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How to make money from quality stocks at low valuations

Hugh Young tells Taha Lokhandwala why the best way to make money is not to lose it
January 31, 2019

When you do something for over three decades it’s quite likely that you will have noticed trends. For example, you may have come to the conclusion that events which seemed unique at the time they happened are actually part of a cycle.

For Hugh Young, who has been running Asian equity funds since 1985, this is very much the case. Asian equities have had a rough time of late, with MSCI Asia ex Japan index down 8.5 per cent over 2018 and MSCI Asia ex Japan Small Cap index down 13.9 per cent. But this came after a strong bull market in 2016 and 2017, and for someone who managed equities through the 1997 Asian financial crisis, last year was of no particular concern.

Mr Young heads a team that runs a number of funds, including Aberdeen Asian Income Fund (AAIF), a large-cap income investment trust, and Aberdeen Standard Asia Focus (AAS), which invests in smaller companies. Both funds follow the style of equity investing that Aberdeen has become known for in Asia and emerging markets: quality stocks at low valuations. But this means that while markets roared ahead in 2016 and 2017 these funds' returns lagged. Over five years, MSCI Asia ex Japan index rose 62 per cent, while Aberdeen Asian Income Fund's share price total return was 41 per cent. But last year Aberdeen Asian Income fell 6 per cent and Aberdeen Standard Asia Focus fell 2.5 per cent – less than MSCI Asia ex Japan index.

“People have retreated from growth stocks and realised they should be careful of things you would have to pay 40 or 50 times earnings for, or companies that don’t have any earnings," explains Mr Young. "They’ve realised it’s not all blue sky and upside, and markets have reverted to the solid old-fashioned values of looking at cash flows, balance sheets and dividends, which suits us. We’re a tortoise rather than a hare, and it looks like a bit of a tortoise market."

The core of Aberdeen's investment strategy, for both its Asian larger and smaller companies funds, is investing in dependable companies that have quality balance sheets. Some of the stocks in the funds have been held for over 20 years. These are typically ones with business cultures that meet Aberdeen's investment criteria, and business plans aligned to the economic growth of the region. But Mr Young stresses that this does not mean these stocks are held purely as macroeconomic plays, but rather following fundamental analysis and because they have 'sensible' outlooks.

“At a very high level, our thought process is if the country is growing, what are safer ways to play that?" he explains. "Safe knock-on beneficiaries. These could be the local retailer, supermarkets or financial institutions. Then you work out which ones to back, so it’s a matter of studying how they work and the culture of companies. [We seek] quality companies – solid businesses run honourably for the good of shareholders. We define quality by the balance sheet – it’s not the only indication - but [for example] debt levels would be a clear sign.”

Mr Young says they are less likely to chase growing tech giants or companies leveraging the region’s cheaper labour market. Investing in manufacturing companies is often seen as the best way to align a fund to growing macro fundamentals, but Mr Young thinks such companies can be quick to shift regions, depending on wage costs, making them more temporary plays.

Examples of the types of companies he prefers include Indonesian private financier Bank OCBC NISP (JKT:NISP), a former family-run local bank now owned by a larger Singaporean company. Mr Young first bought into the company over 20 years ago and describes it as a “conservative” lender that "didn't lend millions of dollars to the president's sons" in the build-up to the 1997 financial crisis.

“It has grown with the country and at a nice multiple of the country’s growth rate," he says. "If we can find a nice bank that doesn’t do daft things, it’s a great play on a growing economy. We’re very comfortable with the culture."

Mr Young and his team pick stocks on the basis of their own merits rather than because of economic or sector considerations. However, in more volatile regions such as Asia and emerging markets, sentiment and macro-economic expectations often drive markets more than fundamentals. So what does Mr Young expect for the region?

“The economic outlook is sombre,” he says. “There is a slowdown in Chinese growth, trade war fears and interest rate uncertainty – the same fears that investors have [in other regions]. Most businesses are being a bit cautious, which was also the case in 2018. But Chinese [economic] growth should be 5.5 to 6.5 per cent [this year] so it’s still not bad.”

Mr Young believes slower economic growth is reflected in share prices. “There are some great companies dotted around Asia at good valuations," he says. "The Aberdeen Standard Asia Focus portfolio is only on an 11x price/earnings ratio, and companies have net cash with rock solid balance sheets. Through bitter experience we have realised that whenever the proverbial is going to hit the fan – and it does on a fairly regular cycle whether due to a crisis or military coup – it’s vital to have that strength and flexibility. So whatever happens in our part of the world they can continue investing in the business. 

"Our style works well when things are a bit tougher. If it’s going to be one of those years, which 2019 feels like it will be, then we should perform relatively well. If a market falls 10 per cent and we don’t move that doesn’t sound terribly exciting. But in our experience the best way to make money is not to lose it."