HFL - Financial results for the year ended 31 August 2022

Monday 7th November 2022

Investment Objective

The Company seeks to provide shareholders with a growing total annual dividend per share, as well as capital appreciation, from a diversified portfolio of investments from the Asia Pacific region.

Highlights

• Total dividend of 23.80p (2021: 23.40p) for the year

• Dividend yield at 31 August 2022 of 8.5% (2021: 7.8%)

CHAIRMAN’S STATEMENT

Introduction

As your new Chairman it would have been good to begin my first letter to shareholders in an environment filled with positives, optimism and a clear glidepath toward rosy investment results in the immediate future. Indeed, as we look back at the past year, there is much to be pleased with despite the challenging time through which we have come in so many areas. Having faced down the trauma of the pandemic with its massive impact on societies around the world, we now face new dramas. The war in Ukraine has not only represented a great humanitarian tragedy, it has driven massive economic dislocation and the very real prospect of a global recession while helping to fuel the inflation that was already out of control. None of this is likely to make for an upbeat investment environment but there are a few reasons for a more positive view, especially in Asia, that we will explore as well.

Performance

Despite the rather dire backdrop of the last financial year, the Company rose to the challenge in many ways, producing a positive NAV total return of 1.9% and year-end dividend yield of 8.5%. These results compare favourably with the FTSE All-World Asia Pacific ex Japan Index total return of negative 3.4%, but less well against the MSCI AC Asia Pacific ex Japan High Dividend Yield Index which returned 7.4%. Capital performance struggled once again this year with yield, as an investment style, remaining out of favour.

Our Fund Managers will discuss our investment results in more detail in their report, but it is right for me to note that our commitment to providing a high and reliable dividend income to our shareholders while still generating capital growth along the way, is not an easy hurdle. Our underlying investment bias toward value rather than growth has had the effect of reducing capital returns over the last few years as growth company valuations expanded dramatically. More recently, perhaps driven by concerns of faltering growth rates, investor sentiment toward value has improved, benefitting our portfolio and resulting in a pickup in relative capital returns. We expect that to continue, at least in relative terms, as economic growth slows in the months ahead. During this period of rising of living costs, investors’ need for dividend income is higher than ever and the Company’s shares often sell at a premium to its NAV as a result.

Dividends

The Company paid a total dividend of 23.80p per ordinary share in the year ended 31 August 2022 representing a 1.7% increase over the prior year and our 15th consecutive year of increasing dividends. The financial year just passed has been a challenging one, but our portfolio companies achieved a good rebound in dividend payments and our forecast for dividends in the current year is cautiously positive. After paying the dividend, we will once again be adding a moderate amount to the revenue reserve, which we use to smooth the dividend when market conditions are severe.

The 4th interim dividend for the year ended 31 August 2022 was declared on 19 October 2022 at a rate of 6.00p per ordinary share.

Governance matters

The Board has long benefitted from a strong team of members as a result of good succession planning and a careful selection process. I want to take this opportunity to thank John Russell, our recently retired Chairman, for his untiring efforts to lead the Board with a high standard of governance and an unswerving commitment to the Company’s key investment objectives. John’s patient guidance will be missed and we wish him well.

The Board has continued to review its longer term development needs in a changing world and recognises its desire and obligation to become more diverse in order to better represent shareholders and retain the right range of expertise within its ranks. Recent regulatory changes from the Financial Conduct Authority continue to raise the bar for board diversity, something that we believe is long overdue and which we fully support. Our ability to be compliant will, however, be constrained by the current Jersey requirement for two resident directors and we are actively engaging with the Jersey regulator to find a successful way forward.

The Board remains committed to an ongoing refreshment process and will be looking to recruit a successor to David Mashiter who has served so well as a director since 2006. We will await the outcome of our discussions with the Jersey regulator before initiating this recruitment process soon thereafter. David has graciously agreed to remain on the Board until that appointment in order to assure a smooth handover process.

ESG

ESG has been the subject of much discussion among investors over the past year, both positive and negative.

Our view has always been that sound investing and responsible investing go hand in hand and recognise that ESG matters are an intrinsic part of the Janus Henderson investment process, helping to shape the approach we take to investment decisions but through a philosophy based on engagement with companies to achieve positive long term results. We do not believe that it makes sense to create ‘no-go’ areas for investment, with the exception of munitions, but instead work with companies to do better across a range of areas. Too often of late, we have found extreme ESG based positions become the subject of criticism for compromising shareholder returns. We believe sound investment decisions and a sensitivity to ESG issues are compatible with the right approach and that our investment team works hard and effectively to achieve this balanced outcome.

AGM

The Company’s 16th Annual General Meeting is due to be held at 11.00 am on 27 January 2023 at the offices of our investment manager, 201 Bishopsgate, London, EC2M 3AE. The Notice of Meeting has been posted to shareholders with a copy of the annual report.

Voting will take place on a show of hands so if you are unable to attend in person, I encourage you to submit your proxy form or instruct your share dealing platform accordingly.

Outlook

It is never easy nor especially reliable to predict the future and the year ahead seems murkier than most. When will inflation start to decline? How resilient will economies be in the face of rising interest rates? How vulnerable will economic growth prove to be given so many cross-currents that could undermine demand and damage business confidence? None of these questions have easy answers but there are certainly some useful observations to be made regarding the environment we face, many of which are expanded upon in our Fund Managers’ report.

First, inflation has been more difficult for central banks to bring down after years of monetary stimulation but there are now signs that it is receding, albeit slowly. Rising interest rates are starting to have the impact that central banks want and slower economic activity is reducing demand pressure and thus, the scope for price increases. Labour demand remains fairly strong, however, rising labour costs will continue to be a key inflation factor for some time to come. Energy prices display a degree of schizophrenia reflecting the impact of the war in Ukraine, OPEC1 production restraints and moderating oil demand in the face of slower global economic activity.

The economies of Europe and North America may well fall into a mild recession (or even be in one now) but Asia is not in synch with all the same pressures as western economies and may benefit from some positives peculiar to the region. For example, China remains the region’s most important economy and unlike western governments is now aggressively stimulating its economy to achieve better economic growth. This will inevitably have a positive ‘spillover’ effect on other economies in the region and we will be monitoring the scope of that impact closely. Concerns about China’s real estate debt crisis fail to take account of the country’s unique financial management tools to cope with this type of problem and with share prices now at much more attractive valuation levels, there is again scope for investment upside.

Markets in the Asia Pacific region will continue to be subject to uncertainty generated by geopolitical concerns, especially between China and Taiwan. The underlying solidity of economic growth in the region, however, remains good and we are positive about the prospects for continuing dividend increases from our portfolio of companies in the region. While we have had a difficult start to our new financial year there are opportunities for individual companies to grow. Asia company payout ratios remain low by western standards and continue to offer real expansion opportunities as we look ahead.

Ronald Gould

Chairman

3 November 2022

1. Organisation of the Petroleum Exporting Countries

FUND MANAGERS’ REPORT

This time last year we were writing about the impact of the Covid-19 pandemic, while at the interim stage in February, the Russian invasion of Ukraine dominated headlines. While these events are still front and centre, the attention has switched from the human tragedy of a pandemic and war to the economic implications that these events are having on inflation, interest rates, currency and growth. In recent months equity and bond markets have whipsawed around economic releases with investors trying to ascertain whether the announcement lowers inflation and interest rate expectations or increases the likelihood of recession or both. Global central banks and governments are walking a tightrope with the risk of a policy mistake rising by the day. The recent turmoil in the UK following the government’s mini budget is a prime example of how unconventional policy can have a dramatic impact when the outlook is so uncertain.

The impact on equity and bond markets has been significant. The S&P 500 has fallen over 19% in US dollar terms from its peak in early January 2022 to the end of August 2022, while the MSCI Europe has fallen 12.6% in euro terms. The FTSE 100 has proved more resilient, falling 0.4% in sterling terms as the currency weakness and the abundance of companies with overseas earnings, as well as oil and mining companies, was supportive to share prices. In local currency terms, Asia Pacific ex Japan fully participated in the downturn, falling 13.1% as the export orientated economies of North Asia succumbed to the weakness in demand from the western consumer.

Markets have continued to fall subsequent to our financial year-end as prominent central banks have reaffirmed their intention to do whatever it takes to suppress inflation. From an Asian perspective, the pressure from inflation is not so intense as regional economies have not faced the same level of wage pressures or asset price inflation witnessed in the west while the ‘Zero Covid’ policy in China has supressed regional demand. At the same time, the Federal Reserve in the US, the ECB in Europe, the Bank of England and the Bank of Japan have been accused of being asleep at the wheel in terms of effective monetary policy to contain inflation, the same cannot be said in Asia Pacific. Although inflationary pressures have emerged in many countries across the region, the gap between CPI1 and interest rates is far narrower than in developed markets suggesting that less work needs to be done to get back to an even keel. The draconian Covid-19 lockdown measures have made China a global outlier with inflation below 2% and positive real interest rates. It is notable that, as a result, China is the only major economy loosening monetary policy which, if successful in stimulating demand, will be a positive driver for the region.

In a reversal of last year’s trends, South Asian markets massively outperformed their North Asian peers. The highly valued growth sectors which had benefitted from ‘work from home’ demand during the pandemic and companies exposed to new innovations in electric vehicles and alternative energy, struggled as investors reassessed weakening demand and elevated valuations in a rising interest rate environment. Korea fell 21% and Taiwan 11% while the technology sector for the region as a whole was down 22%. Conversely the opening-up of South Asian economies, a lack of technology exposure and less sensitivity to rising energy and materials prices helped Indonesia, Singapore and Thailand post gains of 25%, 10.7% and 6.8% respectively. India was another market that posted positive returns. Despite inflation above the regional average, higher interest rates and a weakening rupee, the domestic economy is performing well with the property market showing signs of life after a thirteen year downturn and retail sales 15% ahead of pre-Covid levels.

Once again, China was the worst performing market. The economy continues to struggle to regain momentum weighed down by liquidity and solvency problems in the property market, a ‘Zero Covid’ policy with constant and ongoing lockdowns and continued tension with the US that restricts the import and export of certain goods. Government focus has turned towards economic stimulus with interest rate cuts, property loosening measures and a renewed focus on infrastructure investment, but these are yet to bear fruit with the economy now expected to grow by less than 3%, according to the latest World Bank forecast - far below the original target of 5.5%.

At the sector level, energy was the standout performer rising 20% in local currency terms as oil and especially gas prices rose significantly over the period. Utilities was the only other sector in positive territory buoyed by the renewed focus on energy security. The worst performing sectors were consumer discretionary and technology. Consumption remained subdued in North Asia by Covid-19 and in ASEAN2 by the slow pace of re-opening, while the internet sector in China and a worsening demand outlook in developed markets for smart phones, personal computers and laptops, hurt chip producers and assemblers. Financials remained resilient, outperforming the region, as rising interest rates should help improve profitability, although South Asian banks performed better than their North Asian counterparts.

The big move in currency markets has had a significant impact on returns, corporate profitability and sentiment. The strength of the US dollar during periods of heightened volatility impacts risk assets and affects the flows to and from asset classes. Historically a strong US dollar has been a negative for emerging and Asian equity markets and this dynamic has impacted returns over the last year despite Asia Pacific being more economically resilient than its developed market counterparts. Over the reporting period the US dollar has appreciated by 5.2% compared to Asia Pacific currencies and 18.4% compared to sterling. The relative weakness in the Korean won, Taiwan dollar and Philippine peso, in particular, materially impacted returns. Although the strength of the US dollar has hampered returns from Asia Pacific, the weakness of sterling has gone some way to offsetting this. Asian currencies appreciated by almost 10% against sterling which has been beneficial for the Company’s portfolio performance and revenue generation.

The Company does not hedge capital or income currency exposure in order to provide transparency for investors and to avoid the complexity of matching revenue streams with variable dividend pay dates.

Performance

The Company’s NAV total return was 1.9% in sterling terms over the period with a share price total return of 1% reflecting a small contraction of the premium that the share price trades compared to NAV. This compares with a 3.4% decline in the FTSE All World Asia Pacific ex Japan Index and a 7.4% increase in the MSCI AC Asia Pacific ex Japan High Dividend Yield Index.

The portfolio benefitted from the increase in the allocation to the energy, materials, telecommunications and financial sectors over the period while the exposure to China and in particular consumer related stocks was detrimental. Of the top ten largest contributors to performance, six were in the telecommunications sector, two in energy and two in financials.

Notable contributors were Australian gas producers Woodside Energy and Santos, which rose 95% and 44% respectively, telecommunications companies PT Telkom and Singapore Telecom, which rose 53% and 29% respectively and Australian investment bank Macquarie which rose 18%. The portfolio further benefitted in August from the BHP takeover offer for copper miner OZ Minerals at a 30% premium to the prevailing price. The biggest detractors were Chinese software company Chinasoft and auto dealer China Yongda Automobiles which both fell more than 40%.

Revenue

Dividend income from the region was strong over the period, boosted by the weakness of sterling. Revenue from dividends received was up 9.2% compared to a year earlier while option premium declined 5.8%. Total income was up 8.0% and revenue per share rose 5.1% reflecting the increased number of shares in issue.

We have been encouraged by the willingness of companies in Asia to hold and increase dividends in 2022 especially in this uncertain period. The energy and materials companies have, understandably, seen the biggest uplift but across different countries and sectors, pay-out ratios have risen reflecting strong balance sheets and increased cash flow. Some of these high-dividend pay-outs may not be sustainable going forward but we are broadly confident that dividends in the region will remain robust, especially if China is successful in reviving its flagging economy.

Strategy

Despite strong performance over the past year, we retain a significant exposure to energy and materials companies. Our focus is on fuels and materials that are integral to the energy transition and are seeing existing and new areas of demand which are constrained by supply. In recent months the price of oil and industrial metals has fallen as the market focused on demand weakness, but the lack of investment in these areas over the last ten years suggests that prices will be underpinned beyond a normal economic cycle by demand for lithium, copper, nickel and similar materials as electric vehicles, alternative power sources and energy security dominate future plans.

We retain our exposure to financials although are increasingly moving towards diversified financials rather than banks. Securities companies in China will take market share in high margin wealth management away from the policy banks, while regional insurance remains a long-term structural growth story. We own CITIC Securities and AIA Group to capture these themes. We are also focusing our bank exposure on South Asia which is seeing system wide recovery and a return to positive credit growth. United Overseas Bank in Singapore and Bank Mandiri in Indonesia capture these trends.

At the country level, Australia is now the highest weighting with three quarters of the holdings reflecting our positive view on energy and materials. Our view on the domestic economy in Australia is less positive as the government and central bank struggle to set appropriate policies to manage rising inflation, a slowing economy and an elevated property market. We have reduced our exposure to Taiwan and remain nervous about the outlook for the technology hardware sector in the face of a global slowdown. At this point we prefer Korea which has valuation support and is further ahead in the interest rate adjustment phase than its North Asian neighbour.

Over the period the weighting to China has fluctuated. We increased from low levels early in 2022 on the expectation that the economy would open-up and then reduced in the second quarter following a period of outperformance that coincided with a realisation that Covid-19 suppression, rather than economic growth, would be the main policy goal. We maintain the view that China will eventually succeed in reviving growth, but only after it has embarked on a mass vaccination of the population, especially the elderly. With locally developed mRNA vaccines still in the test phase this will only happen in late 2022 at the earliest, but more likely in the first quarter of 2023. In the meantime, we expect economic policy to be marginally supportive but not sufficient to move the needle. However, with conditions deteriorating in other regions this may be enough for Chinese equities to perform well on a relative basis. We retain a 17% weighting in the portfolio with a focus on diversified financials, materials and consumer discretionary but will most likely look to add as events unfold.

ESG

Environmental, social and governance concerns are a core part of our investment approach, but we believe in a pragmatic stance that looks to engage rather than avoid. We believe that the transition from where we are to where we want to be is the most important part of this process and take the approach that it’s unfair to impose developed market ideologies on countries that are at a different stage of development. What this means in practice is that we don’t exclude any sector, with the exception of munitions, from our investment universe but look to invest in companies with an awareness of their environmental and social impact, as well as an approach to managing them, and work with them to set and achieve targets for improvement. Our belief is that the best companies will take market share away from the worst over time improving the environment and working conditions for all. As responsible investors, it is our duty to help this transition rather than to divest and hand that responsibility to someone else. We regularly engage with the companies we invest in to ensure that the targets set are viable and that there is a clear and coherent strategy on how to achieve them.

Outlook

We have a cautious view on equity markets in the short term. The debate around inflation, interest rates and recession will dominate market direction well into 2023 and we expect Asian market performance will be dictated by these ‘big picture’ themes. In this environment the US dollar is likely to remain well supported which will curtail some of the appetite for assets in the Asia Pacific region. Despite this challenging outlook, there are some reasons to be optimistic. On the whole Asian economies have managed the cycle quite well with the historical weaknesses of emerging countries in periods of dislocation not evident this time round. There are plenty of well managed companies in the region with solid fundamentals which are now trading at valuation points below long-term averages while dividends are well underpinned by cash flow with the potential for pay-out ratios to rise over time.

The Company is ungeared at present reflecting the uncertainty that currently prevails, but we remain alert to finding investments that meet our criteria should this volatility present further opportunities.

Mike Kerley and Sat Duhra

Fund Managers

3 November 2022

1. Consumer Price Index

2. ASEAN countries include Brunei, Cambodia, Indonesia, Laos, Malaysia, the Philippines, Singapore, Thailand and Vietnam

Please refer to the PDF to view the full announcement

Mike Kerley

Fund Manager

Henderson Far East Income Limited

Telephone: 020 7818 5053

Sat Duhra

Fund Manager

Henderson Far East Income Limited

Telephone: +658 388 3175

Dan Howe

Head of Investment Trusts

Janus Henderson Investors

Telephone: 020 7818 4458

Harriet Hall

PR Manager

Janus Henderson Investors

Telephone: 020 7818 2919

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

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