Principal Asia Pacific High Dividend Equity Fund -- Fund Manager Interview

 Q: What is your view towards the Asian equity market in the remaining of 2021?

A: During the first quarter of 2021, US market outperformed, helped by a superior vaccine rollout and a strong US dollar. Asia does have the potential to outperform for the rest of the year as Asia and emerging equity tends to do well during strong global economic recovery, although the pace of successful vaccine roll out could have a dominant impact in 2021, likely making performance vary from country to country by notable margin within the region.

 

Overall macro backdrop globally remains supportive to risk assets. Policy makers still see weak levels of economic activity and employment as key risk. Inflation is not yet seen as a concern or an immediate threat. As such, policy is still being loosened outside China. Fiscal packages have recently been announced in Malaysia with $4.87 billion stimulus on March 18, and Korea with $13.3 billion in fresh stimulus on March 1st, which highlight current macro policy priority.

 

On monetary front, although it is unlikely to see further policy rate cuts, we do expect targeted easing of liquidity easing policies to be deployed by central banks to support their respective economies. Unlike what happened back to 2008 GFC, when banks were exposed to severe capital and collateral damage causing “bank balance sheet recession”, the COVID 19 induced recession only occurred at earning level so global as well as regional banks do have dry powder to lend if credit demand is to pick up. Consumers are also in a much better position thanks to mailed-in check from governments. US personal savings rate for example is at 20% vs. 6% before COVID 19 hit. Once social and travel restrictions are lifted upon successful vaccine roll out, a strong pend-up demand is likely to boost economy recovery and corporate earnings.

 

Q: Are the fundamentals of Asian shares still attractive?

A: MSCI AC Asia Pacific ex Japan’s trailing price to book (P/B) ratio was 2.03x at the end of first quarter, compared to a mean of 1.75x over the past two decades. On a forward-earnings basis, the market was trading at 16.8x price to earning vs. historical average of 15.4x. Current market consensus expects earnings growth in the region to be 27% relative to 2020, and 19.5% in comparison with 2019 earning level. Although valuation is higher than historical average, we believe strong prospect of corporate earnings, helped by on-going accommodative monetary policy, fiscal support, strong bank balance sheet, and solid consumer spending power, will remain supportive for the equity market. Travel and leisure related pent-up demand post COVID 19 toward 2H of 2021 will also likely to help industries and countries that have leverage.

 

One notable change in market dynamic was rapid yield curve normalization during the 1Q of 2021 relative to the last two months of 2020, causing broad valuation readjustment within the high growth part of the markets. Equity market valuation spread, which refers to the valuation of expensive stocks relative to the multiple of cheap stocks, have much narrowed at this point relative to the level in the mid of 2020. As the results of these market dynamics, we believe relative earning strength will be key to separate the winners from the losers in 2021.

 

Q:How is the fund positioned to take advantage of the potential upside?

A: We continue to like technology sector. For example, China technology supply chain localization, 5G specifics upgrade, and Intel renewed foundry ambition provide favorable earnings backdrop for companies that can tap into these dynamics. We are also overweight in travel related sub-sector in developed markets in the region namely Australia, New Zealand, and Singapore as they are likely to lead the region in terms of successful vaccine roll out. Travel made up 5% Australia’s GDP pre-COVID and pend-up demand potential is significant, admittedly risk to the speed of recovery still being high.

 

We remain optimistic over earning outlook in e-commerce, bio-tech, and green energy space. Import substitution industrialization in India remains an attractive area for fishing stocks with strong earing growth. Global supply chain diversification also benefit those India companies that have built solid capacity to meet rising demand.

 

Q:Would the recent strength in the U.S. dollar be a pullback for the market?

A: The US Dollar Index was up by 3.7% last quarter after 6.7% decline in 2020. It would be a headwind for Asia and emerging equity if Dollar continues to edge up. US Dollar strength reflects the fact that US is ahead of the rest of world on vaccine roll out. Large US fiscal stimulus is also expected to push US economic growth to be above trend in 2021-2022. US yield curve upward shift also helped US Dollar during the first quarter.

 

The question remains if strong US growth will translate into stronger broad global growth. If it will, US Dollar is likely to revert back according to historical data. Rising global shipping rate and widening US current account deficit during 4Q of 2020 seem to suggest that elevated US money supply is rippling through the global markets. US annualized fiscal balance as % of GDP being down from -4.5% pre-COVID to -15% also puts pressure on US dollar according to long term relationship. All in all, we have to monitor how successful ex US countries catch up on vaccine roll out, which is likely to be the main driver of currency move in the short run.

 

Q: Are you concerned about rising inflation?

A: Rising inflation, or the prospect of that, is a concern to the market. High growth, high multiple, or bond proxy stocks are sensitive to inflation expectation in particular. It is a critical risk to watch closely in 2021.

 

As far as policy implication, policy makers in the region still see weak levels of economic activity and employment as key risk. If inflation hits, it will be a global phenomenon and US Fed action will provide hint to the region. Fed is currently still running $US120bn monthly net purchase. The first rational step would be a “tapering announcement”, which is not widely expected by market consensus until the end of this year. Obviously, if inflation does move up sharply, it will be a challenge to monetary policy and its direction will be adjusted. On that front, oil price continues to be an important data point to monitor as recent history has shown 90% correlation between inflation expectation and oil price.

 

There is some concern that the massive stimulus in the US and considerable increase in saving will lead to excess demand and inflation. This is largely a US concern, and most of the world are expected to still run negative output gap next year, limiting the impact from stimulus on inflation. Additionally, the impact could be temporary because stimulus is not expected to be repeated the year following, implying a potential spending drawdown or cliff. As such, stimulus impact on inflation seems most likely to be transitory in nature.

 

Q: How is the fund positioned to protect the portfolio from potential downside risks?

A: Major risks the markets are facing in 2021 include US-China geopolitical uncertainty, inflation & policy response, uncertainty of global vaccine roll out. We also see antitrust regulatory headwinds as a notable risk for big tech companies both in the US and China.

 

The portfolio has tilted away from interest rate sensitive companies where valuation looks expensive or earning visibility stays vague, such as REITs and China banking sector. We are also avoiding investing in companies that have benefited from COVID 19 pandemic as one-off where temporary earning strength may not be sustainable, i.e., consumer staple stocks in Australia. The fund is paying close attention to interest rate sensitivity of the portfolio, keeping a relative neutral stance so interest rate move itself won’t have a significant impact on fund’s performance.

 

David Han, CFA
Portfolio Manager
Principal Global Investors

 

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