How is Asia faring?

Portfolio Manager for the Fidelity Asia Fund, Anthony Srom updates clients on his views from Asia.  Does he remain cautious on the outlook for Asian company earnings and has this been factored into prices yet? How is China really faring - first in, first out and with supply increasing, is anyone buying?

Anthony also discusses where he is finding new ideas, what is he avoiding and how he is staying connected with companies and colleagues around the world. 

Gary Monaghan:

Hello and welcome to Fidelity Live the Asia edition. I'm Gary Monaghan, Investment Director for Asian Equities and I'm joined today by Anthony Srom, Portfolio Manager of the Fidelity Asia Fund. This is our second live call on this strategy amid the ongoing Coronavirus with our first one being on the 18th of March. Now we're one month in a couple of days on and the Asia ex Japan index is up around three percent in Australian dollar terms since then, with the fund lagging about 50 basis points behind. Year to date the fund had fallen four percent which is not too bad actually, with all things considered and as a reference, the ASX 200 is down around 20 percent over that same period.

Gary Monaghan:

Now for this call I will be posing the questions but you too can ask some by submitting a question by the Q and A tab on the zoom interface. I believe this is at the top of the screen for those using iPads and at the bottom of the screen for those dialling in via laptop.

Gary Monaghan:

So moving on Anthony, first of all, welcome. And when we held this call just over a month ago, you were quite cautious on the outlook for Asia company's earnings for 2020 and felt that the markets had not really fully priced in this bleak outlook. Has this view changed, or has this view actually solidified?

Anthony Srom:

No, it's more solidified, I'd say. No real change to the outlook over the last month. China has rebounded somewhat in terms of economic activity, but it's still soft and I just think earnings expectations for a lot of companies out there in the market haven't come down sufficiently or the street hasn't started to move just yet. So when you're trying to factor in a bear case, usually end up much worse than what you think the initial bear case is. And I think that's what we'll go through as the year progresses.

Gary Monaghan:

So if you're looking at this from a more macroeconomic perspective, do you think we're facing a prolonged period of recession that may even stretch into 2021 and how does that reconcile with your fund and the positions that you hold? And linked to this as well, an additional side question, the macro earnings environment is volatile, so how are you actually able to get conviction on the current and new names in the portfolio?

Anthony Srom:

Yes. I think maybe addressing the last part first, in terms of conviction, it really comes down to the valuation part of the process. So, we did see equities fall steeply over the last two to three months. That provided some opportunities for the fund. You would have seen the name count increase in valuation, has to get a tick in the box. Otherwise, that just doesn't make sense from my perspective. So you will get macro swings and roundabouts, but I just think if you're buying at a good valuation and you like the fundamentals attached to the company, valuation is pretty much your number one predictor of future return performance. So, and that's how I really go about doing it. Again, a one year view is quite a short term view for me. So always trying to think two to three years down the track and let the noise wash out. In terms of the macro environment and prolonged recession and maybe what kind of shape recovery it is.

Anthony Srom:

I've seen a lot of letters out there from the V's to L's to U's to W's. If I had to put a shape on it, I don't think it will be a letter, it'll be like a tick. We've gone straight down and things will rebound, but it's not going to be straight back up again like a V. So I think we will get some sort of recovery coming through. I think it's going to be more drawn out than what the market's anticipating. And look, if economic conditions don't pick up quickly enough, central banks and governments never run out of bullets. I think they'll just keep throwing money at the problem until they see some sort of resolution. We saw monetary policy to action. You've seen, it's called stimulus come into play. If that's not enough, they'll just keep going, and get some sort of outcome and that in itself I think provides a lot of instability, once we look through the next six to nine months, just given the leverage out there in the global economy. Likely inflationary outcomes that could happen from all this stimulus that we're seeing.

Gary Monaghan:

A bit later, I want to just touch maybe in the Q and A on fiscal policies and stimulus. But just moving on since we last spoke, again, the COVID-19 outbreak is actually taking a much larger grip, particularly in Europe, in the US. Do you think that you're going to have demand implications globally and are there any industries that actually you're concerned about in this regard? And on the flip side, are there any opportunities linked to this?

Anthony Srom:

Yeah, in terms of Europe, the US facing economic difficulty, I think was pretty clear about a month ago. You're already getting knock on effects into the Asian economy from that. So put it this way, if you go back to say January, production ramping up into Chinese New Year, inventories being built in anticipation that'll be delivered in Feb March. China starts to kind of recover somewhat from the Coronavirus. Europe and the US catches it. Businesses in the US say, "Look, I don't want my orders anymore." So there's been, I think, a bit of a production slowdown in China and inventories that were supposed to be delivered are looking for homes now. Whether it's on a boat, in a warehouse, where can they possibly go. So I think, we probably had a bit of a heartbeat for economic recovery out of China and I think that's probably gone on ice for a little bit at this particular juncture.

Anthony Srom:

So in any industries that could benefit, or not, look, I think the market has re-rated obvious ones. For me that's things like a DianPing, Tencent, Alibaba. I think the pendulum swung way too far on those. I'm a bit sceptical on what kind of recovery they'll get in terms of earnings. The other sectors that are doing quite well, I think gives you a sense of how the market's thinking, is Chinese domestic exposed companies. So for example, we've got Angel Yeast in the portfolio, very much domestically orientated. It's a yeast extract manufacturer you see in home cooking, all that. I mean that's absolutely flown. I think within China there's, I think a fair bit of scepticism on an economic or export rebound that would be coming in terms of where's the opportunities. The travel sector is still very beaten up.

Anthony Srom:

So think airlines, think airports, think travel agents. Again, if you take a multi-view, it'll be a drawn out process of recovery. I think you're probably going to get some early signs of that coming through maybe in the next one or two quarters. So that could be an interesting avenue to explore. Also, just concerns around US. So think companies that have got substantial businesses in Asia, but also the US. I mean one that we own is Techtronic, power tool equipment manufacturer. So again, the angle would be, okay look, if Europe and the US slows, market's not going to like it short term, but hey, they've got a great franchise, margin expansion potential, great management. And by the way, if modern monetary theory and infrastructure spend comes down the pipeline, that's cream on top. So go back to what I said earlier, valuations look attractive, we're willing to step up to the plate there. We already bought some for the fund, but I'd look at buying more if things get a bit more rocky. So that's a few ideas I'm thinking about.

Gary Monaghan:

Linked to that, actually Anthony, we've had a question that's come through as well around China factories coming back online and are they coming back to work and is this something you're actually observing? And so my question is, is this something we're actually observing and is production getting back online? And just from your answer there, I'm assuming that the concern is that yes, they're building stuff, but actually then there may be an issue of oversupply down the line. Is that the line of thinking that you're taking?

Anthony Srom:

Yeah, I think what you're going to see is some inventory overstocking, de-stocking, so I think that part of the economic cycle might be a bit exacerbated. But from what we can see, companies that the fund holds for example, Hon Hai is an iPhone assembly company, amongst other things, employees have gone back to work. I'm very sceptical that people say China's rebounded, 90 percent of capacity's back online or whatever. 80, 90, 100, then you've got to ask yourself, well what's the utilisation of that 80, 90, 100 and I think that the economic kitty in China is still substantial. Some of our own data that we track as a house, earlier this week we published internally, they see half the economic activity that's been taken offline in China has fully come back. So let's say you're down 20 percent, 10 percent's come back.

Anthony Srom:

You can see tracking data from mobile phones. So people's movement, where are they going, what's happening? So think subways, think restaurants. And so, subways, not the restaurant Subway, but the train station subways and restaurants. And you can see people really moving in China. But again, I think, you're nowhere near back to pre COVID levels. So China has come back, we can see the movement, we can see the production, you can see air pollution, you can see coal burn, people movement as I discussed. But no I think there's still a long way to go before they get back to where they were.

Gary Monaghan:

So all of what's gone on, there's obviously lots of noise out there at the moment, but there's a story of de-globalisation that seems to be emerging and whether that's around companies moving supply chains, particularly away from China and even things around sort of ongoing travel restrictions going forward. So what are your thoughts on this and what are the companies telling you about how they're dealing with this and the news around this sort of de-globalisation theme that seems to be emerging.

Anthony Srom:

Yeah, so if you take a step back, the world was almost de-globalising before Trump got elected anyway. You could see that from movement like global trade volumes, how they were tracking versus GDP. It wasn't usual relationship that you were seeing. So Trump comes in, that gets another shove. It becomes a lot more accelerated. And you fast forward to the trade war. So again, pre COVID-19. You know companies were getting a bit suspect about China 2019, late 2018 so do we really need our production facilities in China? Can we diversify somehow? That got a bit of momentum in 2019 and I think COVID-19, the virus has actually dramatically accelerated that. I think it brought home to a lot of companies how reliant they are on China in their supply chain. And I think you're going to see a bit of de-risking there. So again, think Techtronic, which we touched on earlier. They started diversifying some of their manufacturing out of China to Vietnam, late 2018, 2019. They're thinking Mexico and other places as well. Suppliers to Nike, so I think the material that goes into the running apparel, et cetera

Anthony Srom:

a lot of that was China. So I think now Cambodia, Vietnam, potentially Indonesia. So I think from supply chain perspective, companies broadly across a lot of industries, I think will start to look to de-risk from China, and that, I think has got implications for Chinese GDP growth as well. I mean, who could benefit from that? Oh, so maybe just rounding it out, I think as you get more dispersed production around the world, I think that that feeds into things like high performance computing, cloud, so I think DRAM memory manufacturers like SK Hynix in Korea. Also I think things like 3D printing, which has got supply chain knock on effect as well.

Anthony Srom:

So I think this will have a lot of ripple effects over the next few years. Industries.

Gary Monaghan:

So on that, I'm just thinking about particularly Southeast Asia. You've mentioned Cambodia and Vietnam and others, and the infrastructure there, let's just say it's not the best. So do you think that this is something that's maybe a decade long sort of drawn out process, because the infrastructure just isn't there, or something that's quite an easy and quick win for those countries?

Anthony Srom:

Yeah. In terms of infrastructure, I think it'll depend on the industry. So for example, the apparel manufacturers for Nike, Adidas, Puma, Cambodia, Vietnam, the infrastructure's there, there's no problem. You probably wouldn't go to Bangladesh though. Again, think of ESG. That goes up another couple of notches if you go to a country like that. So I think Vietnam is still good for things like mobile phone manufacturing, power tool manufacturing, et cetera. So I think it'll be country by country, whether infrastructure requirements are met, et cetera, et cetera. So put it this way, a case by case basis.

Gary Monaghan:

You just mentioned the shift of supply chains away, and some production slow down in China is going to have an impact on GDP over time, but as we look at the portfolio, you've still got a fairly significant exposure of around 27% of your NAV in A-shares. And many of these companies are very much relying on the domestic China stories, so Hype Vision, Kweichou Moutai. We can also name other Chinese names listed elsewhere, like Yum China and Galaxy. So despite what you just said, you're actually still relatively confident on the relative strength of the domestic Chinese demand versus global demand.

Anthony Srom:

Yeah. So in terms of that thematic I'd say yes, the other point being that some of the newer additions to the portfolio like Galaxy, you mentioned, Macau Casino Operator, the valuation level when I was buying, I felt the risk reward payoff was asymmetric. So even in the event of let's call it subpar GDP growth outcome, you're going to be compensated by at least a good level of mean reversion. So reading to that, you probably didn't need to bank on economic growth as much as you would have if you were buying that stock six months ago. So that's the first thing I'd say on the portfolio.

Anthony Srom:

Again, risk reward versus valuation in the light of let's say, softening GDP growth in China. The other thing I'd say is, the weighting towards China in the portfolio has come down over the last three to six months. So I mentioned Angel Yeast before. Maybe I'll bring up the share price chart of that. You know, that the funds reduced 5,300 basis points of that company, and some others being tipped out last year as well. So in terms of the weighting in the portfolio, A-shares has come down because there's been other opportunities elsewhere. So that's probably what I'd say in terms of answering your question.

Gary Monaghan:

Now, there's been a lot of talk about this lockdown creating a significant step shift to online spending habits and online searches and such. However, you still avoid the biggest online names in the region like Alibaba and Tencent. So why is that?

Anthony Srom:

I think if you look at online spending... A lot of the online grocery consumption, online gaming, and all that kind of stuff's got a lot of headlines, but when you think about it, yes that may have gone up, but discretionary retail would have plummeted. And if you take it a step further, the economic softness that we're seeing globally, I think is going to have a big consumer confidence hit. And again, that'll feed through buying habits, and I don't think China will be any different. If you look at Alibaba for example... Okay, look there. There's really good parts of the business. Now earnings expectations for 2020 financial year are no different than they were three years.

Anthony Srom:

Now what gives? You hear so much positivity about companies like that. It's just it seems like you're just playing swings and roundabouts in the valuation multiple at this particular juncture. But take it a step further. Despite all these positive tailwinds that they've got, margins really aren't expanding, return on capital's not expanding. It's basically bobbing along the bottom. They've done a lot of M&A, they've done a lot of promotion. I wouldn't say the M&A has been that successful for a lot of these companies.

Anthony Srom:

It's diluted returns as a result, but you're still being asked to pay sky high valuation multiples, in essence. So one of two things has got to happen. The valuation multiples have got to retrace to reflect reality that's in the financial statements that they're publishing or those margins and returns that I was discussing have got to start trending up materially, justify where you are. So either way it doesn't look like a favourable risk reward outcome from my perspective.

Anthony Srom:

And then, get back to what I was saying earlier and what you're touching on, some of the China domestic plays were really bid up in the last two months because of what we're talking about, people really worried about export, there's home cooking, online shopping, you name it. They caught a nice bit as a result. So to me, valuation is very lacking at this particular juncture, and some of the longer term risks over the next three to five years haven't really changed in terms of how do they deal with device change for example.

Anthony Srom:

It's inevitable that we'll move away from smart phones just as people went from shopping on PCs to shopping on smartphones and playing games on smartphones to something else. It could be glasses, it could be digital assistants. How do they transition their business model to something like that? It's not really a slam dunk in my view. You've got a thread of competitors coming down the pipeline. We've seen Tiktok slash ByteDance emerge out of China and hamper Tencent somewhat, and people say, "Oh you know, they didn't see them coming," but I'll totally disagree, given industry structure changes that you're seeing in China.

Anthony Srom:

And then globally, so I think massive compute power is a lot cheaper than it was 20 years ago. You can buy data sets. The threat of two guys in a garage is much greater today than it was 20 years ago when you didn't have those two things going in your favour. And the other thing is trade wars. We've got a phase one deal, whatever that means. I don't think anyone really knows. If there's further positive progress on that, good, but if it turns sour, US has got leverage there in terms of high technology that Alibaba and Tencent are really reliant on, and think these processing chips that are produced by Nvidia, which going to search recommendation algorithms. They can't get those.

Anthony Srom:

What happens to your ASP? So there's a lot of risks that I see on a three to five year view. I mean, I'll keep going and going, but in the interest of time, I'll probably draw it there. So there is a line in the sand where I would look to buy these things for the portfolio. We almost got there last month, but again, if I can't tick valuation, I don't think it makes sense to buy it for the portfolio. And that's where we are today.

Gary Monaghan:

So I do just have a quick follow-up question, particularly on Alibaba, where there's a lot of talk around their cloud business potentially being the next big business, and some potential margin expansion going forward. Do you agree with that? Or do you think that there's just too much competition in that space, to make a lot of money?

Anthony Srom:

No, I think if you look at where the industry is heading, as I was saying, kind of HPC or high performance computing, AI, machine learning, cloud, it's definitely a trend. It's definitely going to be fast growing. A high chance you're going to make good money out of it, but would you rather buy Alibaba or would you rather buy somebody else, who benefits more directly from that? I think, you know the old saying, don't buy the miner. Buy the guy that sells them the picks and shovels. So you start thinking about SK Hynix TSMC, industry structure's quite favourable, valuation makes a lot more sense, long runway for growth, good relative out-performers.

Anthony Srom:

I mean, TSMC, we recently purchased SK Hynix for the fund, but to me, I'd rather play that kind of industry trend than something else at this particular juncture.

Gary Monaghan:

We've spent quite a bit of time on China. Of course, it's extremely important for the entire region, but I just want to shift geographies quickly over to India, and to get your thoughts there. What's your view on the Indian market, and there's been some heavy falls there. And so, is valuation attractive enough in your mind? Or are there actually opportunities? And if there's a lockdown there, so economic activity's pretty stagnant, but what are you seeing there, and what are your thoughts around India?

Anthony Srom:

Yeah, it kind of feels a bit like China where you've seen dispersion, in the sense that markets really hugged what they were familiar with and what they loved. So think Tencent, Alibaba in China, think maybe the paint companies in India, and what's got absolutely smashed, think financials in India. Again, financials, I think have been quite substantially in the region, some of it warranted, some of it unwarranted. Maybe that's past psychology. The last crash we went through in '08, '09, banks were the epicentre of it. So maybe it's sell first, ask questions later, and I mean, you've seen what's happened to the Aussie banks over the last few months.

Anthony Srom:

It hasn't been too dissimilar elsewhere in the region. So from my perspective, that dispersion that we're discussing presents some opportunities, and at the margin, we have been adding money through something like Shriram Transport Finance, which is in the portfolio, was in there from last year. And I think risk reward at these levels is very attractive. So in terms of India, it was a well owned market by foreign investors going into this fire.

Anthony Srom:

So I think that's abundantly clear in terms of how stocks have reacted. And again, if you can step up to the plate and take advantage of that, hopefully that'll pay dividends over the next few years. So again, looking at India, the fund has some exposure to HDFC Bank, Shriram Transport Finance and ITC cigarette manufacturer, which was absolutely hammered and has rebounded somewhat, but you know, you'd say we haven't

Anthony Srom:

been fishing in popular areas of the pond there in India, because valuations just really didn't retrace that much, given that dispersion we touched on.

Gary Monaghan:

Just want to take a step back from the question before actually with what you were talking about technology and internet stocks, which has very much been deemed the winners and the market leaders of the 2010s.

Gary Monaghan:

Do you think actually as we go into the 2020s that they will continue being the market leaders, or is there an opportunity for leadership change for the market?

Anthony Srom:

Well again, late last year talking to brokers, they see a fantastic decade for the Chinese internet guys. I'll put it this way. I mean look, as I said earlier, they've got some really good parts of their business. To me, they look and trade and seem like newspaper companies a hundred years ago.

Anthony Srom:

They're great franchises, good businesses to owners, dependent on the valuation that you're able to pick them off at. But in terms of the sectors or the companies, if you're talking about the standouts from the decade, for the coming decade you've probably got to think that they're going to be a small part of the benchmark today the way it is.

Anthony Srom:

I mean, Google I think IPO-ed in '03 or '04. No one really cared at the time. Small part of the market. Look at it today. Same thing with Alibaba, Tencent. When they started, small part of the market. So the thing that of stands out to me in terms of well, what's a small part of the market, getting maybe a little bit of love at the moment. I think it's got really good fundamentals, it's possibly gold.

Anthony Srom:

Where you don't want to be I think is in fixed income. The next decade given what we touched on with monetary policy, fiscal policy, I think central banks will fix the yield curve. Will returns in fixed income will be pretty poor. I don't think it paints a very positive picture for equities either, but probably more positive than in fixed income. And within equities gold's a negligible part of the market.

Anthony Srom:

And you go back to what I was talking about earlier, the level of gearing that's happening globally. If we get a monetary theory or outright financing of government expenditure depending on the country, I think that should be quite positive to gold.

Anthony Srom:

So that's one area in the market that I think has got very good potential for this decade and the fund has got exposure through that via Shandong Gold Mining in China, it's about three and half percent active in the portfolio. So we've had that for a couple of years now.

Gary Monaghan:

I want to dig a bit deeper into the portfolio and we often talk to clients about new ideas in particular being fairly contrarian. So can you run through a couple of the new ideas and actually demonstrate this contrarian tilt that you have in your process?

Anthony Srom:

Yeah, so I think when you look at the contrarian tilt, I think a lot of it comes through the sentiment part of the process. So there's three buckets, fundamental sentiment and valuation. So negative sentiment is always of interest to me when the market reacts like that.

Anthony Srom:

So think about very under owned, people dumping it, not wanting it, asymmetric payoff profile. That to me was something like Galaxy. Market freaked out when our casinos were going to be shut for two weeks, and they were. And I think what happens in terms of periods of market shock, the market discounts spot into perpetuity almost.

Anthony Srom:

So think poor fundamentals, think currency, if that's fallen substantially, and then that somewhat recovers and unwinds and stock price starts reacting. So when the fund was buying Galaxy, again, no one really wanted it. Shut for two weeks, that's really bad. Hey, they might be shut for longer. Nah, too hard. Valuation looks quite attractive.

Anthony Srom:

Now my view is, things will normalise. Look, we may get a second round of infections, which is I think quite likely. This is not going to be a straight V out of here. But again, fundamentals are quite sound. Balance sheet is very robust, very well positioned for recovery when that eventuates.

Anthony Srom:

And look, my thinking is the next two or three years. I'm not expecting a massive rebound within the next 12 months for these kind of stocks. So that was a sector does very much in the dumps. And kind of go back to what I was saying earlier, market discounting negativity for I think an overly extended period of time and you take advantage of that.

Anthony Srom:

Same thing with Techtronic. Very good business. I think January or something, it was 65, 70 Hong Kong dollars a share. The fund really stepped up to the plate below $45 a share. What happened there? Hedge funds were forced to de-lever. You've got forced selling in the market. You may call that a bit of irrationality, evaluation really makes sense.

Anthony Srom:

And again, fundamentals. Okay, look, next 12 months exports from China or Vietnam and these places that they manufacture their power tools probably won't be great to Europe or the US. But my thinking, next two to three years you see a bunch of fiscal stimulus, that's going to be spent on something and if a good chunk of that goes to infrastructure, you're going to need power tools for it.

Anthony Srom:

As a side benefit, I don't think many people were thinking about all this work from home. It's probably going to be good for home renovation stuff. And I haven't seen people writing about that, but I'm guessing that's probably what's going to come through, and so we might get a short term surprise.

Anthony Srom:

But again, think about the process. Fundamental, sentiment, valuation. Sentiment very negative, forced deleveraging. Valuation makes a lot of sense on a multi-view and fundamentals kind of ticks the boxes as well. Good management, good product, efficiency, margin expansion, market share gain, linked into growth thematics, which is fiscal expenditure that we're going to see.

Anthony Srom:

I mean, that's cream on top. But that was an example where that stock was falling eight, 10% and some stepping up to the plate to buy some.

Gary Monaghan:

Shifting into portfolio construction. And we talk a lot about interest stock correlations playing a really significant role in portfolio construction. So have you observed that stock correlations have been converging to one during this period of market shock?

Gary Monaghan:

And have there been actually any areas or stocks whereby correlations have actually fallen verses the market and offer potentially diversification benefits?

Anthony Srom:

I think in terms of correlations having fallen, I wouldn't really say that, just given the sheer volatility that we're seeing in the market has led to the former, more uniform market moves. I did mention there's been some dispersion in the market.

Anthony Srom:

So you would say, well there's been pockets of less correlation, but the portfolios weren't there. The least correlated securities that I could see in the portfolio today would be the gold exposure and the crude oil carrier.

Anthony Srom:

China Merchants Shipping Energy would be quite lowly correlated, but it's been more the former where correlations have had more converged to one specifically as I touched on earlier, financials as a sector would fall into that bucket.

Anthony Srom:

But in terms of the risk profile of the portfolio, despite having a fraction of the names that that's in the benchmark, what I track in terms of total risk isn't too dissimilar in the benchmark, and hasn't really changed that much versus the benchmark over the last two to three months.

Anthony Srom:

So that takes into account volatility of the positions, the correlation of the individual securities amongst each other and the weighting in the portfolio. They're the three combinations that go into how we consider total risk.

Gary Monaghan:

You just mentioned China Merchant Energy Shipping has been, let's say slightly less correlated. So if we could dig into that, because it's a fairly new idea. And of course, oil's been making all the headlines in the last couple of days with the fall of the futures.

Gary Monaghan:

So how does that sort of fall in your price factor into China Merchants Energy Shipping? And I mean ultimately, I think you believe it's potentially a positive. So could you run through the thesis and how that plays out in the current environment with low oil prices?

Anthony Srom:

Yeah. So you're right, it was a recent addition to the portfolio for January of this year, so earlier than Galaxy and Techtronic that we touched on earlier. But again, back in January, no one really cared about the shipping sector. So I think essentially, more upside to the stock price versus your valuation and downside. Fundamentals, this is the third leg of the process.

Anthony Srom:

What we're seeing was one major thing, which is very low order book before crude oil carriers. So you had a big engine in ship orders in 05, 06, the last boom. Once these ships get past 15 years old, they're harder to charter, and think 20 years old, they start to get scrapped.

Anthony Srom:

And the next leg of the thesis is IMO 2020, which kind of feeds into that. So low sell for fuel oil and wearing scrubs on the ship doesn't make economic sense, and in most cases it doesn't though these things get scrapped and again, that feeds into the positive supply demand dynamics on a multiyear view for sector.

Anthony Srom:

Now you go forward to 2030 where another layer of IMO is going to come in and no one really knows what it's going to be at the moment. It's not going to be diesel fuel oil. Is it going to be LNG? Is it going to be hydrogen, is it going to be something else? No one really knows.

Anthony Srom:

So you're going to slap down 100 million bucks for a ship, you're going to think long and hard before you do it these days. And that's what we're seeing, no one's really pushing the button on ship orders, given these things have got 15 to 20 year economic lives and they might change in 10 years time or is highly likely to change in the next 10 years time.

Anthony Srom:

So that paints a good supply side picture and that's usually what sows the seed for a nice economic cycle for that particular sector. So again, the analogy would be that the miners like BHP Rio in '03, '04 when China joined WTO and GDP growth started to skip up and there was just a lack of supply versus demand. Same thing with crude oil carriers. We see a lack of supply versus demand going forward.

Anthony Srom:

Now, what's happening today is cream on top in terms of how the thesis has played out. We didn't bank on it, but you've seen very steep contango in the crude oil market. It's a massive supply from Russia and Saudi Arabia and these production cuts, they're a bit of a furphy in the sense that it's nowhere near the headline, I think 20 million barrels or whatnot that was discussed.

Anthony Srom:

So it really floods the market with product versus demand out there. That product has got to go somewhere. It goes into onshore storage or it goes into offshore storage. If it goes into offshore storage that goes into the crude carriers that China Merchants Energy Shipping

Anthony Srom:

owns amongst other companies. So traders buy physical oil, whack it on floating storage as we've seen day rates for these VLCC, so very large crude carriers have gone up tremendously. They are literally printing money at the moment. So, that in itself has helped propel the stock price versus the market. And then it's a question of well, "You know, when do we look to exit the position?" So, that's the cream on top. That's kind of provided a bit of extra return that we weren't anticipating say back in January. So we'll see how we go from here. But that's the thesis in a nutshell.

Gary Monaghan:

Just shifting tact over to dividends. You're not a dividend manager. So it's not a crucial focus of the process, I know, but the dividends have been in the news with particularly regulators in Europe, effectively stopping some companies and industries from paying dividends. And then of course we've got, the rather, let's say, tricky outlook. So it's the cash flows. So there could be some dividend pressure. So, do you think there's a risk in Asia that dividends are under threat from either the regulators or just the economic and macro environment? And in terms of the stocks that you have, are there... there's a couple of actually paid decent meals. So are you sure that these won't be cut?

Anthony Srom:

Yeah. In terms of some of the positions that have decent yields, I think it's a minority of the portfolio. So, negligible impact there, I think, do you see dividends being cut? Yeah, I mean, I think the Reserve Bank of India has come out giving kind of guidance or essentially saying, "Don't pay dividends". I think some state owned enterprises, which have got to do some national service, dividend payout ratios are likely to be lower on top of lower earnings. So, the same thing that you've seen with the Aussie banks and you know, APRA are giving essentially guidance on dividends.

Anthony Srom:

And again, kind of philosophically, if you're a company and you're getting a government handout, it's kind of a bit rich to be then paying out dividends while all that's going on as well. So, yeah, look, I see dividend pressure there. It's already coming through in examples that I've just provided. So yeah, that's probably all I can say is that it's... If it was notionally high dividend yields.

Gary Monaghan:

We're coming to the end of the call and I've got two more questions to run through. The first one, the penultimate question is with regards to the global lockdown and working from home and really, how is that impacting the way that you work and the interaction with the analysts and also critically interaction with the companies that you're investing in or analysing?

Anthony Srom:

No real big dramas, I mean you are kind of... I mean that's been a trend that's been massively accelerated. Work from home and more flexible kind of working arrangements and no, I think that'll have a feeding to some of the thematics that we discussed earlier in terms of cloud compute, the farms and all that kind of stuff. Which will feed into companies like TSMC eventually. So no that's of been a trend that's been in place and probably accelerated a little bit. But, from my perspective, everything's all online, up and running, just doing a bit more conference calls rather than face to face meetings. But, no big dramas.

Gary Monaghan:

And actually I can add to that, in that in Q1 of this year we held 1,200 company meetings. That was versus 1,307 in Q1 last year. So it was a bit of volatility if you like around Chinese new year when people are getting used to new ways of working. But since the basically mid-February, all of the company calls have been via conference call or, or Zoom as people are onboarding that.

Gary Monaghan:

So, the final question, a couple of questions with regards to monetary policy, there's a lot of printing out there, with all this money printing, do you think that inflation will be rising over the coming years and will there be an impact do you think on the stocks that you own?

Anthony Srom:

Well, in terms of will there be inflation? I think central banks will try their absolute hardest to get it because that's the easiest way of inflating away this that you've got. The way I see it, it's trying to get a Goldilocks outcome is a very slim chance. I mean, what you're seeing out there is, a lot of the volatility has been exacerbated by the leverage in the system. Now if you draw the line that monetary policy is at an end and we're moving more into fiscal and a lot of monetary theory being kind of direct money printing. So central banks directly financing government expenditures through zero coupon, zero maturity bonds essentially, they can spend unlimited quantities.

Anthony Srom:

So, the question is, I think not so much do you get inflation over the next two to three years or four years is how much do you get? If they overdo it, I think it could skip away quite rapidly, in which case it could be in quite a negative outcome for the equity market. So, trying to get a Goldilocks scenario from here is going to be difficult. Especially even you don't know when the economic rebound is going to come or how severe it could be in terms of pent up demand, etc. Feeding this way through once the virus settles. So to me, I think it's a, it's a quite an uncertain outcome. Quite a risky outcome and again, equity markets like a little bit of inflation, they don't like too much. So that's something to be mindful of as inflation tends to go higher and higher elevation multiples tend to compress and compress.

Anthony Srom:

So how's the portfolio positioned? What am I thinking about? We touched on gold exposure that's within the portfolio and again, happy to dial that up or dial that down depending on how that plays up and how that plays out in the process. But you know, the companies that I think would perform relatively better in that kind of a scenario would be things where you know, you're not... The worst one would be very capex intensive and low margin that's probably the businesses that you want to avoid if you think inflation is coming down the pipeline. Because they're going to need to replace that plant and equipment eventually. And having a small margin doesn't leave you with a lot of buffer there. So what you want is companies with pricing power. So I think Kweichou Moutai for example which is in the portfolio, that's about five percent, give or take active and you want companies with... they can expand volume with little capital expenditure.

Anthony Srom:

So, that's the other, the other aspect or other attractive feature that's out there. Now, companies that tick that box and for the want of better words would be these kinds of platform companies, so again, I think a lot of Australian clients on the call, well you know, Altium, Wisetech, you know all these kinds of companies. The platform's not a lot of incremental capex that you need to deploy to get a lot of incremental revenue in raw analogies of those kind of companies to Asia. But again, I don't think valuations are that attractive at this particular juncture for, for a lot of those.

Anthony Srom:

So there are a couple of examples that are provided you that's in the portfolio. And recently the companies that are of interest to me dependent on valuation.

Gary Monaghan:

Got it. We've slightly overrun, so we've come to the end of the call. Now, I believe this call, the call recording will actually be made available on the fidelity dot com dot au website. If you have any follow-up questions, please reach out to your Fidelity representative and we can look to address these. So, we say thank you to Anthony for your time today and best of luck navigating these markets. But most of all, thank you to those listening and for spending your time with us today and your ongoing support. Goodbye.

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Anthony Srom is a Portfolio Manager at Fidelity International based in Singapore. He has 21 years of investment experience and is currently responsible for managing Fidelity Funds – Asia Pacific Opportunities Fund, Fidelity Asia Pacific Opportunities Fund, Fidelity (AUS) Asia Fund, Fidelity Korea – Asia Equity Investment Trust and some institutional segregated mandates.

Anthony joined Fidelity in Singapore in 2006 as an Investment Analyst. He was appointed portfolio manager of the Fidelity Thailand Fund in 2008, which he successfully ran until 2012. Thereafter, he managed an internally funded Asia Pacific ex-Japan Pilot Fund between March 2012 and June 2014, developing a strong performance record. In June 2014, Anthony took over management of the Fidelity Funds – Asia Pacific Opportunities Fund (SICAV) and he has managed the Fidelity Asia Pacific Opportunities Fund (OEIC) since its launch in September 2014.

Prior to Fidelity, Anthony worked as a Transport Analyst at ABN Amro, Goldman Sachs and Deutsche Bank in Australia. He holds a Bachelor of Commerce from Bond University, Queensland, Australia. He is also a CFA Charterholder.