We see plenty of reasons for investors to be positive on the outlook for Asian equities in 2022 now that peak coronavirus appears to have passed and the region's economies are reopening.

Progress in the roll-out of vaccinations allied to improved anti-viral treatments point to a policy transition from zero-Covid tolerance to one of endemic coronavirus management.

We anticipate further easing of mobility restrictions and a resumption in travel. We also expect Asian exports to pick up as demand grows in the US and Europe. This promises to drive consumption and corporate earnings.

A key question globally concerns how transitory inflation really is, and we don't have a crystal ball. But unlike Western markets, we haven't seen much price pressure in Asia so far.

Investors should feel reassured that Asian central banks have more headroom to adjust monetary settings, having been more conservative with state policy tools in recent years.

The Bank of Korea has signalled a potential rate hike soon, but Asian policymakers on the whole continue to prioritise economic support. Asian balance sheets are also in a healthy state, with most of our holdings either meeting or exceeding earnings expectations in recent results.

Economic reopening will help to mitigate inflationary pressures tied to near-term bottlenecks in supply chains. This remains an area we will continue to monitor closely. We urge investors to diversify across markets and sectors and focus on firms with pricing power that can pass on cost pressures to protect their margins. We see many quality businesses doing exactly that.

While Asia experienced an equity market rally in the first half of this year, a regulatory reset in China and the prospect of US tapering led to a correction. Still, corporate Asia is well placed to withstand a cycle of a stronger dollar overall.

We expect China's property sector to remain under pressure, while China's zero-Covid policy approach is likely to stay in place until after it has hosted the winter Olympics at least. Regulatory intervention will likely be at the forefront of investor thinking in the run-up to the Party Congress in November, when President Xi Jinping is expected to secure a third term.

Again, investors can rest assured that Beijing has levers to pull in the event that economic conditions become less stable. Bear in mind, much of China's growth slowdown is self-imposed via restrictions in property and energy sectors and the common prosperity push.

Investors can find quality Chinese businesses on the right side of the policy agenda delivering strong growth.

Investors need to be selective. But look carefully and they can find quality Chinese businesses on the right side of the policy agenda delivering strong growth. Structural drivers behind consumer spending in China remain intact. We predict that rising disposable incomes and increasingly health-conscious citizens will drive demand for healthcare products and services.

Growth in domestic consumption remains a strategic priority for Chinese authorities, so we view quality consumer stocks as well placed to withstand regulatory headwinds.

We believe Southeast Asia will be the biggest beneficiary of economic reopening. Hit hard by Covid, Indonesia and Vietnam are just emerging from the pandemic. They're working through supply-chain indigestion, with cyclical stocks long overdue a meaningful rebound.

India's stock market has been taking a breather of late, having rallied hard this year. But we're confident there's plenty of market upside to come given favourable demographics, low mortgage rates, rising household incomes and improving housing affordability.

After years of subdued economic growth, India looks primed for a rebound that should feed through to earnings. A brightening picture is boosting sentiment and company spending plans.

There's also excitement around India's tech sector. The nation has produced 100 unicorns and counting.¹ Many are listing on exchange, transforming the corporate landscape. Our team has been wading through stacks of IPO information to cherry-pick likely winners.

Foreign direct investment continues to flow into the tech sector. As these businesses grow and harness new technologies, they will invest - creating jobs and lifting incomes. Consumers will also benefit from better products and services.

India's government, too, is reforming the business environment, attracting foreign investment, incentivising companies via tax benefits and raising spending on key infrastructure projects. We expect a broadening of India's entire tech ecosystem, driving more growth in digitisation.

In terms of valuations, Asian stocks look reasonable relative to developed markets. The 12-month forward price-earnings ratio for MSCI AC Asia Pacific ex-Japan Index stands at 15.6x, versus 22.5x for S&P500, 16.2x for MSCI Europe and 20.3x for MSCI World.² Consensus earnings growth for Asia Pacific ex-Japan markets forecast to be in double digits for 2022.

We believe Asia's burgeoning middle class will fuel rising demand for health-care services and wealth management, while the region's urbanisation and infrastructure needs remain vast. At the same time, changes brought about by the pandemic could prove durable and reinforce existing trends - such as increased adoption of cloud computing and 5G networks.

Policymakers globally are also committing to a lower-carbon future and Asia is at the forefront of change. Investors can anticipate tailwinds for companies operating in renewable energy, batteries, electric vehicles, related infrastructure and environmental management.

As an investor we focus on quality firms with strong balance sheets and sustainable earnings prospects best-placed to capitalise on structural growth opportunities in the region. We see market corrections as an opportunity to add to our long-term quality holdings affordably.

In Asia, investors need to think long term. But Asia's attractions remain as bright as ever.

¹ Credit Suisse Equity Research, March 2021     ² Bloomberg, 18 November 2021

Author: James Thom, Senior Investment Director, Asian equities

Despite the world speeding along on the road to electrification, we think the humble petrol station will still be needed for some years to come, particularly here in Australia. Which is why the Montgomery Small Companies Fund has invested in both Waypoint REIT (ASX:WPR), and mining companies producing the lithium that goes into electric vehicles batteries.

Throughout the year, we have written about the once-in-a-generation shift from the internal combustion engines to electric power trains.

And we're delighted you've been paying attention. Indeed, some investors have gone further, noting our enthusiasm for electric vehicles (EVs) and lithium demand, and querying our investment in WPR by the Montgomery Small Companies Fund. So, here's our thinking.

Waypoint REIT

There are 20 million registered vehicles on Australia's roads (including motorbikes presumably). Each year about one million new vehicles are sold with about 300,000 of those added to the total fleet and the remaining 700,000 replacing existing vehicles.

According to the Australian Electric Vehicle Council, 6718 EVs were sold in 2019. In 2020 that number rose to 6900 and while sales surged in the first half of 2021, only 7248 electric vehicles were sold in addition to 1440 plug-in hybrids (PHEV).

Even if every new car sold was an EV or PHEV, and the total Australian fleet continued to grow at the current rate of 1.5 per cent (with the current 3.5 per cent of the fleet replaced each year), it would take 23 years before the entire Australian fleet is fully electric.

Today, only 1.4 per cent of annual sales are EVs (albeit sales are accelerating). At this rate, it will take more than three decades, and perhaps four, for Australia's internal combustion engine fleet to be entirely replaced by EVs.

So the petrol stations owned by WPR will have a purpose for some time yet. Furthermore, we don't think the portfolio value reduces to zero in an EV only world. Many petrol stations are strategically located along major transport routes and could provide EV charging services while drivers rest and grab a bite to eat. Alternatively, some metro sites might eventually be redeveloped for alternative uses for a tidy profit.

The trajectory for lithium

Elsewhere in the world, however, the take-up rate of EVs is much faster, and consequently demand for upstream inputs is roaring. EV sales in the US and China are surging despite the semiconductor memory chip shortage. In Europe sales are also strong.

In China, EV sales are running at 366,000 per month (up more than seven per cent in September over August) with Tesla and Berkshire-owned BYD dominating. In Germany, by way of example, plug-in vehicle sales are 30 per cent of total vehicle sales.

That demand is having a serious impact on the price of lithium. In US$/t, lithium hydroxide (LiOH) has jumped more than 50 per cent year-to-date and lithium carbonate equivalent (LCE) has doubled. In China, 99 per cent LCE priced in RMB/t has jumped 250 per cent and LiOH 275 per cent. Spodumene (US$/t ) is up almost 250 per cent year to date.

Spodumene has rallied from US$4,000/t in January this year to over US$18,000, while Asia LCE has risen from US$8,000/t to US$19,000/t.

Unsurprisingly, and as we warned might occur, Mineral Resources' (ASX:MIN) share price is up over 80 per cent this year, Orocobre (ASX:ORE) has risen over 25 per cent and Plibara Minerals (ASX:PLS) is up about 20 per cent.

Annual global EV sales, including passenger, bus and commercial vehicles, are forecast to grow 13-fold by 2030 from 3.1 million vehicle sales in 2020 to 40 million in 2030. All these vehicles need batteries.

Measured in gigawatt hours (GWh), and including energy storage and EV batteries, demand is forecast to grow twelve-fold in nine years from 195 GWh in 2019 to 2,583 GWh in 2030. Nine years isn't long in terms of investment horizon.

Of course, there are various EV batteries, including those using a variety of nickel-cobalt-manganese combinations in their cathodes, but all require lithium. Even if all 'probable' lithium mines were ramped up, total lithium supply will be in shortage by 2025. If ever there was a clear reason for a commodity price to rise significantly, this is it, and Australian based producers may just be in the box seat.

Written By Roger Montgomery

Active investing within the fund management space seeks to utilise a hands-on approach to capital accumulation and preservation, benefiting from extensive research functions within investment teams that work in pursuit of discovering attractive investments within the marketplace.

The main benefit from passive investing is within the low maintenance nature of allocating capital into particular investment classes or indices without the need of undertaking extensive analytical market research. Investors should be mindful that low-cost passive market exposure may come at higher potential downside risk.

Risk reward

Risk management plays a pivotal role in both investment styles.

In particular, active investing facilitates fund managers to deploy highly involved strategies that are designed to generate returns regardless of the underlying economic environment. Such tactics may include capturing short-term opportunities, downside protection and appropriate sector allocation. Active fund managers are therefore better equipped to dynamically respond to such circumstances and may benefit those investors who are willing to broaden their risk tolerance to capture returns throughout the economic cycle.

Portfolio diversification 

For experienced investors looking to diversify their portfolios, the added versatility of active investment may be a crucial element in ensuring that the level of risk vs reward is appropriately sustained. In essence, the difference between an experienced investor (such as a retiree) looking to generate returns, and an inexperienced younger investor simply investing in passive investments in the long-term is fundamentally differentiated from the impacts of time, willingness to take risk and their understanding of emerging and evolving new markets.

Younger investors may sway towards passive style investments, as the quality of the investment class over the long run may better suit their financial needs.

On the other hand, experienced investors may be seeking to preserve capital and benefit from returns that may be generated without the underlying influence of time, in which case, active investment may be more suitable. While younger investors may be more willing to allocate 100 per cent of their portfolio to passive investments such as ETFs, experienced investors may consider assigning a 40:60 ratio of active to passive investment. This ratio can be tailored to the individuals' financial needs and circumstances. 

Performance

Equity investments over the past three years have generated substantial returns to managed funds, such as Datt Capital's Absolute Return Fund, which achieved 17.27 per cent per annum after fees (as at September 2021) within that time. Comparatively, the ASX 200 index achieved 11.92 per cent p.a, exemplifying the consistent yet lower return nature of some conservative indices. 

Striking the balance between active equity investment funds and other passive investments such as ETFs and the like can essentially provide investors with the best of both worlds, with the associated risk and return to be proportionally embedded within a particular portfolio. Experienced investors, therefore, may consider allocating a portion of their portfolio to both.

Written By Emanuel Datt

Family offices seem open to private credit in defensive strategies in a way that other investors are still to appreciate. All investors are searching for consistent returns within the defensive part of the portfolio.

In essence, they are more open to investing in a business that creates consistent, repeatable returns rather than depending on the traditional coupon from a bond.

John Swallow from Laureola has seen a great deal of the new business for the life settlements group coming from family offices in USA, Asia and now developing in Australia.

Fixed income investors look to bonds to share in a company's progress by buying their debt and waiting for the interest payments and then the repayment of the capital.

It's not working this century because of low interest rates, heavy government borrowing and now Covid-19 is disrupting markets and expectations on returns.

And these problems won't change - the yield on bonds is very low and interest rates need to rise to make new bond offerings more attractive. And if interest rates do rise, the capital value of trillions of dollars of existing bonds will fall.

Life settlements as an asset are non-correlated to markets. The life settlements sector - buying insurance policies off older Americans who no longer need the coverage.

Life settlements are one example of a business where an investor is sharing immediately in the returns being generated as the life policies purchased come to maturity and insurance companies pay cash to the fund. And it is highly regulated and seen as an ESG outcome by regulators.

This is about investing in a business which is producing cash flow - not simply buying bonds in a company and hoping that the coupons are paid on time and capital is returned.

A well-managed life settlement fund can be expected to generate 7-11% pa returns (in AUD terms). Such levels of returns can be expected regardless of inflation scenarios. The returns in life settlements are stable and consistent over the years. Given the level of returns, life settlements can be relied upon as a bedrock in a portfolio. The only inflationary scenario where life settlements might struggle would be a hyper-inflationary one (like the Weimar Republic in the 1920s).

Written By Tony Bremness

Can we be sure that we are removing the same amount of carbon dioxide from the atmosphere as we have emitted as a business? That was the simple question we looked to answer as we approached our business carbon neutrality this year with the same rigour as our stock analysis.

In the process of measuring emissions, researching offset projects, and then purchasing offsets, we were surprised at what we found. Not only is carbon offsetting a largely unregulated industry, but most carbon offsets don't even remove carbon dioxide from the atmosphere! Read on to find out how Firetrail enhanced our carbon emissions offsetting process for FY21. By doing our homework, and focusing on what matters, we strived to ensure Firetrail genuinely is a carbon neutral business.

Step one -  measure the emissions

Firetrail expanded the scope of our emissions estimation process this year to include assessments on:

• Electricity usage
• Staff commutes and taxis
• Waste/water/paper/gas usage Flights and hotel stays
• Supply chain costs, including cleaning, software, and catering, and
• Working from home emissions when government restrictions were enforced, such as lighting, computer usage and heating

We worked in collaboration with Pinnacle, who have engaged in offsetting their business emissions for the last few years and achieved Climate Active Carbon Neutral certification for their FY20 emissions. Pinnacle also released their inaugural Corporate Sustainability Report in FY21, including details on their carbon inventory assessment, which can be found here. Firetrail's calculated carbon emissions for FY21 were 134 tonnes of carbon dioxide equivalent. A breakdown of the contribution to total emissions is provided below.

There are a couple of anomalies to highlight in the emissions for the past year. The Covid pandemic continued to impact daily life. This meant that business travel was virtually non-existent for the Firetrail team. We expect business travel to increase as border restrictions (both domestic and international) are eased, and as such expect that this portion of our carbon emissions will increases substantially in the future. We also avoided major lockdowns for the majority of the team in the July 2020-June 2021 period. However, we expect working from home emissions will be a feature of the FY22 carbon emissions due to the extended lockdowns at the beginning of the period. We admit our measurement process is not perfect, and estimation methods are evolving and improving over time as we get access to better data. Where relevant, we erred on the conservative side through this process. Firetrail will look to enhance our approach as we continue in our offsetting efforts in the year ahead.

A tonne of carbon is not a tonne of carbon

Once we calculated our total business emissions, we began the search for an appropriate way to offset them. The atmosphere cannot tell the difference between a tonne of carbon dioxide removed from the atmosphere and a tonne of carbon dioxide emitted into the atmosphere. It doesn't care how, or where this is done. It's all one planet and its all the same. But when it comes to offsetting, this isn't the case! What really matters to us is ensuring that if we are offsetting our emissions, that we are genuinely removing carbon dioxide from the atmosphere.

Source: Bloomberg

Carbon offset markets are evolving rapidly. Despite this evolution, less than 5% of carbon offsets are actually removing carbon dioxide from the atmosphere. These methods are Afforestation and Reforestation, and Carbon removal technologies (the far-right columns in the graph above). Most offsets still are firmly in the 'prevention' bucket, i.e. they are potentially stopping carbon from entering the atmosphere. The big question here is whether most of these projects would have gone ahead anyway.

The efficacy of the two biggest sources of offsets is questionable:

1. Renewable energy projects. The logic here is by building a solar farm or wind farm, you would displace energy that previously came from a fossil fuel source and should earn credits for it. There is no due diligence however on whether this occurs. Secondly the projects would have likely gone ahead anyway given the lower cost of renewables development. Fortunately - most voluntary carbon credit schemes are now starting to disallow these forms of credits.
2. Avoided deforestation. Best described as "Unless you pay me, I will chop that forest down". It's very hard (if not impossible) to prove whether the trees would have stayed anyway. In many cases the land is protected by covenants or planning restrictions also. And even if the trees do stay - it's just status quo for the atmosphere!

Of the two options which genuinely offset carbon emissions:

1. Carbon removal technologies are very expensive. For the fee of 960 Euros (AUD ~$1,500), Climeworks will suck 1 tonne of CO2 out of the atmosphere. Read more here.
2. Forest planting is a far lower cost option. As a tree grows, about half its mass is carbon, formed by breathing carbon dioxide in from the atmosphere. In Australia, the cost is ~$20 for this - depending on land prices.

To ensure that offsets pass the pub test, offset projects should be a) a project that is not the status quo and b) truly reduces carbon in the atmosphere.

Investing in the Flanders Carbon Project

Our science based, fundamental approach led Firetrail to purchase offset units from a Queensland native vegetation regeneration project called 'The Flanders Carbon Project'. The project is subject to independent audit as well as review by the Clean Energy Regulator. Once we purchased these Australian carbon credit units ("ACCUs"), we cancelled them in the Australian National Registry of Emissions Units, so that no one else can buy them. Doing this and avoiding any double counting means the offsetting is real. At $33 per tonne, the cost of doing this was more than double the cost of other carbon offsets we investigated.

The Flanders Carbon Project is situated in the southwest Darling Downs region of Queensland. Vegetation is growing and removing carbon dioxide from the atmosphere on land which was previously intensively overgrazed. The Flanders Project is spread over 32,000 hectares, and in FY21 140,976 tonnes of CO2 will be removed from the atmosphere. From an Australian national emissions perspective, the reforestation of Queensland is also critical. During the 2000s the rate of land clearing (destroying plants) was adding almost 100 million tonnes per annum to Australia's emissions. This process is now reversing through projects such as the Flanders project and reforestation - this can be seen in the dark green line below. Excluding this Australia's emissions reductions are minimal (ex-Covid impacts).

Source: Australian National Greenhouse Gas Inventory

Conclusion

Firetrail are dedicated to playing our part in creating a positive future environment for all our stakeholders and continue to make significant progress in our approach to responsible investing and sustainability. Our journey to carbon neutrality was an eye-opening experience this year, as we enhanced our methodology on not only emissions measurement, but choice in offsets. Carbon markets are certainly evolving, and our advice would be to do your due diligence when embarking on your carbon offsetting endeavour! We are very happy to share more on what we have learnt thus far and hope to keep developing our knowledge through engagement with our clients, portfolio companies and peers.

Disclaimer

This article is prepared by Firetrail Investments Pty Limited ('Firetrail') ABN 98 622 377 913 AFSL 516821 as the investment manager of the Firetrail Australian Small Companies Fund ARSN 638 792 113 ('the Fund'). This communication is for general information only. It is not intended as a securities recommendation or statement of opinion intended to influence a person or persons in making a decision in relation to investment. It has been prepared without taking account of any person's objectives, financial situation or needs. Any persons relying on this information should obtain professional advice before doing so. Past performance is for illustrative purposes only and is not indicative of future performance.

Pinnacle Fund Services Limited ABN 29 082 494 362 AFSL 238371 ('PFSL') is the product issuer of the Fund. PFSL is a wholly-owned subsidiary of the Pinnacle Investment Management Group Limited ('Pinnacle') ABN 22 100 325 184. The Product Disclosure Statement ('PDS') and the Target Market Determination ('TMD') of the Fund is available at www.firetrail.com. Any potential investor should consider the PDS before deciding whether to acquire, or continue to hold units in, the Fund.

Whilst Firetrail, PFSL and Pinnacle believe the information contained in this communication is reliable, no warranty is given as to its accuracy, reliability or completeness and persons relying on this information do so at their own risk. Subject to any liability which cannot be excluded under the relevant laws, Firetrail, PFSL and Pinnacle disclaim all liability to any person relying on the information contained in this communication in respect of any loss or damage (including consequential loss or damage), however caused, which may be suffered or arise directly or indirectly in respect of such information. This disclaimer extends to any entity that may distribute this communication.

The information is not intended for general distribution or publication and must be retained in a confidential manner. Information contained herein consists of confidential proprietary information constituting the sole property of Firetrail and its investment activities; its use is restricted accordingly. All such information should be maintained in a strictly confidential manner.

Any opinions and forecasts reflect the judgment and assumptions of Firetrail and its representatives on the basis of information available as at the date of publication and may later change without notice. Any projections contained in this presentation are estimates only and may not be realised in the future.

Unauthorised use, copying, distribution, replication, posting, transmitting, publication, display, or reproduction in whole or in part of the information contained in this communication is prohibited without obtaining prior written permission from Firetrail. Pinnacle and its associates may have interests in financial products and may receive fees from companies referred to during this communication.

This may contain the trade names or trademarks of various third parties, and if so, any such use is solely for illustrative purposes only. All product and company names are trademarks™ or registered® trademarks of their respective holders. Use of them does not imply any affiliation with, endorsement by, or association of any kind between them and Firetrail.