Portfolio Positioning & Updates

I generally don’t like to write posts like this one for good reason: I am not a professional investor nor a qualified financial advisor. Unfortunately for readers, the “have blog, will write” syndrome now compels me to share my frankly unsolicited opinions. The standard disclaimers still apply.

Outlook & Positioning:
I am increasingly uncomfortable with the market environment today. The macro picture looks more complicated and I struggle to understand (let alone navigate) it. And while I usually find it more productive to spend my time looking at the micro, I am currently finding very few compelling undervalued opportunities. Overall, then, this is a period of looking at a lot but doing very little.

During challenging times, it often helps to go back to basics. I believe that long term investors should aspire to build, in the approximate words of David Swensen, an adequately diversified portfolio with an equity bias. One should also avoid trying to time the market. For most individual investors, this therefore means retaining a meaningful exposure to the stock market. The important equity allocation decision to make is whether to go with a passive, low-cost approach (e.g index funds) or a more active, potentially higher-cost approach (e.g. individual securities or actively managed funds).

On balance, index funds are probably the way to go for most individual investors. I think this is particularly true for those seeking exposure to developed markets such as the US, where the index reasonably captures the underlying growth opportunity in the region. Increased competition also means that the US equity markets are probably less inefficient today than they once used to be. Finally, the quality and sophistication of index fund products available to investors in developed markets has also improved over time, particularly in terms of index construction and re-balancing (thanks to firms such as Dimensional Fund Advisors).

In Asia, by contrast, the index fund products available do not do a very good job representing the underlying growth opportunity in the region. For example, the MSCI index is heavily weighted towards mature economies such as China, Hong Kong and Taiwan and less so to other economies in ASEAN and South Asia. It also has relatively less exposure to the consumer growth story in the region. Readers of this blog will recognise that this point has been made by a number of the active investors we cover, so I won’t expand on the argument here. I do think the index representation problem and quality of products available to investors will improve over time, but the current reality does pose a challenge for Asia-focused investors.

There are two other points I would like to add in the context of the ongoing active vs. passive debate. First, fees alone are not the most important thing. As James Hay said in a recent interview, it is actually fees after performance that matter. You are not necessarily better off paying low fees on low returns. That being said, active managers have had it good for far too long. High fees in the absence of added value for clients was never going to be a sustainable business model. One of the positive trends for individual investors in this environment is that active manager fees are starting to come down. It could be a good time to go shopping.

Second, in market environments such as this one, where things have been going up for the last ~8 years, people can start to get complacent. They are not worried about the things they should be worried about. In the case of some index investors, they may not even be fully aware of what they own. I am not sure that we are at “peak” passive yet, but I am actually quite optimistic in my outlook for a subset of active managers. The good ones tend to prove themselves in bear, not bull, markets.

So, where does this leave us? Here is how I am thinking about my portfolio today:

  • For developed and extremely competitive markets such as the US, an indexed approach makes sense. If you were to pin various equity markets around the world on a spectrum of efficient to inefficient, the US would probably be closer to the efficient end of the spectrum. The same cannot be said of many Asian equity markets. My preference in the region is to therefore either invest directly or go with active, value-oriented managers.
  • A large index exposure to the US has worked out very well over the last ~8 years, but this is perhaps the time to reduce some of that exposure and increase allocation to cash in anticipation of greater volatility. Unlike many institutional investors, there is no pressure for individual investors to always be doing something. The optionality of cash can be valuable.
  • Make sure current holdings (either directly held or on a look-through basis) are “proofed” for a bear market. Put a lot more emphasis on balance sheets and margin of safety and less emphasis on earnings. Balance sheets get you through difficult times.

Portfolio Updates:
A rising tide lifts all boats. In a similar fashion, almost all the picks presented on this website are up along with the overall market. Not enough time has passed to truly judge the quality of the recommendations, so I don’t really have anything meaningful to say on performance. One thing I do want to clarify, however, is that the tracking portfolio is not fully representative of my overall portfolio. Please see the comments on the tracker page for the full disclosure notes.

Here are brief updates on each of the picks.

1010 Printing: Great management operating in a very tough industry. Over time, there is only ever going to be one winner. Sales were down ~8% year on year, the first time in the company’s operating history. Management saw margin erosion across all three business units and expect continued pricing pressure from publishers. Furthermore, most of the cost savings through automation and supply chain management have been realised and management expects the company’s operating margin to be affected from now on. The company is also struggling with its search for a successor to CK Lau. The share price has moved up >20% since I first wrote up the idea, but the outlook for the company is now considerably more negative.

Scottish Oriental: No change in the thesis. Currently trades at a ~14% discount to NAV. Cash levels are now up to ~14% of total assets. Management remains cautious in their outlook for equity markets. They would like an opportunity to deploy the cash but prefer to wait for more reasonable valuations.

Singapore Shipping Corp: Not much to add at this point. Off-hire due to dry-docking resulted in lower 9M operating income / profit for the core shipping business. The agency & logistics segment continues to face headwinds but remains profitable. Corporate expenses accrued and incurred were significantly higher for 9M 2017 vs. 9M 2016, which is something to look into.

SiS International: The company has continued its transformation into a real estate investment company, with meaningful exposure to Japan. In 2016, the company acquired seven hospitality properties in Tokyo, Osaka, Kyoto, Sapporo and Otaru. Gearing ratio as at December 31, 2016 was up to 78%, versus 55% in 2015. NAV is now up to HKD 10.63 per share, versus a current market price of HKD 3.90 per share. No update on their plan to unlock the value of their real estate investments.

Ming Fai: The company paid out a special dividend of HKD 0.20 per share earlier this year, following some gentle encouragement from David Webb. Thesis remains largely unchanged. Ming Fai’s net cash still covers ~58% of the company’s market cap and the core hospitality supplies business continues to be obscured by the loss-making retail business. Management is taking positive steps to pare this segment, including shutting down non-performing stores and reducing operating costs (they are down from 543 to 387 retail outlets year on year).

NetEase: Strong operating results for FY 2016. Year on year, net revenue was up 67% while net profit was up 72%. The company released 40 new mobile titles in 2016 and revenue from online games (including mobile) contributed approximately 73% of total revenue for the year. Onmyoji, in particular, was named one of the top 10 outstanding games of 2016 on China’s iOS app store. NetEase began the international release of the game in Southeast Asia in December and plans to roll it out in Japan, Canada, Europe and the US later in 2017. Overall, the mobile game market in China continues to grow but at a slower rate than in previous years.

TK Group: Total revenue was flat year on year. Revenue for the company’s mold fabrication segment grew but revenue for their plastic components manufacturing business decreased slightly. The current revenue split is now ~39% mold fabrication and ~61% plastic components and manufacturing. The business is starting to slowly shift towards the higher margin mold fabrication segment. Gross margin increased by 2 percentage points year on year, increasing from 26.1% to 28.1%. Dividend payout was also increased to 54% from 45% the previous year. Shares still trade at a ~10% earnings yield.

Playmates Toys: Chairman Thomas Chan is retiring after 50 years with the group. Sidney To will succeed him in the role while Chan’s son will join the board. Year on year, revenue and operating profit were down ~36% and ~56% respectively. Management expects competitive pressures to intensify this year, especially for its TMNT toys. The key driver will be its Voltron toy line, which was launched this Spring. At the current price, the shares seem to reflect the negative operating outlook and should have enough downside protection (the relatively small position size also helps). The company’s first half results will be important.