Alliance Trust : Quarterly Newsletter 2023 Autumn

QUARTERLY NEWSLETTER • AUTUMN 2023

JAPAN'S

CORPORATE

RESURGENCE

ON TRACK

By Jamie Rosenwald

After their strongest start to a year in a decade, Japanese equities have traded sideways since June, but the structural reforms underpinning the country's improving economic prospects and buoyant stock prices continue to gather momentum.

So it's important to stay focused on the emerging opportunities in a country that, because of its lost decades of deflation, so often gets overlooked or, at worst, written off as a source of potential returns for UK-based investors.

Take the update recently issued by Tokyo Stock Exchange (TSE) on progress towards listed companies achieving share prices that at least match the value of the business, known in the jargon as price-to-book ratio (PBR) of 1.0.

As part of this initiative, management teams were required to disclose their cost of capital and specifically address how they planned to achieve a return on equity (ROE), calculated by dividing net income by shareholder's equity, above 8%, which is deemed consistent with achieving a PBR above 1.0.

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Past performance is not a reliable indicator of future returns.

ALLIANCE TRUST:

DIVERSIFIED,

HIGH CONVICTION

Research shows that active equity managers add most value through a small number of their highest- conviction positions.1

Yet, the performance of concentrated portfolios can also be highly volatile.

The Alliance Trust portfolio mitigates this risk by blending together the best ideas of nine best-in-class2 Stock Pickers, each with different, complementary styles. We believe our diversified, high-conviction, global equity strategy should deliver more consistent outperformance and lower volatility than a strategy run by a single manager. Returns from single-manager strategies are often prone to sharp up and down moves; we aim to provide investors with a smoother ride.

Alliance Trust's specialist Japan manager, Dalton Investments, says this request may seem anodyne in a country with a shareholder model like the US.

But it was actually revolutionary in that, for the first time, Japanese company managers, usually so keen to balance a wide range of competing interests, ranging from employees to customers and suppliers, often at the expense of shareholders, were being mandated to explicitly focus on something which until then had often been viewed as none of their concern: namely the price of their stock!

Dalton says the minutes of the TSE meeting held on 29 August 2023, provided an insight into just how serious the TSE was about its initiative.

"To us, the message from the minutes of the meeting and associated presentation materials was clear:

• The TSE has no intention of slowing down its initiative and Japanese company management will continue to face pressure from the TSE to comply
• Companies should disclose their ROE targets
• Japanese companies need to improve their PBR to 1.0 at a minimum
• Importantly… Companies that have a PBR of above 1.0 are not excused - they too need to actively consider their cost of capital and disclose their plans."

UPDATE ON PROGRESS

1. Sebastian & Attaluri, Conviction in Equity Investing, The Journal of Portfolio Management, Summer 2014.
2. As rated by WTW.

Figure 1

Status of disclosure by number of companies (Prime and Standard segments of the TSE)

284

Disclosed Initiatives

263		Under Consideration

No Disclosure

2,723

Source: TSE as of 30 September 2023

As Figure 1 shows, there has been a steady uptake of the TSE's request, with 284 companies making their public disclosures and another 263 stating that these are under consideration. However, this leaves a sizeable part of the listed universe (2,723 companies to be precise) which have yet to comply.

Figure 2

Breakdown of Prime segment companies disclosing by market capitalisation and PBR

Market Capitalisation (USD)

PBR <1

PBR >1

>$700m

30.4%

20.6%

$170-700m

21.6%

9.1%

<$170m

12.5%

8.1%

Source: TSE as of 30 September 2023

Figure 2 makes it clear which companies have been quickest on the uptake. The larger companies in Japan are clearly feeling the greatest pressure to comply, particularly if they have a persistently low PBR. It is also fair to note that these larger companies often have greater resources to spend

in undertaking and disclosing these important reviews. Nevertheless, the TSE has made it clear that there are no exceptions for smaller market capitalisations or even for higher PBR companies - all companies need to comply with the request. While there will likely be a continued stream of disclosures coming particularly from large low-valuation companies, Dalton also believes there will be significant opportunities in the small-cap space as these companies play catch-up.

So, what exactly is in the initiatives disclosed so far? Of the

284 disclosures so far made:

• 72 provided their cost of capital
• 235 set one or more explicit targets for their business:
• • 199 ROE targets
  • 57 Return of Investment Capital (ROIC) targets
  • 39 Price/Book targets

"While the above is not exactly perfect, as seasoned Japanese investors, we believe the setting of target metrics such as the above represents a sea change in thinking for Japanese management."

Dalton

Figure 3

The content of the initiatives disclosed (Prime and Standard segments)

250
200
150
100
50
0	221	137
	Investment for	Human capital
	growth	investment

134	163	50	67	77	158
Review of	Strengthening	Reduction	Strengthening	Enhancement	Sustainability
business	shareholder	of cross-	of IR	of governance	initiatives
portfolio	returns	shareholdings

Source: TSE as of 30 September 2023	The remarkable case of Aisin

Figure 3 attempts to summarise the content of the text of the initiatives, grouping them into broad categories where the management teams want to drive improvements. Clearly all of these are positive steps, and Dalton sees the evidence of continued improvements in shareholder returns (record buybacks and dividends) as well as the start of a rationalisation of company's business structures, including selling off or closing low profitability or non-core operations.

It is also encouraging to see Japanese firms embracing sustainability initiatives, given these continue to lag global standards.

However, Dalton is particularly interested in the 50 companies that discussed the plan to unwind their cross- shareholding structure.

"We view cross-shareholdings (where inter-related companies such as suppliers and customers will hold stakes in each other's business) as one of the biggest remaining challenges in the Japanese equity market, and intend to make this a major focus of our engagement over the coming year. In our view, the TSE reforms supply strong ammunition to engagement- focused managers such as Dalton in driving positive change."

Dalton cites Aisin as a poster child for the new mood sweeping Japanese boardrooms.

"Aisin is an $11bn market capitalisation company which produces components and systems for the automotive industry, as part of the Toyota Group of Companies (Aisin is the fourth biggest division in the group). The company is 40% controlled by the Toyota Group, and has historically acted in unison with the Toyota management and given limited focus to its minority shareholders. Despite this, and driven by the TSE's demands, on 14 September the company gave a 'Mid/ Long-term Business Strategy Briefing', which included some remarkable elements:

• Completely selling out of its (mostly Toyota Group) cross- shareholdings (JPY 250bn in total)
• Increasing shareholder returns through share buybacks and dividends
• Transferring out or closing non-core and low profitability business lines
• Setting explicit ROIC (13%) and PBR (>1x) targets
• Outlining a specific focus on key sustainability issues such as carbon neutrality

"In our view, if a company like Aisin can move to completely unwind its cross-shareholdings, then this is an extremely positive sign for the wider Japanese market."

Dalton concludes:

"We are truly encouraged by the TSE's continued and persistent reform agenda and believe it is having a profound impact on the Japanese market. As engagement-focused investors, being able to speak to Japanese company management in the common language of cost of capital, valuation and ultimately share price is revolutionary".

"With the Japanese market's strong performance (at least in Japanese Yen!) in recent periods, we are often asked whether we believe the opportunity is over in Japan. On the contrary, we believe we are still in the early stages of a multi-year opportunity in the country, as the management of Japanese companies respond to the pressure to drive better returns for shareholders".

Figure 4

Percentage of Prime and Standard segment companies trading below TSE targets

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

1,660 companies	1,745 companies
Less than PBR	Less than ROE
1.0	8%

Source: Bloomberg as of 30 September 2023

"As Figure 4 shows, there remain a huge number of companies listed in Japan with metrics below the TSE's minimum targets, most of which are yet to make public disclosures of their plans to address these failings. Even if we only consider the large-cap skewed TOPIX index, we see a pronounced gap between Japan and the rest of the world (Figures 5 and 6) on these key metrics, meaning there remains the potential for sustained relative outperformance from Japan."

Figure 5

Ratio of companies with ROE lower than 8% (TOPIX, S&P 500, STOXX 600)

Figure 6

Ratio of companies with PBR lower than 1 (TOPIX, S&P 500, STOXX 600)

100%			100%
90%			90%
80%			80%
70%			70%
60%			60%
50%			50%
40%			40%
30%			30%
20%			20%
10%			10%
0%			0%
Japan	US	Europe	Japan	US	Europe
Source: Bloomberg as of 30 September 2023			Source: Bloomberg as of 30 September 2023

Jamie Rosenwald, CIO and Co-Founder, Dalton Investments

READ MORE INVESTMENT

INSIGHTS

This information is for informational purposes only and should not be considered investment advice. Past performance is not a reliable indicator of future returns. The views expressed are the opinion of the Manager and are not intended as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell any securities. The views expressed were current as at October 2022 and are subject to change. Past performance is not indicative of future results. A company's fundamentals or earnings growth is no guarantee that its share price will increase. You should not assume that any investment is or will be profitable. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. TWIM is the appointed Alternative Investment Fund Manager of Alliance Trust plc. Alliance Trust plc is a listed UK investment trust and is not authorised and regulated by the Financial Conduct Authority.

Connection Emerging Markets

EMERGING

MARKETS:

WHY ALLIANCE TRUST'S STOCK PICKERS HAVE REGAINED THEIR APPETITE

Emerging market stocks weren't all that palatable in 2022. Russia's nasty invasion of Ukraine played a large part in dulling investor appetite: rewriting the geopolitical equation and altering the perception of emerging market risk, particularly given the potential for a China/Taiwan flashpoint.

The war sent shockwaves rippling through the global economy, stoking inflation, and forcing global interest rates to go higher and the US dollar to strengthen. Unfortunately, as is often the case when developed economies come under pressure, emerging markets tend to suffer even worse.

Today, the picture seems different. Although the Russian/ Ukraine war drags on and the West continues to wrestle with inflation, Alliance Trust's Stock Pickers think emerging markets (EM) have plenty of opportunities to indulge in. Here's why EM have become their flavour du jour.

EMERGING MARKETS FOR YOUR PORTFOLIO

There's a view that emerging markets, should be a core part of your portfolio. Ostensibly, they are seen as riskier than developed markets due to the perception of higher economic and political volatility and lower standards of corporate governance. And yet, in addition to portfolio diversification benefits, they are also home to some of the world's most innovative companies, nestled in its fastest- growing economies.

The investment case is tantalising for a host of reasons.

First, over the long term, emerging market growth is forecast to remain well ahead of developed markets. Although the juicy economic boost generated by the decades-long transition from rural subsistence farming

to urbanisation has largely passed, the explosion of homegrown consumption in an expanding middle class sets a strong bedrock for growth in economies that house 70% of the global population.1

Second, in the near term, the wider macroeconomic picture in emerging markets seems to be improving, with inflation across many emerging countries falling and interest rates beginning to follow as supply chain issues are resolved, food and energy prices ease, and as the US dollar plateaus or weakens against numerous EM currencies, for example the Chinese yuan, the Brazilian real, and the Indian rupee.

And third, following a spell of EM being out of favour, valuations are looking attractive, especially given the potential for growth in profitability, as they catch up with developed markets over time.

As a result, Alliance Trust's Stock Pickers are finding EM a fertile hunting ground for stocks. Moreover, it isn't all about China.

"Over the long term, emerging market growth is forecast to remain well ahead of developed markets."

1. https://www.fidelity.co.uk/markets-insights/markets/asia-emerging-markets/is-now-the-moment-to-get-into-emerging-markets/

Past performance is not a reliable indicator of future returns.

NURSING THE DRAGON BACK TO HEALTH

China's long-term story is certainly impressive. It remains a flourishing economy with remarkable infrastructure that gives it an edge in global manufacturing and export. Alliance Trust Stock Picker Sands points to the "increasingly affluent middle class", and the fact it has "plenty of daring entrepreneurs". What's more, its focus on building advanced sectors pave the way for long-term investment opportunities in AI, high tech, and advanced manufacturing in areas such as electric vehicles.

These are some of the reasons why China's stock market has become a significant beast, with its 6,000 or so companies representing 29.79% of the MSCI Emerging Markets Index.2 One investment for the Alliance Trust portfolio is Stock Picker Black Creek's position in tech giant Baidu.

Still, while there are undeniable long-term opportunities, there remains elevated risks in the near term too.

President Xi's move to centralise state power in recent years and rein in business has eroded the technocratic influence on policy, resulting in a heavy-handed approach to regulation. On top of shifting domestic politics, deteriorating geopolitical relations with the US are creating headaches for China, with a tech trade war that's hobbling its ambitions to become a technologically advanced economy. And after years of drawn-out Covid lockdowns, the economy still has some recovering to do, with growth stalling following an initial post-Covid bump earlier this year, not to mention a real estate sector in crisis and unemployment high, particularly among the young.

While there's no doubt these issues will be worked through, the Stock Pickers at Alliance Trust point to some of the exciting opportunities elsewhere in EM.

NOT SO FRAGILE

Numerous markets across the EM stable look attractive, according to the Stock Pickers at Alliance Trust.

Stock Picker GQG, for example, is seeing opportunities in India as supply chains shift away from China, and as it continues its push to upgrade its infrastructure. They point to the fact that, from a macroeconomic perspective, India looks like it's taken a page out of the "developed market economic playbook", with "low public debt to GDP, moderate inflation, and the positive real rates of return".3 It's why the market has some of its "highest conviction ideas", having come far from ten years ago when it was labelled one of the "Fragile Five" EM economies; over the decade since, it has outperformed the wider MSCI EM Index by a significant margin.4

As a result, GQG, alongside Alliance Trust Stock Pickers Sands and SGA, has invested in giant Indian bank HDFC for the portfolio, with GQG remarking that "HDFC Bank has an excellent management team, strong underwriting discipline, and headroom for growth", not to mention "significant synergies" with its parent company, HDFC-India's largest mortgage lender - with which it recently merged.

"Numerous markets across the EM stable look attractive, according to the Stock Pickers at Alliance Trust."

1. https://www.msci.com/documents/10199/c0db0a48-01f2-4ba9-ad01-226fd5678111
2. https://gqgpartners.com/insights/rise-bengal-tiger
3. https://www.msci.com/documents/10199/1ad792ce-3199-445c-8be3-f2a035ac782d

Past performance is not a reliable indicator of future returns.

For Sands, banks are thematically appealing not just in India but more widely across EM. In developed markets, it sees banking as a "mature industry that sells commoditised products and services", whereas in emerging markets, it observes "very low rates of penetration" which are creating "secular growth opportunities".

Elsewhere, GQG is also finding opportunities in South America, for example Brazil, where it believes concerns over the perceived extreme leftist tendencies of newly elected president Lula da Silva were overblown. It also believes the macro environment is strong, given the 1.5% fiscal deficit, attractive valuations, and inflation that seems under control. One investment picked for the Alliance Trust portfolio is Brazilian oil & gas producer, Petrobras.

Also looking to South America are SGA and Sands, with investments in dominant Argentinian e-commerce platform MercadoLibre, which SGA remarks is "well positioned to capitalise on e-commerce growth in Latin America, given its dominant e-commerce marketplace and its leadership position in consumer financial technology."

"HDFC Bank has an excellent management team, strong underwriting discipline, and headroom for growth."

ALLIANCE TRUST

Alliance Trust invests in emerging markets as part of a well-diversified global strategy, and is currently overweight emerging markets relative to its benchmark index, at 19.4% of the portfolio versus 18.6% for the MSCI All Country World Index.

Marcus de Silva, Freelance Investment Writer

READ MORE INVESTMENT INSIGHTS

This information is for informational purposes only and should not be considered investment advice. Past performance is not a reliable indicator of future returns. The views expressed are the opinion of Towers Watson Investment Management (TWIM), the authorised Alternative Investment Fund Manager of Alliance Trust PLC, and are not intended as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell any securities. The views expressed were current as at October 2023 and are subject to change. Past performance is not indicative of future results. A company's fundamentals or earnings growth is no guarantee that its share price will increase. You should not assume that any investment is or will be profitable. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. TWIM is authorised and regulated by the Financial Conduct Authority. Alliance Trust PLC is listed on the London Stock Exchange and is registered in Scotland No SC1731. Registered office: River Court, 5 West Victoria Dock Road, Dundee DD1 3JT. Alliance Trust PLC is not authorised and regulated by the Financial Conduct Authority and gives no financial or investment advice.

Connection Stock spotlight

EQUITY MANAGER SPOTLIGHT

VULCAN VALUE PARTNERS

C.T. Fitzpatrick,

Founder & CIO,

Vulcan Value Partners

INVESTMENT PHILOSOPHY

The pillars of our investment philosophy are value stability and a long-term time horizon. Value stability is important for two reasons. First, for companies that have stable values, stock price volatility creates opportunity for

us. Stock prices can be more volatile than our values, which enables us to increase our margin of safety when price inevitably deviates from value. Second, if a stock is mispriced, there are two ways for that gap to close. Value can fall to meet price, or price can rise to meet value.

A stable value gives us confidence that when the gap is closed, it will close by price rising to meet value.

Once we identify a company with a stable value, we follow it, sometimes for well over a decade, so that we can purchase it with a margin of safety, should it ever become discounted. Our collection of stable value companies is called our MVP list. Adding a company to our MVP list means that we are making the decision to buy it, should it become discounted. We invest the resources to follow these MVP companies almost as if they were in the portfolio. We keep our values current, and do a deep dive review every two years, to make sure that the company's competitive position remains strong and hopefully is getting stronger.

There are several advantages to following these companies over time. One is that we can observe the actual results that these businesses deliver, and compare those results to the assumptions we are using to value the business over a long period of time. Another advantage of our investment process, is that we get to know the businesses on our MVP list and the people running them very well. As a result, when there is stock price volatility, we can move decisively to allocate capital into extraordinary businesses when they become discounted, because we know the businesses well and we have confidence that our values are stable.

STOCK

SPOTLIGHT:

CBRE GROUP

INC.

CBRE Group Inc.

CBRE Group Inc. is one of the largest commercial real estate services companies, which offers comprehensive real estate services globally. The company serves real estate investors and corporate occupiers of real estate by providing leasing, brokerage, M&A and investment advisory, as well as property and facility management services. To complement its core offerings, the company also has a large global

real estate investment management business with steady recurring fees. The industry is highly fragmented. Industry consolidation has been occurring for decades, and we believe CBRE will continue to take market share. The company's revenues are diversified by geography, asset class and service lines. Additionally, CBRE has inherently variable cost structures. The company does not own any real estate, which provides the flexibility to adjust costs when the macro environment becomes less favourable. CBRE continues to benefit from the secular trend towards outsourcing. Corporate clients are focusing on reducing costs, and outsourcing real estate services is a driver of expense reduction. CBRE is winning business, because very few providers have the global scale to match that of its global clients.

In times of industry or market stress, we lean on qualitative factors such as business model, market structure and management quality. This discipline allows us to see through uncomfortable near-term market dynamics and execute our process of identifying stable value businesses. When considering the qualitative aspects of CBRE, we believe there is a lot to like.

MEET THE ALLIANCE TRUST MANAGERS

FAST FACTS ON CBRE GROUP INC.

1906				$30.83bn
Founded	Headquarters	CEO	circa 115,000	Revenue
1906	Texas, USA	Robert Sulentic	employees

Companies mentioned are for informational purposes only and should not be considered investment advice.

Connection Stock spotlight

EQUITY MANAGER SPOTLIGHT

SANDS PARTNERS

Sunil Thakor,

Research Analyst and

a Co-Portfolio Manager,

Sands Capital

INVESTMENT PHILOSOPHY

Sands Capital is an active, long-term investor in leading innovative growth businesses, globally.

Our approach combines analytical rigor and creative thinking to seek to identify high-quality growth businesses that

are creating the future. Through an integrated investment platform spanning venture capital, growth equity and public equity, we provide growth capital solutions to institutions and fund sponsors in more than 40 countries.

Sands Capital is an independent, staff-owned firm founded in 1992 with offices in the Washington, D.C. area, London, and Singapore. Sands Capital managed $51.0 billion in client assets as of June 30, 2023.

The operating environment remains challenging for many businesses, as the global economy continues to work through the "bullwhip" effects that were created by the pandemic.

That said, we are seeing potential signs of stabilization and overall improvement in the spending environment, which has us increasingly optimistic. This is particularly the case in the enterprise market where it feels as if the period of consolidation and "optimization" are largely behind us, and businesses across the globe are continuing to embark on their ongoing digital transformations. Importantly, we believe ongoing digital transformations now must incorporate increased investments in artificial intelligence, which we expect to provide a healthy tailwind to many businesses owned in the Global Focus portfolio.

We're also encouraged by the financial strength of our portfolio companies, as Global Focus tends to invest in businesses with robust cash balances, strong unit

STOCK

SPOTLIGHT:

ROPER

TECHNOLOGIES

economics, and less debt than the average MSCI ACWI constituent. Financial strength could become a competitive advantage should the economic environment worsen.

Fundamentals have driven our investment results over the long run, and we continue to have conviction in the growth potential of the businesses we own today. Over the next five years as of August 31, 2023, we expect our portfolio to deliver weighted average annualised earnings growth of approximately 32%.

Roper Technologies

The most recently purchased business in the portfolio is Roper Technologies, a diversified industrial technology company that operates over 40 businesses in more than 40 niche markets. The company sells software and engineered products and solutions across four segments: application software, network software and systems, measurement and analytical solutions, and process technologies.

The corporate strategy prioritises cash flow growth, which Roper then seeks to deploy into acquiring new businesses. Roper maintains strict investment criteria when evaluating acquisition targets, and its rigorous standards are based on its proprietary "cash return on investment" metric. The company is indiscriminate in the types of businesses it seeks to own; rather, it focuses exclusively on free cash generation and management quality. Each business is decentralised and operates autonomously, with a mandate to grow and generate cash.

Our research suggests that Roper is an acquirer of choice for engaged management teams that desire to continue independent operations. Over our investment horizon, we expect steady cash flow growth as Roper executes on its disciplined acquisition and growth strategy.

FAST FACTS ON ROPER TECHNOLOGIES

1890				$5.37bn
Founded	Headquarters	CEO	circa 18,400	Revenue
1890	Florida, USA	Neil Hunn	employees

Companies mentioned are for informational purposes only and should not be considered investment advice.

The specific securities identified and described do not represent all of the securities purchased, sold, or recommended for advisory clients. There is no assurance that any securities discussed will remain in the portfolio or that securities sold have not been repurchased. There is no guarantee that Sands Capital will meet its stated goals. For more information see https://sandscapital.com/disclosures.