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Taking a Closer Look at Aberdeen Asia-Pacific Income

Despite a management change, this fund retains its Bronze rating.

Steven Pikelny, 03/07/2014

Between a recent management shuffle, the rapid depreciation of the Australian dollar, and refinancing its leverage structure, it has been an eventful 10 months Aberdeen Asia-Pacific Income FAX. But with this Bronze-rated fund trading at a 7.8% discount, now might be a good time for contrarian investors to take a look. To be sure, Aberdeen Asia-Pacific Income is not for everyone. As evidenced by its nearly 21% loss on a share price total return basis for 2013, the portfolio entails a large amount of currency risk. This poor performance was driven largely by the portfolio's 40% stake in the Aussie dollar, which fell about 14% against the U.S. dollar in 2013. Moreover, the portfolio's regional concentration in Asia might be difficult to stomach, considering the looming risks of a hard slowdown in China and the fiscal deterioration of several Southeast Asian countries. However, investors who believe the AUD is oversold or who have a long-term positive conviction on the growth of Asian economies might find the current discount and leverage structure to be highly attractive.

People
In January 2014, Aberdeen promoted Victor Rodriguez to head of Asia-Pacific fixed income and also to lead manager of this fund, replacing former head manager Anthony Michael (who plans to leave the firm following a transition period). Rodriguez was formerly head of Australian fixed income, where he led the team's interest-rate, inflation, and risk-management committees. He's been with Aberdeen since 2009, when the firm took over Credit Suisse's asset management group, and he has about 20 years of total investment experience. Nick Bishop, Rodriguez's second in command in Australia, will now head the Australian fixed-income team. Meanwhile, Adam McCabe, former head of Asian currencies and interest rates, will head the Asian fixed-income team. Previously, McCabe worked closely with Michael on the Asian sleeve of the portfolio.

Rodriguez has limited experience with Asian markets, which makes Michael's departure significant. However, the Asian fixed-income team maintains its deep bench, with six sovereign debt and currency analysts, five credit analysts, a quantitative analyst, and seven bond and currency traders; this should help soften the blow. In addition, the 12-member Australian team remains well-staffed. Despite the departure, the team is still a solid one, in our opinion, and helps the fund retain its Bronze rating.

Process
The fund seeks to generate a stable level of income by investing in the corporate and sovereign fixed-income markets of Australia and Asia. Managers first look at macroeconomic factors affecting each region (such as interest rates, inflation, monetary policy, and political factors) to help determine regional and currency allocations to the portfolio's Australian and Asian sleeves. Positions generally reflect the team's long-term outlook, but they will also make smaller changes to reflect their quarterly cyclical views. The team also draws heavily on Aberdeen's global macro risk group to place their regional analysis in context.

From a bottom-up standpoint, Aberdeen argues that many developing Asian markets are highly idiosyncratic and that a local presence helps the firm take advantage of market inefficiencies. Managers and analysts work out of offices in Singapore, Hong Kong, Bangkok, and Sydney, and they regularly visit target countries to meet with central bankers, finance ministers, and corporate managers. Analysts specialize by region, with sovereign analysts also covering local currencies.

In 2013 the team gradually shifted the fund's regional exposure toward Asia and away from Australia. By year-end, about 37% of assets were invested in Australia (compared with 40% the previous year), and 54% in developing Asian countries (compared with 52% the previous year). South Korea and China made up most of the portfolio's Asian exposure at roughly 10% of net assets each, with Indonesia, Hong Kong, the Philippines, Malaysia, and Thailand each comprising between 4% and 6% of the portfolio. The Australian and U.S. dollar each accounted for about 41% of currency exposure, with the remainder devoted to smaller Asian currency positions.

The portfolio's 40% corporate positioning was largely in Australian financials and Aussie dollar-denominated development debt, but it also included some higher-quality Chinese real estate debt and South Korean utility and financial debt. Credit quality was reasonably high, with 85% of assets rated investment-grade and 33% rated AAA. With 90% of the portfolio maturing in less than 10 years, the fund had a modified duration of 4.3 years.

While Aberdeen views the fund's $600 million in leverage as a structural component of the strategy, the makeup of the leverage changed in 2013. In particular, Aberdeen made efforts to refinance in June 2013 to protect against rising interest rates. The fund previously used a line of credit exclusively, but now it can draw only $150 million on the line of credit. To replace the credit, it issued a series of four $100 million senior secured notes, which mature in 2016, 2018, 2020, and 2023. While these rates are fixed, they are also notably higher than those paid for floating-rate leverage. Privately placed preferred shares comprise the remaining $50 million. Overall, this gives the fund a leverage ratio (total assets/net assets) of 1.32.

Distributions and Performance
Overall, the fund's unique geographic exposure makes it difficult to evaluate performance. For example, the fund's heavy weighting to the Australian dollar, which has mostly appreciated against the U.S. dollar over the past decade, helped it become one of the top-performing world-bond open- and closed-end funds over the past 10 years with an annualized total return of 6.9% for the period through March 5. But a rapid depreciation of the Aussie dollar against the U.S. dollar in 2013, as well as the poor performance of Asian debt, led to a 10.5% loss in 2013, landing the fund in the bottom 5% of all world-bond funds. Making matters worse, investor sentiment soured over the course of the year. Shares traded at a small premium for parts of 2012 and 2013 but fell to a 12% discount by 2013 year-end.

From a distribution standpoint, investors should note that the coupon payments of the portfolio only generated enough income to cover two thirds of the fund's fiscal 2013 distributions. To maintain distribution stability, the fund returned realized capital gains and the proceeds from its derivative contracts, which it later reclassified as net investment income. In all, the fund has a long history of paying a stable level of income, and has maintained its $0.035 monthly distribution since 2002. This translates to a 7% distribution rate at share price.

Fees and Alternatives
FAX does not have much competition in the Asia-Pacific fixed-income retail fund space. Wisdom Tree Asia Local Debt ALD is a decent bet for investors who aren't looking for Australian bond or currency exposure. Similarly, PIMCO Australia Bond Index ETF AUD and WisdomTree Australia & New Zealand Debt AUNZ are suitable vehicles for investors looking for pure-play exposure to Australia or Australia and New Zealand. But investors looking for the whole regional package might be better off sticking with Aberdeen Asia-Pacific Income. Although 2013's macroeconomic conditions led to a 10.5% net asset value loss for the fund, investors would have been worse off with a combination of the exchange-traded fund options to gain similar levels of leveraged regional exposure. However, Aberdeen Asia-Pacific Income's widening discount nearly doubled its losses. With the current discount well below its 3.9% five-year average, share price risk is less of a concern than it was at this point last year.

From a fee standpoint, the ETFs are certainly cheaper, with expense ratios ranging from 0.45% to 0.55%. Aberdeen Asia-Pacific Income charged a total expense ratio of 1.50% in fiscal 2013, but this is inclusive of the fund's leverage expenses. Unless investors have access to extraordinarily cheap leverage financing and are willing to buy the ETF options on margin, FAX is likely the more cost-effective route. 

 

Steven Pikelny is a closed-end fund analyst at Morningstar.
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