HFL – Financial results for year ended 31 August 2023

LEGAL ENTITY IDENTIFIER: 2138008DIQREOD38O596 HENDERSON FAR EAST INCOME LIMITED Financial results for the year ended 31 August 2023 This announcement contains regulated information 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. PLEASE SEE THE PDF FOR THE FULL RESULTS CHAIRMAN'S STATEMENT Introduction 2023 has been a very difficult year for investors with rapidly increasing interest rates shifting expectations dramatically and undermining what many hoped would be a strong post-Covid recovery period in the Asia Pacific region. This was not to be. Instead, we have faced geopolitical shocks, ongoing supply chain disruptions and new juxtapositions in market behaviour. Against this backdrop, our investment results are easier to understand, however disappointing they may be. Performance Whilst the Company has once again achieved our high income objective, the investment performance from a capital growth perspective over the past financial year has been unsatisfactory. The NAV total return performance for the period ended 31 August 2023 was -13.0%, versus the FTSE All-World Asia Pacific ex Japan Index of - 7.2% and MSCI All Country Asia Pacific ex Japan High Dividend Yield Index of 0.1%. The year-end dividend yield of 11.1% was not enough to compensate for a falling share price, with the share price total return standing at -14.8% for the period. Since the year-end, investment performance has deteriorated further and this represents a three-year period of underperformance, where capital returns have suffered when compared to both market indices and many of our competitors. Against this backdrop, the Board has looked often and hard at the reasons for these results and I will use this opportunity to present both an analysis of the factors which shaped this outcome and an outline of what your Company is doing to address them. What happened? ? Investment styles go through periods of being both in and out of fashion. In the low interest rate environment, valuation tended to matter less, and our Fund Managers valuation-focused investment style has therefore been out of favour. ? China weightings, China stock selection and the timing of our exposure to this important economy and market have been the most significant contributing factors. Since the lifting of Covid restrictions, the pace of China's recovery fell short of expectations and the negative impact of global supply chain shifts on how Chinese companies would prosper has been more severe. An over allocation to China was exacerbated by our exposure to Hong Kong which has increasingly moved in lockstep with the mainland over the Covid period and beyond. ? The low combined weighting in India, Japan and Taiwan in our portfolio has also had a negative influence. Our strong income bias has historically justified this absence but these markets have performed strongly over the period. ? Our overweight exposures to the energy and materials sectors, the latter including investments in copper and lithium which will be in demand to meet 'green' targets, have been held back by questions about the rate of economic recovery. Our Fund Managers' report expands on all these points in further detail and outlines their forward thinking alongside the current positioning of the portfolio. Strategy Working closely with the investment manager, your Board holds a formal review of the Company's investment strategy at least annually. This year we have spent a substantial amount of extra time outside of formal board meetings considering this matter - the impact of that strategy on performance and its appropriateness both over the long term and in the current market conditions. We also focused on the yield of the portfolio, projections for dividends from the Asia Pacific region, and our investment prospects for the portfolio and the region in general. In light of this re-examination, several points can be made: First, that our strategy to provide an attractive, growing dividend without giving up the potential for a degree of long-term capital growth remains both appropriate and achievable. As we have in the past, we aim to achieve this objective by identifying a combination of companies with high and sustainable cash flow generation and dividends, and those achieving growth that are predicted to be the high yielding companies of the future. As dividend growth in the region slowly returns to its historic trend next year, we believe that prospects for the future will be much improved. Second, while we believe our broader strategy remains correct, we have sought to refine the process used to achieve our objectives. Given our income focus, income returns from stocks has been significantly undermined by the strength of sterling, especially over the last year. Our Fund Managers had sought to enhance income and offset sterling strength through portfolio rebalancing but this had a negative impact on capital growth. Our analysis has now led us to revise the way in which we capture dividends, an approach that has too often led to diminished capital growth. We have now largely restructured the portfolio to allow the renewed growth in portfolio company dividends to come through along with better capital growth returns. Through this transition period, we will use our distributable reserves to supplement your Company's dividend. In addition to maintaining a progressive dividend, re-establishing the Company's long-term record of capital growth will be a critical factor in restoring shareholder confidence. The Fund Managers' report will comment on this in more detail. Third, strong sentiment around China's reopening prospects in the fourth quarter of 2022 reinforced our long-term investment case for the market and supported a significant position. While the economic power and potential of many Chinese sectors remains compelling, macroeconomic influences have ultimately overwhelmed some robust fundamentals, with broader market sentiment now muted on the market. Further, there is increasing homogeneity between the markets of Hong Kong and China. With this in mind, and with the dividend culture in other markets including India improving rapidly, we are broadening our scope to include more companies from elsewhere in the region. We have worked closely with our Fund Managers to address our capital performance challenges and devise an effective path forward. As part of this process, we have agreed that now is the right time to pass the fund management leadership role to Sat Duhra. The Board has full confidence in Sat's ability to manage the portfolio going forward, and he has been part of a long-standing succession plan having been co-manager since 2019. Mike Kerley will be retiring from the asset management industry in June 2024 and will support Sat to ensure a smooth transition process. Mike has played a critical role in the Company's historical development and the Board would like to thank him for his many contributions over the years and wish him well in all his future endeavours. We believe it is in the best interests of all shareholders to support these changes while benefitting from a revised investment implementation approach. The Board remains committed to its historic progressive dividend policy together with capital growth and we will continue to monitor performance closely, taking additional action if we believe our revised implementation approach is not improving investment returns as we expect. Dividend The Board has again increased its dividend to shareholders, marking 16 consecutive years of uninterrupted dividend progress. A total dividend of 24.20p has been paid in respect of the year ended 31 August 2023, representing a 1.7% increase on the dividend paid last year. In keeping with the outcome of our discussions on strategy and implementation, we have opted to augment our fourth interim dividend using the Company's substantial reserves. We have therefore covered ?5.7m of the dividend from distributable reserves. Doing so enables our Fund Managers to better position the portfolio, with scope to invest in a greater number of companies with higher growth characteristics. Board refreshment I was pleased to announce the appointment of two new directors on 19 September 2023. Susie Rippingall and Carole Ferguson will join as members of the Board with effect from 1 December 2023. Both are outstanding investment professionals with strong backgrounds in areas that will enhance your Board's future decision-making while giving us a better overall balance. Susie is an investment professional with more than 25 years of fund management experience in Asian markets. Carole has extensive experience in the financial services sector in research, finance and sustainability. We believe both will contribute meaningfully to our discussions and bring new perspectives. Indeed, they have already made important contributions to our discussions of strategy and implementation. We invite shareholders to join us at the next annual general meeting to meet Susie and Carole, along with the rest of the Board. Both will offer themselves to shareholders for election. Having successfully completed this recruitment process, David Mashiter will be retiring at the conclusion of the forthcoming annual general meeting. I would very much like to thank David for his many years' service to the Company, his thorough and thoughtful contemplation of the matters for discussion in and out of Board meetings, as well as his robust, but always courteous, challenge to all of us. His views will be missed. AGM The Company's 17th Annual General Meeting is due to be held at 12.00 pm am on 24 January 2024 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 this annual report and I encourage all shareholders to submit their votes to the registrar or their share dealing platform accordingly. The Fund Managers will provide their usual update on the Company's performance and their outlook for the region. They and all directors will be available to answer any questions you may have. Recent results & outlook While the underlying business performance of our portfolio holdings has been much as expected, their stock prices have not generally reflected these gains. Since our financial year-end in August, our high exposure to Greater China has been an unhappy experience, reflecting a far less robust rate of recovery than we earlier expected. Some new holdings have benefitted results but not enough to offset the damage from elsewhere. As I have noted above, we are in the process of making changes that we believe will lead to improved results over the balance of the year and beyond. The economic fundamentals of the Asia Pacific region remain attractive and will look increasingly so when compared to the slowing performance of western markets. As our portfolio re-captures its capital growth and with our commitment to the Company's progressive dividend policy, we look forward to reporting more satisfactory results in the future. Our focus and commitment are determined and unwavering. The opportunities are still very much evident and at more attractive valuations than we have seen in many years. The Fund Managers' report that follows will give you a more detailed discussion of both past events and future expectations. I believe it underscores many good reasons for optimism about the future. Ronald Gould Chairman 29 November 2023 FUND MANAGERS' REPORT The period under review was dominated by global inflationary pressures, conjecture on the path of interest rates and the war in Ukraine amongst other factors. The scars of the Covid-19 pandemic continued to be uncovered as evidenced by the magnitude of the shock to supply chains, which was unanticipated by investors and contributed to the initial rise in inflation data. However, it was manner of the response to Covid-19 in China and the subsequent weak recovery once restrictions had been lifted that produced the greatest impact on our performance. We had expected to capitalise on a strong recovery in China once the economy re-opened after a period of strictly enforced restrictions, however, this failed to materialise and our China consumer holdings suffered as a result. In addition to that, a steady flow of negative macroeconomic data, property sector defaults and concerning levels of leverage at local governments impacted sentiment towards our other holdings in the country. Our performance in China in recent years has been unsatisfactory and we are in the process of re-positioning this part of our portfolio towards higher quality growth names, which are now attractive on valuation, and come with a genuine domestic advantage and growing dividends. Our investment style aims to take advantage of market mis-pricings where we believe the Net Present Value of future cashflows is not reflected in the current share price. However, this style has been distinctly out of favour in recent times as demonstrated by the outperformance of growth over value in most markets. Despite interest rates rising and therefore the cost of capital increasing in equity valuations, the emergence of themes such as Artificial Intelligence ('AI') have supported the thesis of higher growth into the future boosting the valuation of many expensive stocks. We expect this to reverse as rates remain higher for longer, pressuring the high valuation of many growth names. However, this may not transpire to the same degree in China where value names are more intrinsically tied to the fortunes of the economy versus underlying operational trends given that much of the high dividend universe are State Owned Enterprises ('SOEs'). The structural issues faced by China, amplified by the collapse of the heavily indebted China Evergrande Group and subsequent defaults, combined with the collapse in property volumes and the ensuing impact on local government fiscal positions, have dampened our enthusiasm for high yield value names in China. We have begun the process of adding more attractive growth and yield names in other markets such as Indonesia and India where there is less regulatory risk and a much clearer path to growth without the structural impediments currently faced by China. Notwithstanding this we expect to continue uncovering opportunities in China, especially at the current depressed valuations. More generally the rapid rise in interest rates has, unsurprisingly, created problems most notably in the regional banks in the US and the UK pension industry where the belief that interest rates would remain low indefinitely, were brutally exposed by the dramatic central bank moves. Consumer spending has slowed but remained more resilient than many expected as savings accumulated during the pandemic have offset the higher cost of food, energy and mortgages. This, though, has probably delayed the economic slowdown rather than postponed it. The World Bank expects global growth to be 2.4% in 2024 with the contribution from developed economies only 1.2%. The US is expected to grow by 0.8% and the EU, by 1.3%. All recent revisions have seen 2023 adjusted upwards and 2024 downwards, reflecting the lagging nature of this cycle's monetary tightening. The inflationary impact in Asia has been less pronounced. Most countries in the region did not receive the same fiscal support as the western world during the pandemic and, as a result, excess liquidity did not push up asset prices and wages in the same way as elsewhere. Labour shortages and supply disruptions were also less pronounced. As a result, the rise in inflation was caused mostly by rising food and energy prices and, as these have fallen, central banks in the region have started to ease rates. In short, Asian economies have had to raise rates less than their western peers and will be reducing them sooner. However, there are exceptions. Australia, New Zealand and Japan are three as they share greater similarities with advanced economies, compared to developing Asia. Despite superior fundamentals, the performance of the region has been disappointing with Asian markets significantly lagging the 5.3% positive return from the S&P 500 and 7.9% return from the FTSE 100 over the Company's financial year. The weakness of China is partly to blame, but the strength of the US dollar and a tightening of liquidity from higher interest rates has prompted flows away from equities as there are now attractive returns to be achieved on cash and lower risk bonds. The other phenomenon that has distracted growth investors is the rise to prominence of AI. A large proportion of positive returns, especially in 2023, have been derived in this area as borne out by the strong performance of the 'Big 7' US technology stocks (Microsoft, Apple, Google, Meta, Amazon, Nvidia and Tesla) compared to the rest of the market. Although Asia has some beneficiaries of this trend, most notably in Korea and Taiwan, the region as a whole could be seen as a net loser from AI as funds flow to more attractive, if less quantifiable, growth alternatives. China was the weakest market in the region, although it rallied over 40% in local currency terms following the removal of the Covid restrictions at the end of October 2022. It has subsequently fallen almost 15% by the end of August. Although there are clearly headwinds associated with slower global trade and US sanctions/ geo-political risk, a number of problems within the China economy are self-imposed. The clampdown on the property and education sectors, in a valiant attempt to address wealth inequality, together with regulatory probes on private enterprises in the technology sector, have sapped confidence. After being locked-down for almost three years during the pandemic, while their largest asset (property) decreased in value, the Chinese consumer is reluctant to spend and, unlike their counterparts in the west, have continued to save. The Chinese government has begun introducing various measures to stimulate demand and to shore-up the finances of property developers, local governments and households. All the while cutting interest rates and bank reserve requirements to ensure the system is sufficiently liquid. As yet, there are no meaningful improvements. Having said that, the industrial production, manufacturing PMI (purchasing managers index) and industrial profits data in September suggest a mild improvement while anecdotal evidence of travel expenditure and consumer trends during the Golden Week holiday at the beginning of October, are somewhat encouraging. In local currency terms, the FTSE All-World Asia Pacific ex Japan Index rose 3.0%. However, with sterling appreciating 10.2% over the period this translated into a total return performance of -7.2%, impacting returns for the UK based investor. The best performing market in local currency terms was Taiwan, where the AI beneficiaries, mostly in the server and data centre arena, were particularly strong. The weakness of the Taiwan dollar though resulted in a small negative return in sterling terms leaving Singapore as the only country in the region to post a positive return in sterling terms, mainly due to currency resilience. China and Hong Kong were the worst performing countries, while basic materials, technology and financials headed the sector list. Performance The Company's NAV total return was -13.0% over the period while the share price total return was -14.8%, as the share price moved to a small discount at the financial year-end. For comparison purposes the FTSE All-World Asia Pacific ex Japan index was -7.2% while the MSCI Asia Pacific ex Japan High Dividend Yield Index for the same period was 0.1%. Without doubt, it has been a disappointing period for the Company's capital performance. Although the high level of yield has partly impacted capital returns, a far greater proportion of underperformance can be attributed to stock selection and country allocation, especially through the Covid period, but also more recently in calendar year 2023. We have highlighted below the key areas impacting performance and our assumptions that prompted this positioning. At the start of 2023, we expected three events to dictate market performance. Firstly, we expected China to stage a broad-based recovery from Covid with the consumer leading the way as excess savings accumulated through the pandemic would be spent. Secondly, we expected slower global growth, especially in developed markets, would lead to lower demand for technology products such as personal computers, laptops and smartphones as consumers felt the squeeze from higher living costs. As a result, we avoided Taiwanese contract manufacturers and hence were under-represented relative to the index and peers when the AI theme took hold. Finally, we believed that materials and energy, and especially green transition materials, would be resilient, partly because of a recovery in China and emerging markets, but more importantly because of a lack of supply and new avenues of growth, namely electric vehicles and grid upgrades. The biggest positive contributions over the period were Bank Mandiri in Indonesia, Lenovo and Samsonite in China and Hong Kong, NTPC in India and Goodman Group in Australia. Detractors from performance were predominantly China based consumer discretionary stocks; JD.com (e-commerce) and Li Ning (sports goods) fell over 50%, while China Yongda (passenger vehicles) over 40%, China buildings material company CNBM also fell over 50% while Digital Telecommunications in Thailand fell more than 30%. Revenue Dividend income from companies held in the portfolio fell 8.2% and income from options was flat compared to last year. The fall in revenue was partly due to the strength of sterling, but also from the lower levels of distribution from energy and materials companies as the price of oil and industrial metals declined. In sterling terms, the level of dividend growth in Asia in recent years has been below our expectations. The volatility in sterling in recent years has had a significant impact given that dividend growth in local currencies has been positive in the last decade with the exception of 2020. The ability of corporates in the Asia Pacific region to pay dividends is certainly not in question with record levels of cash held on balance sheets and one of the lowest net debt to equity ratios globally. It is the unwillingness of corporates to increase dividends in periods of elevated global volatility that has contributed to a recent lack of meaningful growth in dividends. In addition, we had an elevated contribution from materials and energy holdings last year, amounting to approximately 31% of our total income. The subsequent weakness in commodities led to a marked reduction in dividends from this sector. However, we expect that Asia will return to a growth profile in line with historical trends and nominal Gross Domestic Product, but in the meantime the Company intends to utilise distributable reserves to meet its objective of a progressive dividend policy. Strategy The Board has reaffirmed its commitment to the dividend and has made it clear that utilising distributable reserves is preferable to chasing yield at the expense of capital growth. This will allow greater exposure to compelling capital growth opportunities where absolute dividend per share is growing but the current dividend yield is yet relatively low. This has also contributed to the lower portfolio turnover this year relative to the last financial year as genuine structural dividend growth opportunities were balanced with high sustainable yield names. Whilst a number of growth opportunities in markets where we have been underweight in recent years such as India, Indonesia and Taiwan have already performed well, there are still significant opportunities in the years ahead. The nascent improvement in Indian and Indonesian macro-economics has the potential for a long pathway of growth, the resilience of the Indian rupee and Indonesian rupiah versus the US dollar this year is a testament to improved sentiment. Indonesia has begun posting a current account surplus, growth is strong and the country is set to reap the benefits of significant infrastructure completion. India is seeing the benefit of earlier reforms such as the Bankruptcy Code, which has helped to de-risk the banking system speeding up recovery of bad debts. In addition, corporates are deleveraging, real estate asset prices are rising and the uptick in private sector capital expenditure alongside higher government investment, bodes well for the outlook. Investments in India have already appeared in our top contributors list for the period despite the current low positioning. We have added to both markets and observe more opportunities. At the overall portfolio level, we retain a balance between stable high yielding companies and those with strong cash flow and dividend growth. The weakness in share prices and resilient earnings have seen Asian companies de-rate to valuation levels that are attractive relative to their own history and to other markets. This applies both to high yielding and dividend growth companies, allowing for plenty of opportunity to accumulate propositions at attractive valuations. In previous years some of the best regional and global themes have been outside the remit of a value-based investment process due to elevated valuations. Recent underperformance has made some of these areas much more attractive and the portfolio now has exposure to Chinese e-commerce, Indian renewable energy, consumption in Indonesia and China as well as mining companies that provide the raw materials for the transition to electric vehicles and clean energy. An example of the opportunities available is Samsonite, the global luggage brand, which we have just added to the portfolio. The Hong Kong listed company is experiencing a strong demand recovery following Covid, but the shares have languished relative to peers with earnings upgrades outstripping share price performance. As a result, the stock is trading at 11x forward earnings despite having 20% earnings growth forecast for the next few years and dividend yield which is forecast to go from zero to 6% within three years. At the country level, our highest weighting at the year-end was in China at 19.7%, the companies we own have exposure to consumption, insurance, wealth management, electricity grid upgrades, technology and an improvement in infrastructure spending. We do not have any exposure to property developers or banks. Our exposure in Australia is predominantly in mining companies as we have a cautious outlook on the domestic economy. In India, the power sector is dominated by state owned companies, but following the push to transition to cleaner energy, opportunities have arisen for some of these companies to embrace this new area of growth. We own NTPC and Power Grid which provide exposure to this theme at a significant valuation discount to the market and bring with them an attractive dividend yield. We have also added HDFC Bank which provides us with exposure to domestic credit and mortgage growth at half the valuations it once traded at following a degree of uncertainty following a merger with its finance arm. ESG Environmental, social and governance ('ESG') concerns are an important 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. 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 these companies will take market share away from the those which don't commit to change 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 are focused on re-establishing the capital performance of the Company alongside our long- standing income mandate and whilst the headlines around China, some fair and some unfair, have dominated news flows, this has masked the strong performance in several of our other markets. The strength of a number of themes which are unique to our region and are yet to fully play out, creates an exciting time for investors. We are witnessing the build-out of green infrastructure, strong consumption trends, technology supply chains supporting global innovation and financial inclusion as household wealth increases, amongst others. Asian markets have, however, struggled over the last five years and are now at attractive valuations relative to other regions. Record low interest rates and supportive fiscal policies have encouraged money flows into alternative risk assets such as housing, private equity, special purpose acquisition companies and crypto currency, to name a few, at the expense of Asia and Emerging Markets. The return of inflation and higher interest rates has called into question some of these investment destinations and should lead to a focus on fundamentals now that the cost of capital is well above zero. There are, though, some headwinds. Higher for longer interest rates in the US will most likely lead to a stronger US dollar, which historically has been a challenge for Asia, and the relationship between the US and China around Taiwan and access to technology continues to have the potential to escalate. There is also considerable risk in China with local governments facing significant bond maturities this year and property volumes still weak. We believe that the Chinese government still has the monetary and fiscal tools to address these issues, but it is sure to be a bumpy ride. In light of this, we have reduced the Company's exposure to China notably since the financial year-end. New positions have been initiated in high quality dividend growth names in other markets where the macro-economics are tailwinds rather than headwinds. We do not anticipate these changes to impact the level of income the portfolio will generate. As the developed world slows over the next couple years, the growth differentials between Asia Pacific and the US, EU and UK will look increasingly attractive, which we believe will prompt positive flows to the region and be supportive of equity market returns. Mike Kerley and Sat Duhra Fund Managers 29 November 2023 Please refer to the PDF to view the full announcement For further information contact: Sat Duhra Fund Manager Henderson Far East Income Limited Telephone: +658 388 3175 Mike Kerley Fund Manager Henderson Far East Income Limited Telephone: 020 7818 5053 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. End CA:00422739 For:HFL Type:FLLYR Time:2023-12-01 08:30:08