process parameters. The manager of the BNY Mellon Investment Management-owned boutique’s Asian Income strategy spent much of 2017 challenged on her relative underperformance to the benchmark.

She points out that last year, the main drivers behind the FTSE All-World Asia Pacific ex-Japan gains were down to Chinese technology companies Baidu, Alibaba and Tencent, colloquially known as the BATs.

However, as an income investor, these companies are of little interest to Kan – due to their not paying out dividends. During the course of 2018, the BATs have seen a reversal of fortune and unsurprisingly her strategy’s performance has since taken an upward turn versus its peers.

Avoid the BATs, stick to batting average

Within the region, Kan’s fund is also one of the few to generate a positive absolute return year to date, in sterling terms. Yet she stresses that the relative success of the strategy is not just down to avoidance of the so-called BATs, but rather through “batting a series of average wins”, a deliberate approach behind the investment process, which has been in place for 12 years. The fund manager explains: “Nobody can outperform the market in every single market environment. We view 2017 as an exceptionally challenging year for income investors because if you looked at the strategy’s performance over that discrete period, we just weren’t generating the turbo-charged returns that the market was delivering.”

She says: “As long-term investors in Asia however, we see downside protection as a more important, and critical, objective. Fast-forward 10 months and suddenly we’re reminded about the power of negative numbers in a total return series.”

This is why, she believes her “batting average” to be better than a series of volatile wins and losses. “By losing less money in market drawdowns, but keeping pace with markets when things are going up, we aim to generate a total return with better risk/reward metrics.”

Kan refutes the view that Asia is predominantly a growth market, adding: “It doesn’t have to be one or the other, it’s the blend of the two – growth and income – that gives you a better long-term outcome from investing in an inherently volatile, but very interesting, part of the world.”

She admits that many investors in Asia struggle with the concept – especially those that focus on the short term. Generally awareness of its rich income universe is lacking, she says, although this is changing as the region matures.

By preferring to focus on quality, defensive names that offer a steadier, less volatile investment journey over a longer-term horizon, Kan believes that her portfolio return is more reliable and steadier, thanks to the compounding power of dividends.

Asia: More than a growth play

“We may not invest in the most exciting companies, like the direct beneficiaries of US electric carmaker Tesla, for example – of which there are plenty in Asia – but we are able to benefit from Asian growth in a more measured, sustainable fashion.”

A favoured example held in the strategy is a real estate investment trust (REIT), which owns a portfolio of shopping centres. Kan says the properties are fairly basic, in terms of their appeal; are

“nothing fancy”, but because they are attached to public housing estates, many of their tenants are service offerings, such as hairdressers, a bank or groceries-related. “These malls serve the local economy and are therefore more defensively positioned,” she adds.

Having invested in Asian equities for 18 years, Kan is enjoying the evolution of the market; her universe of dividend-paying companies is expanding as the market matures and corporate governance is improving at a steady rate. She says there are some clear structural linchpins on which that evolution is based, such as its ageing population.

“Korea will have one of the world’s oldest populations by 2050, so it needs dividend-paying companies just like we do in the UK,” she says. “There’s more pressure from the government, because the National Pension Service owns large chunks of the index so there’s a lot of vested interest for the universe of dividend-paying companies to grow.”

Not just about storytelling

Another aspect of the market Kan has to consider is state intervention, with state-owned enterprises featuring widely across the region. She says: “We have to be very careful when it comes to state-owned companies, because not only are the earnings being driven in a certain way by the government for the interests of the nation, but they also will control the dividend.

“For instance, you may see a ramp-up in dividend payments ahead of an election year, so the government can fund spending elsewhere. We have to watch out and be confident that those dividends are sustainable and not destroying company value in the long term.”

Looking ahead, Kan expects the year ahead to bring more volatility; if 2017 was about rapid and synchronised growth and 2018 about trade war escalation and volatility, 2019 will more likely be characterised by the same uncertainties.

“In a ‘Goldilocks’ environment, the BAT stocks may fare well, but with rising volatility, you need more certainty of earnings, whereby we believe investors would be served better by a less volatile fund.

“BATs, Goldilocks and Asian growth stocks were all great stories in 2017, but not so much in 2018. I have never been good at telling stories,” she adds. But she certainly appears skilled at sticking to the plot, as this year has demonstrated.

Source for all performance: Lipper as at 31 December 2018. Fund Performance for the Institutional Shares W (Accumulation) calculated as total return, including reinvested income net of UK tax and charges, based on net asset value. All figures are in GBP terms. The impact of an initial charge (currently not applied) can be material on the performance of your investment. Further information is available upon request.

Past performance is not a guide to future performance.

The value of investments can fall. Investors may not get back the amount invested. Income from investments may vary and is not guaranteed.

There is no guarantee that the Fund will achieve its objectives.

The Fund invests in emerging markets. These markets have additional risks due to less-developed market practices.