Pacific Horizon (PHI) is an Asia ex Japan investment trust that specialises in investing in growth companies. Baillie Gifford & Co (Baillie Gifford) has been appointed to manage PHI’s portfolio on behalf of Baillie Gifford & Co Limited, the trust’s alternative investment fund manager. Baillie Gifford has managed PHI since 1992. Baillie Gifford is a long-term growth investor and it believes that there is a significant opportunity to outperform markets over the long term using this approach.

Pacific Horizon was promoted to the FTSE 250 index with effect from 27 January 2023.

About the manager

Baillie Gifford has 155 investors/analysts based in its Edinburgh office, with a further four in the US and five in China (these exclude ESG analysts). It is structured as a partnership and encourages a collegiate approach to managing money, although it allows its portfolio managers the freedom to have the final say about their portfolios. It managed or advised on about £216.6bn at the end of September 2023. PHI and the Baillie Gifford Pacific Fund (its open-ended equivalent) had combined total assets of roughly £3.06bn as at 30 September 2023.

Roderick Snell, who is the senior fund manager for Baillie Gifford’s Asia ex Japan strategies, is the lead manager of PHI’s portfolio. He is supported by Ben Durrant, who was appointed as deputy manager in January 2023.

Roderick Snell joined Baillie Gifford in 2006 and became a partner in 2023. He has managed the Baillie Gifford Pacific Fund OEIC since 2010 and has been lead manager of PHI’s portfolio since June 2021, having been its deputy manager since September 2013. Prior to joining Baillie Gifford’s emerging markets team, Roderick spent time in its UK and European equity teams. Roderick is a co-manager on the Baillie Gifford China Growth Trust and co-manager of the emerging markets leading companies strategy. Roderick graduated from the University of Edinburgh in 2006 and a BSc (Hons) in Medical Biology.

Ben Durrant joined Baillie Gifford in 2017 and, prior to joining the emerging markets team, spent time in Baillie Gifford’s UK, global discovery and private markets teams. Prior to joining Baillie Gifford, Ben worked for RBS in their group strategy and corporate finance team. Ben is a chartered accountant and a CFA charterholder. He graduated from the University of Edinburgh in 2012 with a BSc (Hons.) in Mathematics. Ben has co-managed the Baillie Gifford Pacific Fund since 2021.

Roderick says that their natural inclination is to be cognisant of political and macro influences in Asia and that thematic considerations are always in the back of their minds. However, they think that you only really get to see the big picture by being a bottom-up stock picker. This is very much a stock-picking fund, and the portfolio bears very little resemblance to the fund’s MSCI All Country Asia ex Japan Index comparative index (the active share of PHI’s portfolio at the end of September 2023 was 83% – unchanged from when we last published).

The pair spend most of their time in meeting companies and undertaking stock-specific research. The process and philosophy that is used to manage PHI has been the same for the last 30 years.

Market roundup – attractive valuations following Asia weakness

As we discussed in our December 2022 note, inflation has not been particularly high in Asia, but Asian markets have suffered as interest rates have risen overseas – especially in the US – leading to capital flows away from the region. This combined with economic weakness in China, has contributed to Asian market weakness.

However, aside from the Chinese market, which suffered as the authorities had clamped down on sectors such as technology, education and housing, Asia as a whole was a relative bright spot within the global economy.

The last 12 months have been relatively tough for both growth-style investing and Asia and while many companies have continued to do well operationally, the macro has outweighed other considerations and their progress has not been properly reflected in their share prices. This has left Asia ex Japan trading at attractive valuations versus history and global equities.

Managers’ view

The managers’ long-term arguments for investing in growth companies in emerging Asia remain broadly unchanged, and we recommend that readers see our previous notes for more discussion. It should be noted that, whilst the managers are cognisant of macro issues and takes long-term structural themes into consideration, the portfolio is very much managed bottom-up. A key summary is as follows:

• China and the broader Asia Pacific ex Japan region offer very strong growth prospects. PHI’s mandate gives it exposure to more than 3bn consumers across Asia. Pre-pandemic, the IMF forecast that the per-capita spending power of Chinese consumers would nearly double in US dollar terms over the five-year period to 2024. The Chinese government’s regulatory interference appears to have peaked and there is an opportunity to add to tech at depressed valuations.
• The managers still have little appetite for domestic Hong Kong stocks. Hong Kong has been a hugely profitable gateway into the mainland, helped by tax-free price differentials, but the outlook for retail spending and tourism still appear to be challenged.
• PHI’s managers still like India and the long-term structural growth opportunities that it offers (particularly those of the new economy companies in the country), but Indian valuations continue to look full, and the managers have been reducing exposure to India in favour of China, reflecting their view that the latter is now more constructive on a medium-term view (see below). However, India still remains the largest overweight.
• The managers continue to like Vietnam, where they continue to see strong long-term growth opportunities in this particularly under-researched market.
• The managers have continued to emphasise cyclical recovery over duration and pace (see pages 5 and 6 of our December 2022 note for more explanation).
• Digitalisation, technological change and the rise of the Asian middle class continue to be key themes within PHI’s portfolio.
• Asian markets still look well-positioned. There is very little inflation and, unlike in the west, there are positive real interest rates. Asia has also been much less dependent on hot money in recent years.
• Asian government balance sheets generally look healthy (they did not have to massively ramp up debt to provide economic support in the way that was seen in the west).
• The managers say that there are increasing signs that Asia’s economy is starting to converge with those of developed markets. Despite the obvious challenges, there has not been a market crisis in Asia for over 20 years.

However, US dollar strength continues to be a significant headwind.

The managers have become more positive on some areas in China

While acknowledging that the macroeconomic outlook has weakened in China, at least in the short term, PHI’s managers have become much more constructive in the medium term. They think that the worst of the downgrades have passed and that a lot is now factored into share prices. Ben and Roddy observe that both sales in bars and restaurants and inbound air-travel are back to pre-pandemic levels, while internet sales remain robust. While growth has slowed, the mood on the ground is that the slowdown is not severe and that, given time, sentiment in financial markets will improve.

The managers also think that there is a decent level of policy support for the private sector and note that the tech clampdown has eased. With inflation at low levels and its finances in good shape, the government has room to ease off the brakes and stimulate the economy (it has a lot of levers it could pull, including quantitative easing). Despite this improved outlook, valuations still look to be at distressed levels. The managers have therefore added to PHI’s overall Chinese exposure (by around 600bp) over the last 12 months, by bolstering existing holdings, mostly in the technology sector.

There have been concerns regarding the property market in China, but the managers are not expecting a hard landing. They acknowledge that transaction volumes are down by between 5-10% but say that this will not lead to a collapse in prices (this was also true in 2008-9 and 2014-16). They comment that real estate in China is less encumbered by debt than is seen in western markets. Many buyers pay cash, so the average LTV is in the region of 30%, and there are not likely to be many forced sellers.

The managers observe that there has been considerable commentary in the media suggesting that affordability is a problem, but this is not what they are seeing on the ground, and they think that the problem is being overblown. Since 2005, prices have increased at 7% per annum, while income has increased at 10% per annum and so property ownership has actually become more affordable. The managers acknowledge that property is still expensive when compared to most peoples’ income but say that prices are not out of line with other emerging markets and are still affordable for the middle class, which continue to be the key buying segment. Nevertheless, the slowdown could be an issue for property developers.

Debt to GDP at around 300% is quite high but the managers comment that this ratio is not growing, and a lot has been done to clean up the debt in the last five years. Loans have been restructured and bad banks have been created to deal with the bad debts. The shadow banking system was decimated, so this area is no longer an issue. Overall, the managers believe that China offers very attractive valuations and decent growth prospects.

Investment philosophy and process

The underlying approach

Baillie Gifford believes that markets are inefficient at pricing long-term growth, especially over a time horizon of at least five years, and that this creates an opportunity to generate alpha. For this reason, it aims to encourage a culture of long-term thinking within the firm. Baillie Gifford believes there is persistence of good company management, business models and stock prices. This translates into a culture of ‘sticking with the winners’.

The company uses proprietary research. The team undertakes much of this, but will often commission research from local research teams, academics and industry experts. Baillie Gifford also subjects some companies to forensic analysis, using the services of investigative journalists and forensic accountants. When it is talking to companies, the conversations with their management teams focus on the long-term prospects of the business.

The managers are able to draw on the resources of the whole investment team, when analysing companies, and can sit in on meetings with companies outside their geographic remit. This is especially beneficial when they are trying to identify how their companies compare with competitors domiciled in other markets.

Each member of the team is assigned a geographical focus for research, and these responsibilities are rotated every few years. Investment ideas are presented to the group, but the lead portfolio manager makes the final decision. Pre-COVID, Roderick would usually spend four to five weeks visiting Asia each year. He has started to do this again.

The open-ended investment company (OEIC) and PHI are run in parallel, with some exceptions; a key driver being the need to keep the OEIC’s portfolio relatively liquid to allow for inflows and the funding of redemptions. There is an internal limit of holding no more than 10% of the portfolio in illiquid holdings, but within this constraint, PHI has greater freedom to hold more illiquid investments than the OEIC. The OEIC has ended up with more of a large-cap bias as a result, while PHI has more exposure to small-cap names. There is considerable commonality in the stocks held, although the individual weightings may differ. PHI, unlike the OEIC, also has the option of using gearing and invests in unlisted companies.

Building the portfolio

Baillie Gifford is an active investor and does not hold stocks just because they are large constituents of any benchmark. Consequently, there are few limits on country, sector or stock weightings imposed on managers. The initial size of a position will reflect the strength of the manager’s belief in the potential risks and rewards of the investment. One of the guiding principles of investing at Baillie Gifford is to ‘run the winners’ (reflecting the belief in the persistency of good business models). However, PHI has a ‘soft’ upper limit of 10% exposure to any one stock. Roderick looks at the shape of the overall portfolio to ensure that he does not have too many companies exposed to similar thematic dynamics.

The mandate allows PHI’s managers to use derivatives to control risk and to alter the portfolio’s exposure to markets. In practice, the managers are not undertaking such activity. The managers have no plans to use hedging to alter the portfolio’s currency exposure.

Sell discipline

Loss of faith in a company’s management is an instant trigger for a sale. Roderick and Ben will also sell if they feel that the business model is not working, or if the market has caught up with their expectations.

Portfolio allocation

As at 30 September 2023, PHI held 72 companies in the portfolio, down from 85 at 31 October 2022 (the most recent data available when we last published). PHI believes that it can achieve an appropriate level of diversification for its strategy by holding 40–120 companies.

The managers have continued to rationalise the portfolio. The number of stocks peaked at around 110 following the market collapse in 2020, when the managers took advantage of a wide range of opportunities that became available. In normal market conditions, the managers consider that, if a position is below half a percent, it needs to have a strong view if it is to remain in the portfolio.

As noted above, the managers have continued to sell down Indian names, reflecting the strong valuations being seen in that market, and rotating into Chinese names where it believes that the economic picture is improving, and valuations look particularly weak. The managers have also been rationalising PHI’s positions in Korea and has been reducing PHI’s exposure to materials, particularly nickel, where supply has been more plentiful than expected. The managers have been adding to names exposed to semiconductors as they believe that we are at the bottom of the memory cycle (Samsung and SK Hynix) and they see the potential from disruptive new technologies (EO Technics – see page 13).

The allocation to Korea remains broadly in line, while the exposures to Indonesia and Singapore have moved up. In Vietnam, where the managers note that the economy is rebounding and valuations look cheap, they have added two new holdings (see below) and have added to Vin Hoan.

The allocation to Taiwan has moved up at the margin, reflecting the fact that the managers have been able to find more opportunities there. There continues to be little in the Philippines that the managers wish to invest in, once again seeing better opportunities elsewhere.

A comparison of the sector allocations above illustrates that the managers have continued to take down the exposure to commodities (once again shifting away from base metals to those needed for the energy transition). The exposures to industrials and energy have also seen 2-3% reductions. Information technology, financials and real estate have all seen 2-3% increases (the managers think that a lot of pain has already been built into these shares prices in terms of a global slowdown).

New positions added to the portfolio include FPT, Jio Financial Services, Mobile World Investment Corporation, Silergy, SK Hynix and Tisco. We discuss some of these below.

FPT – Vietnam’s largest IT services company

FPT (fpt.vn) develops software, provides IT and telecom services (including broadband internet), and is a distributor/retailer of IT and communication products. Like Mobile World below, it is a company that, with 49% foreign ownership, is at its FOL. The company offers outsourcing services to more than 650 global customers and partners and also owns significant telecoms infrastructure, including a main north-south fibre link, and its private telecom network allows it to service all 64 of Vietnam’s provinces. PHI’s managers like the long-term growth story for FPT, noting that it has strong ties to Japan but is able to offer much cheaper solutions (FPT employs the largest software engineer workforce in Vietnam and benefits from Vietnam’s well-educated and hardworking workforce).

Mobile World – Building one of Vietnam’s largest grocery retail networks

Mobile World is Vietnam’s largest retailer and is focused on three key areas: mobile phone retail (The Gioi Di Dong), consumer electronics retail (Dien May Xanh) and grocery retail (Bach Hoa Xanh). It also has investments in pharmacy retail (An Khang). Mobile World is already Vietnam’s largest electronics retailer, with a strong track record in execution, which it is now applying to grocery retail (it has a proven ability to identify strong structural growth areas to enter), a key attraction for PHI’s managers. The company has opened some 2,000 stores to date (it achieved 1,000 stores within four years of opening) and has been very successful at taking market share from the traditional wet markets in Vietnam. After a period of consolidation – the company closed some underperforming stores in 2022 – it has been expanding its footprint during 2023, particularly in the north of the country. PHI’s managers think that the company has been successful in refining its grocery proposition and it is now well-positioned to see strong profitable growth. This stock is difficult to buy, as it is at its FOL, but some became available allowing the managers to buy into what they see as a strong long-term growth story.

Jio Financial Services – well positioned to leverage its huge database for cross selling

Jio Financial Services (www.jfs.in) is one of the largest non-banking financial companies in India. The company, which was spun out of Reliance Industries and listed in August 2023, describes itself as a ‘one stop shop’ for financial solutions in India. Following the demerger, PHI’s managers are excited about the prospects for the company over the next five to 10 years. The company’s customer base now has over 450m subscribers, for which it has their details allowing them to cross-sell a range of financial products. It is entering the insurance segment where it is offering life, general and health insurance policies. It is tied into lots of stores and merchants, for which it can offer products, and has also done a joint venture with BlackRock to add fund management products.

PHI’s managers say that, despite its high-profile backer, the company was spun out with very little information and is both under-researched and not well understood, resulting in a low valuation – c 1x P/B. They think that the opportunity could be huge, and have continued to add to the position since initiating a holding.

Top 10 holdings

Figure 10 shows PHI’s top 10 holdings as at 31 October 2023 and how these have changed since September 2022. Holdings that have moved into the top 10 are Ramkrishna Forgings, Tata Motors, Ping An Insurance, Zijin Mining, EO Technics and India Bulls Real Estate.

Names that have moved out of the top 10 are JD.com, Merdeka Copper Gold, Li Ning, Jadestone Energy, Reliance Industries and Bank Rakyat Indonesia. We discuss some of the more interesting changes in the following pages. Readers interested in other names in the top 10 should see our previous notes, where many of these have been previously discussed (see page 28 of this note).

Ramkrishna Forgings (4.1%) – very strong share price growth on the back of a strong operational performance

Ramkrishna Forgings (www.ramkrishnaforgings.com) is one of India’s largest manufacturers and exporters of forged components and is focused on the automotive and commercial vehicle sectors. Whilst its initial focus was on heavy commercial vehicles in India, the company now gets around 60% of its business from overseas, mainly from North America and Europe but it has also been growing its customer base in China. PHI’s managers comment that the company has been well managed, generates high returns and given significant capacity expansion and order wins, is expected to continue on its strong growth path.

As is illustrated in Figure 18 on page 15, the company was the largest positive contributor to PHI’s performance during the last financial year, with its share price rising 189% during the year. It was also the fifth-highest positive contributor to PHI’s performance over the five years to 31 July 2023. Ramkrishna Forgings’s share price has provided very strong growth over the last 12 months on the back of a strong operational performance. For example, for the six months ended 30 September 2023, total revenue rose by 20.8% y-o-y to INR 17,086m, while net profit increased by 40.0% y-o-y to INR 1,559m. The company has been benefitting from strong growth in both its domestic and export markets as well as cost control measures. It has also been diversifying into railways (for example, forged wheels) and castings and has added capacity to both hot and cold forging. The share price has tracked sideways recently, reflecting concerns that global commercial vehicle demand may be close to peaking. However, PHI’s managers continue to see a long growth runway for the company.

Ping An Insurance (3.2%) – investment in technology gives a strong advantage over competitors

Ping An Insurance (group.pingan.com) is the leading private insurance company in China, although since its founding in 1998 it has broadened its activities and now has subsidiaries that provide banking, asset management, financial and healthcare services. PHI’s managers comment that, with a very low insurance penetration rate in China, the company has a very long growth runway in front of it and, having invested heavily in technology that gives it strong competitive advantage versus its state-owned peers, Ping An is well positioned to capture this opportunity. However, despite these obvious advantages, it remains cheap, trading significantly below book value.

On 8 November 2023, rumours emerged that Ping An had been asked by the Chinese government to takeover Country Garden, China’s largest private property developer, in a state-engineered rescue package. The property sector, which accounts for around a quarter of economic activity in China, is struggling under heavy indebtedness and sluggish economic growth, and there are fears that its collapse could spark a broader financial crisis in China. Ping An responded quickly, denying the rumours, and the market’s reaction looked relatively sanguine – the share price was down 0.8% on the day.

Zijin Mining (2.8%) – Chinese mining company with global presence

Zijin Mining (www.zijinmining.com) describes itself as a large multinational mining group. Headquartered in China, the company is engaged in the exploration and development of assets related to copper, gold, zinc and lithium. Its projects are located in China, central Asia, Russia, Mongolia, Africa, Eastern Europe, South America and Oceania. Historically, Zijin Mining has been focused on gold, but increasingly its growth has come from copper. However, the company has been moving into materials required for battery production in order to take advantage of the long-term structural growth that the agenda to decarbonise and move to net zero offers. This has seen it purchase some lithium assets.

PHI’s managers comment that having a social licence to operate is key to any mining operation’s long-term success. PHI’s managers have, for example, questioned Zijin on its human rights due diligence, community engagement in Peru and water use in Inner Mongolia. PHI’s managers says that they have received detailed answers to their questions and that Zijin has established community grievance mechanisms at all of its sites and has committed to following the 15 principles of the Global Industry Standards on Tailings Management. The company was PHI’s sixth-best-performing stock during the last financial year (see Figure 18 on page 15) and materials was the best-performing sector, with Zijin and MMG benefitting from the strong performance of copper. Its strong performance has helped push it up PHI’s rankings.

Indiabulls Real Estate (2.7%) – Potential merger could create one of the largest Indian real estate developers

Indiabulls Real Estate (www.indiabullsrealestate.com) is a position that PHI’s managers added to, on share price weakness, during the last financial year. The company, which was established in 2006 and is a subsidiary of the Indiabulls group, is one of the largest real estate companies in India. It is focused on the construction and development of residential, commercial and ‘special economic zone’ property projects across major Indian metropolitan areas. Proposals for a merger between Indiabulls Real Estate and Embassy Group’s NAM Estates, which would have created one of India’s largest real estate development companies, were rejected by the National Company Law Appellate Tribunal (NCLT) in May 2023. However, Indiabulls Real Estate is appealing the decision.

Property was the second-best-performing sector for PHI during the last financial year, driven by the trust’s holdings in India. While Indiabulls Real Estate does not feature in the top 10 list of contributors, it has nonetheless benefitted from the strong tailwinds behind Indian real estate.

EO Technics (2.4%) – Approaching demand inflexion point as semiconductors become smaller and more complex

EO Technics (www.eotechnics.com) produces advanced lasers for semiconductor manufacturing. The company was the third-largest contributor to performance during the last financial year (see Figure 18 on page 15), benefitting from an acceleration in orders. PHI’s managers are very excited about the long-term prospects for the company. Although the company has benefitted from increased demand on the back of recent semiconductor shortages, they believe there is a much greater opportunity to come, with demand for EO Technics’ laser products expected to hit an inflection point as semiconductors become smaller and more complex, making current manufacturing technology obsolete – ceramic blades and drills will have to be replaced by lasers. The managers added significantly to this holding towards the end of the last financial year and PHI has profited from its strong share price performance since.