Don’t Expect 2020-Type Returns in 2021

In 2020, Asia Pacific stocks overcame the deep uncertainties caused by the coronavirus pandemic. In Canadian dollar terms, the Morningstar Asia Pacific GR Index was up 17.38% in 2020. Yet, even with markets currently in a volatile mood, stock pickers such as Benjamin Zhan believe this year may be less demanding.

“Based on the results we may think that 2020 was a great year to be an investor, but the reality was quite different. Most professional investors will agree that last year was easily the most difficult year in our careers,” observes Zhan, vice-president at Toronto-based 1832 Asset Management LP, and lead manager of the 5-star,  silver-rated $420.4 million Dynamic Asia Pacific Equity Series F. “From a standpoint of economic uncertainties, 2021 will be much easier and a better year.”

In 2020, Dynamic Asia Pacific Equity Series F returned 47.06%, versus 23.88% for the Asia Pacific Equity category. Year-to-date, however, markets have been jittery, and the fund has returned -5.42% (as of March 12), versus 1.69% for the category.

Asia Investment Case Strong
Zhan maintains that the investment case for Asia is stronger today than 12 months ago. “We have to get our near-term expectations right,” says Zhan, a native of Kunming, China who earned an engineering degree from Shanghai Jiao Tong University and worked in the chemical, high technology and real estate industries, before joining Dynamic Funds in 2003. Zhan began as a real estate analyst and rose up through the ranks to assume the Asia Pacific portfolio in 2017.

“This year won’t be one for huge returns, but one for preparation and re-positioning. Many of our clients have portfolios with very little exposures to Asia. For them, today’s market correction is exactly what they need to bring up their Asia and China exposure and so they can enjoy the full benefit of participation in the secular growth story in Asia.”

Now’s a Buying Opportunity
Zhan concedes there are many signs of over-heating in global markets and some kind of correction was long overdue. “We have been spending the past six months preparing for this correction,” says Zhan, noting that he and his six-person team, which includes Dana Love, vice-president and head of the core equity team, have been taking profits from top-performing stocks and diversifying into less-crowded areas. As a result, the fund expanded from over 40 stocks a year ago to about 60 today.

He adds that many great Asian companies have seen their stocks recently decline 30% or more, thus creating buying opportunities for Zhan and his team.

On a sector basis, they have increased the healthcare weighting from less than 5% a year ago to about 27%. Other sectors include 20% consumer discretionary, 17% information technology and 15% industrials.

Four Positives and Some Negatives
Zhan argues that Asia will be the best performing market for the next decade, based on four secular trends. First, technology will continue to change our societies. Second, he expects the acceleration of a trend known as consumption premiumization (which speaks of consumers seeking ever-more expensive consumer goods). Third, the healthcare industry is entering a new phase in medical breakthroughs and development. Finally, China continues to rise as a global power.

Conversely, there are risks that could impact markets. They include mutations of the COVID-19 virus and disruptions of global supply chains. But worries about inflation prompting higher interest rates are misplaced, argues Zhan.

“Some people believe that money-printing alone can lead to inflation. But those people have forgotten about the experience of Japan. Persistent inflation can only be possible with persistent under-supply of goods. If we think about the world, the opposite is true. Our world has for years struggled with a jobless problem, which suggests there is excess capacity across all industries. Some price hikes today are temporary and the result of global logistics disruptions.”

But, he argues, as many governments push for local manufacturing that will lead to a pick-up in production capacity, which may worsen the oversupply problem down the road.

China Leads the Pack
A bottom-up value-oriented investor, Zhan and his team look for companies that are within so-called quality growth industries, enjoy market leadership and high profit margins, which indicates the quality of product development. In seeking to add value, the team will also make contrarian bets when stocks are under pressure either because of temporary operational challenges or in market sell-offs.

Intriguingly, China accounts for the largest single country weighting at 66%, or more than double the benchmark. Other country weights are proportionately smaller, with Taiwan accounting for 7% of the portfolio, Japan 6.8%, and South Korea 4.4%.

“That Chinese weighting was not by design but the result of fundamental research for the past couple of years. Once we identify a secular growth industry, we will study and compare the best and largest companies across all relevant countries,” says Zhan. “We assess their revenue potential, their margin progression, balance sheet and management track record. It is a highly fundamentals-based process. But we always put the broad economic environment into consideration.”

Indeed, he notes that last year Chinese companies attracted a valuation premium, mainly because China was the safest place to avoid the virus last year, and the first to recover. Still, as the global economy gradually recovers, Zhan intends to gradually reduce the China weighting closer to about 50% of the portfolio.

Stocks Zhan Likes
Among the names that Zhan favors is Tsingtao Brewery, the second largest brewery in China. “Chinese companies were known for cutting prices, but things are changing now. After years of consolidation, the largest five beer companies in China control 75% of the market. They have shifted their focus to profit growth and have reduced capacity and have moved prices up,” says Zhan. Tsingtao’s share price is trading at 26 times 2021 earnings and is not cheap, admits Zhan, who acquired the company in 2017. “But if China’s beer prices can go up to somewhere near those in the U.S., normalized profits in Tsingtao beer will be multiples higher than what they are today,” argues Zhan.

Another favorite, and the largest portfolio holding, is BYD Company, the largest maker of electric cars in China and also one of the largest manufacturers of batteries in the world. “It’s the only Chinese company in Warren Buffet’s holdings and last year, was also one of the top-performing Chinese stocks,” says Zhan, adding that BYD is such a large technology powerhouse in China and has built a portfolio of 25,000 patents.

BYD is trading at a lofty price/earnings multiple of 75 times 2021 earnings. “It’s not cheap because many of its technologies have yet to contribute meaningful earnings.” But, he argues, it’s one of the best-positioned companies in the world to enjoy the explosive growth of the electric car. Acquired in 2017 at about 50HKD, it is now trading at 197HKD. “When we bought BYD, the stock was ignored. But since BYD became a momentum stock last year, we’ve been trimming our positions. When a company becomes well-loved, we take some profit and put it into other ignored stocks. These moves help us avoid being carried away when things are good and also enable us to take advantage of opportunities in market sell-offs.”