Preliminary Results

Overview

What defines us is growth. We believe Asia ex Japan will be one of the fastest growing regions over the coming decades and we strive to be invested in its fastest growing companies. It is growth multiplied by growth or, as we like to call it, 'Growth Squared' ('Growth²').

Such an investment style was richly rewarded over the year to 31 July 2021 as the Covid-19 pandemic spurred the rapid acceleration of technological adoption, and unprecedented levels of economic stimulus globally. This was combined with large parts of Asia handling the crisis relatively well, allowing their economies to reopen quickly and growth to rebound sharply.

This, however, was not a time to stand still. The extreme dislocations in markets afforded investors a 'once in a decade' opportunity to buy high quality growth businesses at extremely attractive valuations. The number of underlying portfolio transactions and the number of companies held in the portfolio (107 as at 31 July 2021) therefore rose to uncommonly high levels.

It may appear surprising for a growth oriented portfolio that many of our best performing ideas over the year came from 'old economy' companies, ranging from copper and nickel producers (materials crucial to the growing green energy revolution), to Indian automotive manufacturers. Holdings in these more cyclical industries had already been increasing prior to the crisis and this demonstrates an important tenet of our investment philosophy - the willingness to embrace growth in all its forms.

Elsewhere, the advantage of being able to invest in private companies continued to increase, with many of the region's best businesses, especially in the rapidly evolving technology sector, choosing to remain private for longer. Opportunities in India proved to be particularly attractive and we invested in four private Indian companies over the period (including in an existing holding, Zomato, which has now listed), along with ByteDance (the world's most popular short form video app) in China. At the end of the period, private companies accounted for 7.2% of the Company's total assets. 

Performance was extremely strong over the period, the Company's NAV and share price increasing by 61.3%^* and 59.2%^* respectively, compared to the comparative index, the MSCI All Country Asia ex Japan Index (in sterling terms), with a total return of 12.7%^*. Although we focus on longer term performance numbers, such performance is pleasing to report. It will, however, almost certainly moderate from these exceptional levels.  

Finally, our enthusiasm for the region remains strong. The risks and opportunities from increased disruption are here to stay. In our view, the market's focus on geopolitics and capital flows misses the bigger picture, that of a global rise in digital penetration, technological change and the rise of the Asian middle class. These fundamentals will underpin growth in the region for decades to come. We believe that the best way to invest in this rapidly changing growth market is to find the best long-term growth companies.

Philosophy

We are excited by the future. We are growth investors looking to invest in the top twenty percent of the fastest growing companies in the region. Believing that time is on our side, we are patient. We seek out companies whose business models and management teams are likely to fulfil their ambitions. We look for areas where our ideas give us an edge over the market over a longer timeframe.

Across the region we have found the most persistent source of outperformance to be those companies that can grow their profits faster than the market, in hard currency terms, over the long term. This trend persists irrespective of starting valuations. Consequently, our research is singularly focused on finding those companies whose share prices can at least double, in sterling terms, on a five year view and we expect most of this doubling to come from earnings growth.

We are particularly interested in three specific and persistent inefficiencies:

1)  Underappreciated growth duration

We believe one of the greatest inefficiencies in Asia ex Japan is to be found in companies with excellent long-term earnings growth but where profits will be volatile from one quarter to the next, often as a result of investment or product cycles that are years in the planning. The market shows an aversion to such companies, preferring the predictability of smooth profit generation even if the long-term growth rate turns out to be a fraction of that achieved by those more willing to reinvest in their business and with greater ambition. This presents us with fantastic investment opportunities, but it requires an approach and culture that allows near-term volatility to be ignored.

2)  Underappreciated growth pace

The market consistently underestimates the likelihood of rapid growth. The evidence shows that most investors cluster around a narrow range of earnings growth predictions, which can in turn lead to significant mispricing of those companies with the potential to grow very rapidly. Our process is focused on finding these companies. By looking further out and searching for low probability but high impact growth opportunities, we have been able to outperform the broader market. This requires us to think carefully about probabilities and possibilities, to spend more time thinking about what can go right rather than what can go wrong in any investment; ultimately, stock markets are driven by a small handful of companies that do extremely well.

3)  Underappreciated growth surprise

The final significant inefficiency in Asia ex Japan lies in the interaction between top-down and bottom-up investing. Asia ex Japan investors do not have the luxury of ignoring macroeconomics. Purely bottom-up investment is a path to ruin in a universe where industrial and economic cycles can dominate investment returns over multi-year periods. The long-term earnings for a vast number of companies - notably in the financial, materials and industrial sectors - are determined by exogenous macro factors beyond their control. This also provides opportunities.

Our analysis shows that while it may pay to invest in those companies that display consistently high levels of profitability, the strongest returns are to be found in those companies that transition from poor levels of profitability to high - a 'growth surprise'.

This may seem obvious - rising levels of profitability are normally accompanied by a re-rating, thereby providing a two-fold kicker to share price performance - but identifying the drivers behind this change is the key and has been a significant source of outperformance for Pacific Horizon. We accept that timing these inflection points perfectly is impossible, but when you have an investment horizon measured over many years, successfully anticipating the future direction of travel is hugely valuable.

Importantly, we are agnostic as to the type of growth inefficiency we are exploiting and will invest wherever we are finding the best opportunities.  At times this will lead to a concentration in particular sectors or countries, and at others a much broader, flatter portfolio, but growth will always be the common theme.

Data as at 31 July 2021, source: Baillie Gifford, UBS PAS, APT, MSCI (see disclaimer at the end of this announcement).

As highlighted in the table above, the growth characteristics of the current portfolio remain strong, with historic earnings growth and one-year forecast earnings growth higher than the comparative index equivalents. The portfolio's estimated price-to-earnings ratio for the current year is 17.2 versus 14.3 for the comparative index. Over the longer term, we believe the higher growth potential of our holdings more than justifies this additional multiple.

Finally, we continue to believe that the rapid development of technology is creating a fundamental change in market behaviour, with digitalisation driving profound changes in economic and political systems, businesses and consumer habits. The number of sectors and industries that are becoming digitalised and connected is increasing rapidly. There is growing awareness of these changes across the globe. Artificial intelligence ('AI') is now taken for granted and the concept of electric rather than internal combustion engine cars is seen as a commercial inevitability rather than a distant vision.

Review

The portfolio is noticeably different from a few years ago when we were more cautious on large parts of South East Asia and were very concentrated in technology and consumer stocks. In the context of the growth inefficiencies we exploit, the Company had a large number of investments in the 'duration' and 'pace' buckets, but very little in 'surprise'. This had been changing gradually as we found more opportunities in more cyclical, old economy companies, but accelerated dramatically over the course of the Covid-19 pandemic as the extreme dislocation in Asian markets provided us with extremely attractive opportunities in these more cyclical sectors.

The result is a portfolio today that may surprise some. In absolute terms our largest exposures remain focused on the key themes of the rising middle class, technology and innovation, however we now have significant exposures to more cyclical industries including materials, industrials and energy that respectively make up the three largest relative positions within the portfolio. There remains, however, one commonality among the companies held: growth.

Using Pacific Horizon's largest relative sector position, Materials, as an example, holdings here are predominantly concentrated in companies exposed to two commodities, nickel and copper, both of which lie at the core of the green revolution. Copper, as the most cost-effective conductive material, sits at the heart of capturing, storing and transporting new energy sources, and demand from green sources could easily grow ten-fold by 2030. Nickel is a core material in electric vehicle batteries, where demand across Asia will be driven by China's intention to have electric vehicles account for a quarter of all automotive sales within the next few years (from around 5% today).

By country, the most noticeable change to the portfolio has been the substantial increase to India, going from a 7% absolute position to 29%, and it is now the largest country overweight in the portfolio (+18 percentage points). Our purchases here can be divided into two parts. The first is 'old' India, where we have increased holdings in traditional sectors such as property, where we believe the Indian property market is at the cusp of a multi-year revival; since 2007, the market has fallen significantly in real terms, affordability is the highest it has been in a decade, and a number of regulatory changes and tightening liquidity requirements have consolidated the market into a handful of the largest and best developers.  

The second part is arguably the more exciting, 'new' India. For many years India has had some of the most attractive companies across Asia, but often this has had more to do with the lack of competition they face, rather than any great innovation or technological edge. Catalysed by the rollout of the world's second largest 4G mobile network, allowing many Indians to access the internet for the first time, things are changing fast. Just as we experienced in China more than a decade ago, a new breed of exciting and innovative technology-focused companies is emerging in the country.

Many of these prized businesses, however, remain private, and Pacific Horizon's ability to invest into unlisted (private) companies has been extremely beneficial.  Over the period we made three new investments into private Indian companies, Delhivery (leading delivery and ecommerce logistics), Dailyhunt (online short form video) and Star Health (India's largest private health provider), while the trust also added to its existing position in Zomato which subsequently listed. 

With around US$200-300 billion worth of technology-focused private companies likely to list in India over the next few years, the opportunity set for investors will be revolutionised. Having built meaningful stakes in a number of these businesses, developed strong relationships with management and gained early insights into these industries and companies ahead of their IPOs, we believe Pacific Horizon will be well placed to benefit.

A significant portion of funding for Indian companies came from the sale of our Chinese names, with China reducing from a 41% absolute weighting in the portfolio to 27%, and in relative terms it is the largest portfolio underweight position at minus 20 percentage points. Noticeable reductions took place to a number of the large technology companies where we had concerns over competition and increasing regulation; the position in Alibaba was reduced and the positions in Tencent and Meituan exited.

Our timing proved to be prescient; the demolition of the private education sector (where we had no exposure), a crackdown on the monopolistic practices of internet giants and enhanced rules on data ownership and security have displaced any confusion, if any existed, regarding who is in charge in China. For the internet companies specifically, it will be crucial going forwards to understand whether the Chinese regulators have simply imposed some sensible regulations to protect consumers, or whether this is the start of the Chinese government exerting ever greater control over these businesses.

Performance

Although our performance was exceptionally strong over the reporting period, we would hesitate to draw too much from such short-term numbers. We are long-term investors, running a high conviction growth portfolio that is index agnostic. Performance will be volatile and there will be short term periods when we underperform. Our investment time horizon is five years and beyond and it is on these time scales that our performance should be judged. Over the past five years, the Company's NAV has outperformed the comparative index by 17.5 percentage points per annum. Such performance is pleasing to report, however it will almost certainly moderate from these exceptional levels.

Over the relatively short reporting period, markets have been volatile, sentiment see-sawed between growth and value, as investors grappled with the implications of enormous global fiscal stimulus, eye-popping monetary stimulus, surging GDP growth, and inflation, to name a few. We pay no attention to debates of growth versus value, however it is interesting to note that the portfolio has generally performed well in both market environments; the first half of the period when growth was generally in favour and the second half when it switched to value.

Such a favourable outcome has largely been the result of the broadening out of the portfolio into more cyclical growth companies, as previously discussed. Consequently, by sector, cyclical industries including materials, real estate and financials, were the second, fourth and fifth leading contributors to portfolio returns. Even within the largest contributor to absolute performance, consumer discretionary, a significant portion of performance came from some of the more traditional sectors such as automotive, where Tata Motors (owners of Jaguar Land Rover) was the third biggest stock contributor to performance. 

By sector, only information technology detracted from performance (by a modest 0.6 percentage points), mainly due to underweight positions in some of the region's manufacturing behemoths including Samsung Electronics. 

We are of course indifferent as to what sectors our stocks are defined as by the market; we are stock pickers after growth companies, and as such it is no surprise that more than three quarters of the portfolio's positive absolute return came solely from stock selection.

Towards the end of the reporting period, performance was also helped significantly by what was not held. This was especially so in China, where the government's decimation of the listed education sector and increasing regulation of internet companies led to dramatic price falls in these sectors. In July 2021, when these changes occurred, the portfolio had no exposure to companies in the education sector, and more importantly was significantly underweight many of the large internet names, for example with a five percentage point underweight position in mega cap Alibaba, and no holdings in index heavyweights such as Tencent and Meituan.

The above, combined with strong stock performance from companies like Li Ning, the Chinese sportswear company that continued to benefit from a shift towards local brands by Chinese consumers, meant China was the top contributor to portfolio returns. This was closely followed by India, where a number of stocks performed very strongly including Tata Motors (up 177%) and Happiest Minds (IT outsourcer, purchased at IPO, up 677%), which were both among the top five stock contributors.  In India it is also noteworthy that Zomato, a private company holding in the portfolio, listed and generated a total return of 171% over the reporting period.

The performance of the portfolio's largest holding, Sea Limited (+113%), South East Asia's leading ecommerce and gaming company meant that by country, Singapore was the third largest contributor to portfolio performance. The gaming division showed great strength, with Free Fire, the company's in-house-developed game, becoming the world's most downloaded game in 2020 and reaching more than 300 million monthly active users. The ecommerce business continued its impressive market share gains across much of ASEAN and, with its increasing scale, looks set to be the dominant online shopping platform across much of the region over the coming decade.  

Despite the strong performance of a number of companies, including Sea, it is worth noting that performance was pleasingly broad-based, with the top ten contributors accounting for less than half of Pacific Horizon's relative outperformance.

The portfolio underperformed in Taiwan, largely as a consequence of the portfolio's underweight position in TSMC, arguably the world's most important semiconductor manufacturer. TSMC continued to increase its technological lead over rivals, and we will be carefully considering the portfolio's exposure to the company over the coming 12 months.

Other notable detractors to performance were a number of technology companies in China including Dada Nexus (logistics), Lufax holdings (Fintech) and HUYA (online game streaming). These were all impacted in the aforementioned Chinese regulatory clampdown on the internet sector.

Environmental, Social and Governance Considerations

As growth investors, we are attracted to companies whose products will benefit from strong future demand. These companies not only have to produce better and cheaper products and services than their competitors, but they must also be alert for changes in the outlooks and attitudes of the societies of which they are part.

Companies that fail to keep pace in this way tend to fail, either because of falling consumer demand for their products or because of government intervention in their activities. When taking investment decisions, we consider the potential positive and negative impact on society that companies may have, and how their commercial activities may be perceived by external stakeholders in the future.

For our long-term investments to be successful, the companies in which we invest must add value to society. This can be achieved in various ways. For example, the products of our regenerative biotech companies may allow many to benefit from otherwise unachievable medical cures, our internet companies provide goods and services at prices and in quantities previously beyond the reach of many, while our technology holdings are enabling the fastest increase in human connectivity and information on record.

Lastly, it is very important to us that the interests of minority shareholders are upheld. We remain careful to make sure our investments are aligned with those of majority shareholders and owners.

Outlook

We remain extremely positive on the long-term outlook for the region. The rise of the Asian middle class, accelerated by technology and innovation, continues to be one of the most powerful investment opportunities of the coming decade. As active managers, with long-term time horizons, we are enthused by the number of exciting growth companies we can buy that should benefit from these economic, social and technological changes across the region. 

All of this is against the backdrop of Covid-19 from which Asia ex Japan, to use an unfortunate phrase, could be a major beneficiary. The modest financial stimulus and monetary response observed across the region stands in stark contrast to the many trillions of dollars desperately being deployed by western economies as their interest rate structures collapse. For much of the developed world, such profligacy will be a major financial burden for years to come, leading to slower growth and potentially weaker currencies. The majority of Asia ex Japan, with decent growth rates, sensible interest rates and limited balance sheet expansion, looks attractively placed in comparison. It is time to look east.

^* Source: Baillie Gifford/Refinitiv and relevant underlying index providers. See disclaimer at the end of this announcement.

For a definition of terms see Glossary of Terms and Alternative Performance Measures at the end of this announcement.

Past performance is not a guide to future performance.
 

Baillie Gifford Statement on Stewardship

Reclaiming Activism for Long-Term Investors

Baillie Gifford's over-arching ethos is that we are 'actual' investors. We have a responsibility to behave as supportive and constructively engaged long-term investors. We invest in companies at different stages in their evolution, across vastly different industries and geographies and we celebrate their uniqueness. Consequently, we are wary of prescriptive policies and rules, believing that these often run counter to thoughtful and beneficial corporate stewardship. Our approach favours a small number of simple principles which help shape our interactions with companies.

Our Stewardship Principles

Prioritisation of long-term value creation

We encourage company management and their boards to be ambitious and focus their investments on long-term value creation. We understand that it is easy for businesses to be influenced by short-sighted demands for profit maximisation but believe these often lead to sub-optimal long-term outcomes. We regard it as our responsibility to steer businesses away from destructive financial engineering towards activities that create genuine economic value over the long run. We are happy that our value will often be in supporting management when others don't.

A constructive and purposeful board

We believe that boards play a key role in supporting corporate success and representing the interests of minority shareholders. There is no fixed formula, but it is our expectation that boards have the resources, cognitive diversity and information they need to fulfil these responsibilities. We believe that a board works best when there is strong independent representation able to assist, advise and constructively test the thinking of management.

Long-term focused remuneration with stretching targets

We look for remuneration policies that are simple, transparent and reward superior strategic and operational endeavour. We believe incentive schemes can be important in driving behaviour, and we encourage policies which create alignment with genuine long-term shareholders. We are accepting of significant pay-outs to executives if these are commensurate with outstanding long-run value creation, but plans should not reward mediocre outcomes. We think that performance hurdles should be skewed towards long-term results and that remuneration plans should be subject to shareholder approval.

Fair treatment of stakeholders

We believe it is in the long-term interests of companies to maintain strong relationships with all stakeholders, treating employees, customers, suppliers, governments and regulators in a fair and transparent manner. We do not believe in one-size-fits-all governance and we recognise that different shareholder structures are appropriate for different businesses. However, regardless of structure, companies must always respect the rights of all equity owners.

Sustainable business practices

We look for companies to act as responsible corporate citizens, working within the spirit and not just the letter of the laws and regulations that govern them. We believe that corporate success will only be sustained if a business's long-run impact on society and the environment is taken into account. Management and boards should therefore understand and regularly review this aspect of their activities, disclosing such information publicly alongside plans for ongoing improvement.

The following is the Preliminary Statement for the year to 31 July 2021 which was approved by the Board on 21 September 2021.

The total column of this statement represents the profit and loss account of the Company. The supplementary revenue and capital columns are prepared under guidance published by the Association of Investment Companies.

All revenue and capital items in this statement derive from continuing operations.

A Statement of Comprehensive Income is not required as the Company does not have any other comprehensive income and the net return on ordinary activities after taxation is both the profit and comprehensive income for the year.
 

* See Glossary of Terms and Alternative Performance Measures at the end of this announcement.

For the year ended 31 July 2021

For the year ended 31 July 2020

†      The Capital Reserve balance at 31 July 2021 includes investment holding gains on fixed asset investments of £287,279,000 (31 July 2020 - gains of £122,011,000).

‡   Cash from operations includes dividends received of £3,858,000 (2020 - £2,917,000) and interest received of £66,000 (2020 - £205,000).
 

List of Investments as at 31 July 2021 (ctd)

List of Investments as at 31 July 2021 (ctd)

HK/China denotes Hong Kong and China.

‡ For a definition of terms see Glossary of Terms and Alternative Performance Measures at the end of this announcement.

^u Denotes private company (unlisted) investment.

^s Denotes suspended investment.

Figures represent percentage of total assets.

†      Includes holdings in ordinary shares and preference shares.

Geographical Analysis

Sectoral Analysis

‡    For a definition of terms see Glossary of Terms and Alternative Performance Measures at the end of this announcement.

There are no dilutive or potentially dilutive shares in issue.    

‡      Neither the contents of the Managers' website nor the contents of any website accessible from hyperlinks on the Managers' website (or any other website) is incorporated into, or forms part of, this announcement.

None of the views expressed in this document should be construed as advice to buy or sell a particular investment.

Glossary of Terms and Alternative Performance Measures (APM)

Total Assets

The total value of all assets held less all liabilities (other than liabilities in the form of borrowings).

Shareholders' Funds and Net Asset Value

Also described as shareholders' funds, Net Asset Value (NAV) is the value of all assets held less all liabilities (including borrowings). The NAV per share is calculated by dividing this amount by the number of ordinary shares (excluding treasury shares) in issue.

Net Liquid Assets

Net liquid assets comprise current assets less current liabilities (excluding borrowings) and provisions for deferred liabilities.

Discount/Premium (APM)

As stock markets and share prices vary, an investment trust's share price is rarely the same as its NAV. When the share price is lower than the NAV per share it is said to be trading at a discount. The size of the discount is calculated by subtracting the share price from the NAV per share and is usually expressed as a percentage of the NAV per share. If the share price is higher than the NAV per share, this situation is called a premium.

Total Return (APM)

The total return is the return to shareholders after reinvesting the net dividend on the date that the share price goes ex-dividend.

Glossary of Terms and Alternative Performance Measures (APM) (Ctd)

Ongoing Charges (APM)

The total recurring expenses (excluding the Company's cost of dealing in investments and borrowing costs) incurred by the Company as a percentage of the daily average net asset value, as detailed below.

China 'A' Shares

'A' Shares are shares of mainland China-based companies that trade on the Shanghai Stock Exchange and the Shenzhen Stock Exchange. Since 2003, select foreign institutions have been able to purchase them through the Qualified Foreign Institutional Investor system.

Treasury Shares

The Company has the authority to make market purchases of its ordinary shares for retention as Treasury Shares for future reissue, resale, transfer, or for cancellation. Treasury Shares do not receive distributions and the Company is not entitled to exercise the voting rights attaching to them.

Gearing (APM)

At its simplest, gearing is borrowing. Just like any other public company, an investment trust can borrow money to invest in additional investments for its portfolio. The effect of the borrowing on the shareholders' assets is called 'gearing'. If the Company's assets grow, the shareholders' assets grow proportionately more because the debt remains the same. But if the value of the Company's assets falls, the situation is reversed. Gearing can therefore enhance performance in rising markets but can adversely impact performance in falling markets.

Invested gearing is borrowings at par less cash and brokers' balances expressed as a percentage of shareholders' funds.

Potential gearing is the Company's borrowings expressed as a percentage of shareholders' funds; (a) as a percentage of (c) above.

Leverage (APM)

For the purposes of the Alternative Investment Fund Managers Directive, leverage is any method which increases the Company's exposure, including the borrowing of cash and the use of derivatives. It is expressed as a ratio between the Company's exposure and its net asset value and can be calculated on a gross and a commitment method. Under the gross method, exposure represents the sum of the Company's positions after the deduction of sterling cash balances, without taking into account any hedging and netting arrangements. Under the commitment method, exposure is calculated without the deduction of sterling cash balances and after certain hedging and netting positions are offset against each other.

Active Share (APM)

Active share, a measure of how actively a portfolio is managed, is the percentage of the portfolio that differs from its comparative index. It is calculated by deducting from 100 the percentage of the portfolio that overlaps with the comparative index. An active share of 100 indicates no overlap with the index and an active share of zero indicates a portfolio that tracks the index.

Compound Annual Return (APM)

The compound annual return converts the return over a period of longer than one year to a constant annual rate of return applied to the compound value at the start of each year.

Unlisted (Private) Company

An unlisted or private company means a company whose shares are not available to the general public for trading and are not listed on a stock exchange.

Pacific Horizon Investment Trust PLC (Pacific Horizon) aims to achieve capital growth through investment in the Asia-Pacific region (excluding Japan) and in the Indian Sub-continent. The Company has total assets of £748.0 million (before deduction of loans of £60.8 million) at 31 July 2021.

Pacific Horizon is managed by Baillie Gifford & Co Limited, the Edinburgh based fund management group.

Past performance is not a guide to future performance. Pacific Horizon is a public listed company and is not authorised or regulated by the Financial Conduct Authority. The value of its shares and any income from those shares can fall as well as rise and you may not get back the amount invested. Pacific Horizon invests in overseas securities, changes in the rates of exchange may also cause the value of your investment (and any income it may pay) to go down or up. Pacific Horizon invests in emerging markets where difficulties in dealing, settlement and custody could arise, resulting in a negative impact on the value of your investment. Shareholders in Pacific Horizon have the right to vote every five years, on whether to continue Pacific Horizon, or wind it up. If the shareholders decide to wind the Company up, the assets will be sold and you will receive a cash sum in relation to your shareholding. The next vote will be held at the Annual General Meeting in 2021. You can find up to date performance information about Pacific Horizon on the Pacific Horizon page of the Managers' website at www.pacifichorizon.co.uk.†

†      Neither the contents of the Managers' website nor the contents of any website accessible from hyperlinks on the Managers' website (or any other website) is incorporated into, or forms part of, this announcement.

22 September 2021

For further information please contact:

Anzelm Cydzik, Baillie Gifford & Co

Tel: 0131 275 2000

Mark Knight, Four Communications

Tel: 0203 697 4200 or 07803 758810

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