Integral Capital Pte Ltd is a Singapore-based independent boutique fund management company. It is founded and wholly owned by its three principals, who have approximately 60 years of combined Asian investing experience. The firm operates as a Registered Fund Management Company (RFMC) under the Securities and Futures (Licensing and Conduct of Business) Regulations [SFR] in Singapore. Integral Capital specialises in the equity markets in the Asia Pacific region, and currently is the manager of the Integral Asia Value Fund.
The Integral Asia Value Fund was set up as a long only fund as opposed to a hedge fund. What were some of the key motivations behind this decision especially given the vulnerability of long only funds to market downturns?
Our decision to focus on a long only approach reflects the partners’ backgrounds and expertise which stretches back some 20 years each and has predominantly been in the long only space. This approach allows us to focus on the fundamentals of the companies more than trying to predict short-term market swings. Rather than being feared, experience has taught us that market downturns presents opportunities to longer term investors. The partners each have more than 20 years of investing experience, and have been through a few market cycles including the 1997 Asian crisis and the 2008 global financial crisis.
We believe that we should recognise and minimise our weaknesses and play to our strengths. Yes, we also recognise that a long only approach may have more short term volatility, but we do believe that if one makes investments with a sufficient margin of safety, then one can still achieve a good risk adjusted return in the long term. A margin of safety basically reduces one’s downside risk during both good and bad environments while giving us a higher probability of a decent return should the negative factors that weighed on the stock dissipate. This is the core of value investing, and is not unique to us. What’s difficult is that this contrarian approach requires tremendous discipline and a temperament that requires at times one to go against the herd.
The Integral Asia Value Fund is up 42.8% while the reference index MSCI AC Asia ex Japan is up 8.0% since inception date of March 2012, and has delivered excellent double-digit returns of 30.0% in 2013, while the reference index was up 3.3%. What internal factors would you attribute this success to? Does it all come down to your unique stock selection methodology?
Well, beyond skill and hard work which is fundamental, a little bit of luck in this business helps! For the bulk of it, we would say, yes it’s from stock picking. We place a lot of emphasis on finding stock ideas at a significant discount to intrinsic value; and are not concerned on whether it is in the benchmark index or if it is well-liked by other investors. We believe a wide margin of safety reduces our downside in bear markets, but gives us a decent return when negative factors that have weighed on the stock dissipate. This is the value approach and is not unique to us. What we as investment professionals try our best to do is to have a temperament that allows us to be contrarian and the patience to stay the course. We also run a concentrated portfolio of 25 - 35 high conviction ideas, and thus each position in the portfolio can make a difference if it delivers results.
Can you share with us some of your main winning and losing themes since last year vis-a-vis region and sector? Which underlying sectors seem most promising to you and which will you be cautious towards?
We don’t invest as such in fashionable themes, but really focus on the underlying potential of each company we invest in. Our top contributor in 2013 was APT Satellite, a Chinese satellite operator listed in Hong Kong. When we first looked at the stock in late 2012, it was on an attractive P/B of 0.4x and a P/E ratio of 6x current earnings. The investment community had largely ignored it for years as it had a weak operating record, and you could not even find a two page research report on the company. But if one looked at their annual reports and the transcripts of their conference calls, it dawned upon us that things were likely to get better - the management were optimistic about taking back their satellite APStar 2R with its customers and the launch of its replacement satellite APStar 7. The stock re-rated sharply in early 2013 when the profitability of APStar 7 came through.
Among our other large holdings, and another strong contributor was Dah Sing Bank which fell to 0.5x price-book when the Hong Kong banks were de-rated as interest margins became compressed. We took a more optimistic view, sensing that the emergence of the offshore RMB would be a game-changer for them. When another small Hong Kong Bank became an M&A target, the mid-size Hong Kong banks rebounded quickly from their lows – Dah Sing among them.
It is hard to predict the future and which sectors will do better or worse, so we focus our energies on the portfolio companies’ prospects. We buy sustainably well-positioned businesses whose downside we believe we have a handle on. If we see stocks where the downside risk can't be ascertained, we rather avoid them. Also, we avoid highly leveraged companies as there can be situations where the downside could be significant in the event of a crisis.
Integral Capital invests with a ‘medium to long-term horizon with a fundamental approach’. In today’s financial markets which are driven by news flow, how often do you find yourself re-calibrating your investment decisions in response to short-term trend reversals in the markets?
Not often. When we make the investment it is with a long term view, so we avoid reacting on short term news flow. Assuming it makes the grade of being at a significant discount to intrinsic value, each idea is tested against different adverse scenarios whether it be rising interest rates, slowing growth or tighter liquidity conditions. The business must have the resiliency to go through the tough times. We review our investment assumptions regularly, and if we believe we have erred in our initial assessment, we will take corrective action. Otherwise, our view is that one has to be patient in investing to achieve superior returns. As Benjamin Graham succinctly put it: "Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies." We share that view.
How has the recent flight of capital from emerging economies in Asia impacted your fund’s performance? Do you foresee Integral Capital diversifying beyond Asia to limit its regional exposure?
Well, the emerging markets did see a major correction when the US Federal reserve first announced the tapering plans to their US$85 billion bond buyback program. In the market correction that ensued, we saw opportunities to add on to our positions in some cases, as well as initiate positions in new ideas as their prices got to attractive levels. The focus for the Integral Asia Value Fund will remain the Asian equity markets, where the partners’ competence lies.
The Eurekahedge Japan Hedge Fund Index has delivered stellar performance so far in 2013, and is up 26.77% year-to-date. Does Integral Capital have exposure to the underlying Japanese markets? Can you share with us your views on Abenomics and your expectations regarding its impact on the Japanese markets and economy?
Regarding Japan, it seems after a long period of deflation, Japan has taken the first bold steps towards re-igniting the economy. Abenomics is a significant change for Japan and if successful will be hugely positive for Japan and the Asian region. The main challenge will be Prime Minister Abe’s ability to push ahead and sustain the reform agenda. We do have the flexibility that allows the fund to buy stocks in Japan, but in reality the fund has been managed with an Asia ex-Japan focus. We have not invested in any stocks in Japan since the fund’s launch, but may do so if an opportunity that meets our criteria emerges.
It seems that the primary focus of your investment philosophy is on the company/industry fundamentals. How does this approach guard towards market downturns arising from macroeconomic shocks to the system? Case in point would be the 5.37% decline in the Integral Asia Value Fund in June 2013.
The reality is that it is tough to forecast short-term market gyrations, but we believe that the focus on capital preservation by buying stocks at a significant discount to intrinsic value, provides sufficient margin of safety to minimize against the permanent loss of capital for the portfolio in the longer term.
Could you tell us about the risk management tools you have deployed that help you safeguard your fund’s investments? How have these changed over the last few months as emerging market currencies declined in value?
We did not effectuate any hedges on currencies in the portfolio. We manage this risk more by understanding the risk to the underlying companies of this sort of currency movements, and if there would be any significant stresses on them. None of the companies in the portfolio have large asset-liability mismatches that alarm us. On the positive side, some have a large USD revenue base but with a domestic cost base, which would make them net beneficiaries of a weaker domestic currency.
What classes of investors (fund of hedge funds, high net worth clients, institutions, etc.) is your fund targeted towards? And, what are the types of investors that have shown interest in your fund so far?
The fund targets accredited investors, who may be from any of the above classifications, but most importantly looks to attract long term investors who are prepared to take the short term volatility for better long term risk adjusted returns. We have seen interest from high net worth clients, as well as more inquiries from family offices and institutions from abroad.
How has your fund fared so far in terms of net asset inflows? What challenges do ‘sapling funds’ face with regards to attracting capital?
It is still early days, but we have been fortunate in seeing some inflows despite the relative short track record of the fund. The global environment after the GFC remains tough, and with new regulatory and tax hurdles like FATCA (US) and AIFMD (Europe), it appears that the bar has risen for smaller firms. The key challenge for smaller funds would be demonstrating a consistent investment approach and a steady track record in an environment that remains somewhat volatile.
Could you give us your medium-term outlook for the Asian equity markets? Furthermore, do you foresee any movements in the market, in the near term that might work in your favour?
As long term value investors, we do not spend much time trying to predict where markets will go form here. What we focus on is the prospects and the valuations of the companies in the portfolio. While we acknowledge that the global economy remains fragile, we are comfortable with the current shape of the portfolio. The valuations remain inexpensive, and the balance sheet of the companies in the portfolio on a weighted basis are in a net cash position, so we expect they will be able to withstand any unexpected stresses in the event of a financial crisis.