Pacific Assets Trust: thoughts from the portfolio managers

Plenty of new investment ideas

Current investment emotions are mixed. We are generating a significant number of new investment ideas for Pacific Assets Trust plc (‘the Trust’). We have bought 14 new companies in the past six months, including four from China, two from the Philippines and four from India1. This is unlike us. Our turnover2 is usually low. And it’s becoming much harder to find room in the Trust - perhaps as hard as it’s ever been - as we are reluctant to let go of any of our existing holdings. We find this is usually a good sign that strong, absolute returns are just ahead!

But significant lagging of the index due to low China weighting

However, recent performance of the Trust is a long way behind the index. While there are always many reasons for lagging performance, the simplest and most important explanation is the exceptionally strong recent bounce in China from oversold levels and the healthy correction of Indian share prices from elevated levels. The MSCI China Index is up +18% year-to-date, while the MSCI India Index is down-10% year-to-date3. Over the last 6 months to 15 March 2025, MSCI China is up +40% and MSCI India is down -16%4. A 56% performance differential. While we generate plenty of ideas in China, we currently have a much bigger weighting in India, although this is slowly changing as our confidence in new Chinese companies grows and the corporate backdrop there becomes clearer.

China weighting is growing slowly but steadily

Our China weighting in the Trust continues to grow for three main reasons. First, our universe of quality China ideas is expanding as companies navigate more difficult economic times, often for the first time in their corporate histories. This has allowed us to take a hard look at the resilience of many Chinese businesses, their basic attitude to risk and mindset of their management teams and owners. While many Chinese franchises have struggled, cut corners and diminished, a decent number have come through the other side much stronger and better positioned for growth. Second, Chinese company valuations5 have become much more attractive. This has allowed us better buying points into companies we have been waiting for on the sidelines. Third, and perhaps most importantly, the changing political landscape and US Government policy has brought increasing clarity to the new Chinese approach to shareholder interests.

China requires four rather than three golden rules

We have four golden rules when investing in China, compared with our normal three. First, the company must meet our quality requirements of management, franchise and financials. A growing number of listed Chinese companies are meeting these requirements. Second, they must be well positioned to contribute to China’s sustainable development6. On this, we are particularly well aligned with the Chinese Government in almost all aspects of sustainable development. Sustainability talk is cheap, but very few countries have walked the walk as purposefully or far as China in terms of reorientating development toward a genuine sustainable path. Human rights risk is the clear and present exception and challenge that we continue to try and navigate with an approach based on individual companies. Third, valuations must be attractive. The prolonged sell-off in Chinese assets has brought many companies back to attractive levels. We believe despite the recent bounce-from-the-bottom, valuations are still reasonable, particularly when factoring in a recovery in earnings.

Our fourth “China-specific” golden rule is the need to form a view on the Chinese Government’s “allowable return” for a particular company. This tries to capture the idea that in China, returns can erode not just with new capital and competition entering a market, but with a change of strategic view by the Chinese Government. In other words, all Chinese companies are actively regulated by the Chinese Government, whether they sell soy sauce, build toll roads or connect small businesses with consumers via online shopping platforms. Over the past decade or so, the Chinese Government appears to have taken a much more proactive approach to allowable return, built on their goals and ambitions. Great companies are not just tolerated by Beijing but embraced and encouraged as part of the development solution, but excess returns are only acceptable to facilitate national development. In order to earn extended supernormal returns in China, not only must companies have sound business fundamentals,  they must also be operating in the “build-out” phase of industries of national importance, as decided by the government. The Chinese Government has been notably transparent in spelling out just what these industries are, with clear long-term development plans reaching out to 2035 and beyond.

Allowable Returns as a development model

Investing in a world of “allowable” or “capped” returns comes with challenges of its own and we are still learning. Long-term sustainable development alignment is a critical first step, but looking through a “toll-road” lens is also helpful. By this we mean, so long as new roads need to be built, toll-road companies are usually allowed to generate attractive returns well in excess of their cost of capital7 in order to reinvest in new roads. This cycle usually comes to an abrupt end once the last roadbuilding project is in sight. We are trying to apply this lens not just to our Chinese companies but more broadly. Where China leads, other countries often follow.