The Aberdeen Asia-Pacific Income Fund (NYSEMKT:FAX) is a closed-end fund that invests in Asia Pacific debt securities with an added mandate of holding at least 20% of total assets in Australian. The fund with an inception date back in 1986 currently has $1.2 billion in total assets. The objective is to generate a high level of current income through a monthly distribution that currently yields 7.7% achieved through the use of leverage and also a regular return of capital component. We think the macro environment sets up a good buying opportunity as this asset class and market segment should benefit from trends including a weaker U.S. dollar and improved risk sentiment towards the Asia region considering a potential resolution to the U.S. China trade dispute. We like that FAX is trading at an 11.6% discount to NAV and the fund also has an established long-term performance history. This article recaps the fund and our view on where FAX is headed next.
Within the context of “Asia-Pacific”, the fund holds bonds primarily of the region’s sovereign governments and related state-owned enterprises. The focus on Australia which represents 28.4% of the geographic exposure is meant to provide a pillar of stability as the sovereign credit is rated “AAA” and recognized as a developed democracy with close ties to Western economies. Curiously, the fund does not hold any Japanese debt which is likely related to the low yields of the yen and as a strategic allocation decision by the investment management team.
Holdings are diverse across the region with India representing 14.7% of the fund as the second most represented country, followed by Indonesia at 13.8%, and China with a 13.6% weighting. One of the positives about the fund is the exposure to a number of high-yield emerging economies within a diversified portfolio.
It’s important to note that the actual foreign currency exposures are different since the fund invests in “global bonds” issued by these countries denominated in other foreign currencies. U.S. dollar denominated bonds represent 41% of the fund. By this measure there is some good balance between the Australian dollar exposure representing 24.6% of the fund along with 26.2% of the fund in other currencies.
(Source: Aberdeen Standard)
Sovereign bonds typically trade based on trends in long term economic fundamentals including GDP growth, inflation expectations, external and fiscal account balances among other factors. Depending on each sovereign credit rating, the U.S. dollar denominated debt will reflect changes in credit spreads while local currency bonds have the added exposure to changes in exchange rate movements for foreign investors. The point is that in general terms, FAX will benefit from positive risk sentiment along with improving fundamentals for the Asia-Pac region.
As mentioned, the focus on Australian debt helps support the overall credit quality of the fund. India, the second most represented country in the fund is rated BBB- by S&P Ratings which is the lowest level in the “investment grade” scale. The chart below shows 21.8% of holdings are “Not Rated”. These are typically going to be the issuance of quasi-sovereign entities or municipal governments from each country. It’s inferred that these ratings follow the sovereign credit as it is expected the government would provide financial support for these entities in a period of stress to avoid a default type of scenario.
(Source: Aberdeen Standard)
Another key feature of the fund is the maturity composition which can be classified as medium-term on the yield curve and includes a modified duration of 5.3 years. Longer-dated bonds are recognized as more exposed to changes in interest rates. These compositions are subject to change. Overall, we like the construction of the fund.
Historically, FAX has delivered an otherwise impressive 7.8% annualized average annual return on NAV and 7.3% on the market price since inception. This level of return is consistent with the growth environment over the past three decades in the “Asia-Pac” region including Australia and China. On the other hand, returns have been weaker this decade highlighting the difficult environment for emerging markets particularly since the turn of the commodity cycle and collapse in oil prices in 2014.
More recently, the Asia-Pac region has contented with decelerating growth in most major countries while returns have also been pressured by a strong U.S. dollar. In 2018, the NAV of the fund fell by 7.3% in what was an exceptionally volatile year. This year the fund has rebounded with FAX up 18.5% year to date based in part to a global trend of lower interest rates. It’s expected FAX will perform well during periods of favorable credit and underlying macro conditions for Australia and the Asian sovereigns.
In April, the fund cut the distribution rate to $0.0275 per month from a previous quarterly rate of $0.035. By this measure, the forward distribution yield based on the current monthly rate is 7.7%, while the stated yield of 8.6% over the trailing 12 months includes the old rate. Clearly this was a disappointment to long-term shareholders, but we think the move was appropriate as the new reduced rate may be more sustainable over the long run going forward.
Most importantly, we don’t view the distribution cut as evidence of poor management or a weakness of strategy but simply a reflection of changing market conditions over the three-decade plus history of the fund and the new environment of structurally lower interest rates globally. This was the first rate cut since 2002. It appears the market shrugged the rate cut off as the fund fell initially on the announcement but is up over 8% in the period since.
Discount to NAV
Independent of the fund’s yield and recent performance, we think the current discount to NAV at 12% represents relative value and supports our bullish outlook for FAX. Based on the trading history, the pricing spread to NAV appears to follow general sentiment towards the Asia-Pac region credit trends and commodity prices to an extent. Going back to late 2012 and early 2013 at the height of the last commodity pricing cycle, which represented a particularly strong period for Australia and emerging markets, FAX traded at a peak premium to NAV of 3%.
The current discount is at about the average over the past five years. We think a bullish case for the macro outlook could drive a tightening of the discount from current levels representing upside in the total return potential of the fund.
Commentary and Forward-Looking Analysis
From a top-down perspective, there are multiple macro themes in play here that will drive the future performance of FAX. We are looking at the fund’s nearly 60% exposure to foreign currencies and highlight a weaker U.S. dollar as generally supportive to returns. The Australian dollar in particular represents 25% of the fund’s exposure, which is recognized as correlated to trends in commodities like iron ore, which itself is largely driven by Chinese demand. In this regard, holding FAX is very much a macro bet on global growth and trade conditions.
The main development right now in financial markets is optimism surrounding a potential resolution to the U.S.-China dispute that has been a source of uncertainty for almost two years now and blamed on much of the weakness in the global growth environment. The bullish case is that a finalized trade deal could lead to a “renaissance” of global growth expectations. An acceleration of the Chinese economy from here based on improving sentiment could lead to a feedback loop which includes higher commodity prices and strong trade conditions for the Asia-Pac region. This scenario would be supportive to credit conditions for the region’s economies and clearly a positive for FAX.
To the downside, a collapse in the trade talks is the main-near term risk while weaker-than-expected growth in the region could lead to another leg lower for commodity prices.
The Aberdeen Asia-Pacific Income Fund is a unique CEF offering investors diversified exposure to region credit trends with a core focus on Australia. We like the fund’s structure and holdings across smaller emerging markets that are typically difficult for retail investors to access. Given the growth and trade linkages of the economies in the region, we view FAX as a macro play on broader emerging market risk sentiment. We think FAX can complement a diversified portfolio to boost income with favorable diversification qualities. Take a look at the fund’s semi-annual report for a full list of risk and disclosures.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.