At the end of November the fund was approximately 99% invested as follows:

Indonesia - 41%
Malaysia - 37%
Singapore - 22%

November wasn’t too bad a month for the fund given what was happening elsewhere. We were fortunate in that despite two of our larger holdings falling by about 10% three of our other companies’ prices all rose, so in the end the fund’s NAV fell more or less in line with the currencies We have benefited as a whole from the strengthening currencies. We still have a few Baht somewhere hence its inclusion in the chart below. The Indonesian Rupiah is lower than it was a year ago and is actually weaker than it was when we launched the fund three years ago.

Overview

These are nervous times and it seems inconceivable that the bull market is going to continue in its rip-roaring fashion in the light of the credit problems we keep hearing about everywhere. At Pangolin we try to avoid the top-down noise and concentrate on company fundamentals, but with one eye on what would happen if all the doom-mongers are proven correct. We aim to be conservative in our company valuations thus giving us some room for error. We invest either for earnings, asset backing or a combination of the two.

Excluding the asset plays, the fund’s weighted 2008 PE is 8x while our three asset plays all trade well below what we think they are worth and what is realisable. Excluding the infrastructure companies with stable concessions and finance companies, the highest net gearing of any of the businesses in the fund is less than 30% which means that there isn’t anything likely to go bust – fingers crossed of course.

We have a large exposure to the Malaysian and Indonesian consumer sector. In Indonesia we have a large weighting in finance companies lending to buyers of motorbikes and cars etc. They are all doing well operationally, are exceedingly cheap and have high margins as well as good asset quality. Now what is happening with mortgages elsewhere in the world tells us that one never knows the real asset quality until problems arise, so I should say that we are hopeful in this regard. The risk to this sector is a big increase in the price of fuel and therefore inflation if the government feels it cannot afford the current level of subsidies, but we think with an election due in early 2009 that this is unlikely.

Otherwise in Indonesia we are exposed to the propensity of young men to wear hair gel and their sisters to slap on face-whitening cream, an increasing appetite for junk food, medicines (as a balance to our junk food exposure) and cheap shoes. Due to Indonesia’s inability to make itself an attractive destination for manufacturers and therefore employers, the growth in consumer spending is mainly coming from the commodity rich provinces rather than Java.

In Malaysia we have a bank with no CDO exposure, a power generator, a property company, a port, a toll road operator and a fashion retailer. They are all reasonably valued and well managed businesses.

In Singapore the fund holds a corporate secretarial and accounting business which is a strong cash flow generator and likely to grow by acquisition, a company involved in managing shipping containers in the region and a manufacturer of furniture for export to the West.

The latter is our one direct exposure to the Western consumer and would be keeping us awake at night if the company was not seeing continued strong growth in its orders as well as being on a single digit PE multiple. It has fallen 25% from its high on these concerns but it is our expectation that this company will be significantly larger and more expensive in the future, so for the present we are happy to forego a bit of sleep and hang on to it.

Our company visits continue to uncover many other undervalued potential investments in the region. We don’t like to chop and change the portfolio too often and this year’s volatility has provided us with the occasional opportunity to add to our holdings. I haven’t disclosed which companies we hold in this newsletter but I am happy to discuss the portfolio in detail with investors and others on request.

Markets and Politics

I have mentioned in previous letters that, in my opinion, many emerging market valuations no longer reflect the political risks associated with investing in these countries. Do politics matter? According to many current share prices they don’t, but in the long run a sensible political situation backed by a decent legal system is pretty much the main driver for economic activity.

Singapore has stability, a clean and competent bureaucracy and efficient courts. The system isn’t perfect but it is by far the easiest place to do business in Asia which is why we and so many others are there and the reason for its success.

Indonesia has a thriving democracy, a terrible civil service and dodgy courts. Little over a decade ago it was still ruled by the firm hand of General Suharto and there are those who argue this was better. I don’t agree. The country did boom in the nineties along with the rest of Asia but under that administration the excesses which led to the catastrophe of the financial crisis were allowed to build up. One hopes that a vocal opposition and a free press will act as a counterbalance these pressures in the future, not that the country is enjoying them currently.

Indonesia’s problem is that the system is not creating a conducive environment for investors. Estimates put the number of people who would happily work for a couple of bucks a day or less at around 40 million but headlines still report closure of foreign owned factories rather than their opening. The country sits on vast oil reserves in nice warm, easily drillable seas yet is still an oxymoronic oil importing member of OPEC.

I will concede there has been some improvement but simultaneously parliament has been passing increasingly nationalistic and populist measures with at least one eye on the election, which is not due until 2009, so we can expect more of the same. An example is the introduction of minimum wage legislation, one reason cited for the closure (and relocation to Vietnam) of a factory on Batam earlier this year. The regional governments are free to decide their own minimum wages thus increasing the uncertainty as to what an employer will actually have to pay, which according to my old economics text book is not a good thing.

The good news is that the checks and balances of a functioning democratic system are unlikely to lead to coups or revolutions, so one can expect the kind of stability they are not currently experiencing in the Philippines and Thailand for example. There is clearly enthusiasm at the presidential level to implement the kind of reforms required to attract foreign investment and reduce corruption, but whether there is much will to do likewise lower down and at the implementation level is questionable.

Given the ratings of some companies in Indonesia at the moment it would definitely seem that the market values the ability to do business there rather highly; rather too highly in some cases we feel.

The political scene in Malaysia is getting interesting as the government reacts in heavy handed manner towards dissenters. Street demonstrations are not illegal in Malaysia but one does require a police permit, something the opposition allege is nearly always denied to them but granted to the other side. There have been two street demonstrations recently, neither of which had police permission.

The first, organised by a group called BERSIH, attracted about 20,000 supporters (4,000 according to the government and 40,000 according to the opposition) and was a rally to call for an overhaul of the electoral system which this coalition of NGOs allege is stacked against the opposition. This turnout was despite police roadblocks all over the country in an attempt to stop people attending. It passed off fairly peacefully until the police, out of boredom I think, lobbed a few tear gas canisters at the crowd who were refusing to disperse. This was captured by an Al Jazeera journalist and the station was heavily criticised by the Malaysian government for airing the clip.

Malaysia has to keep a lid on ethnic tensions and therefore the rally by the Hindu Rights Action Force (HINDRAF), attended by 10,000 ethnic Indian roadblock-dodgers, has stirred things up rather. Ostensibly the rally was to deliver a petition to the Queen of England for Queen’s Counsel to represent the Indians’ claim for restitution from Great Britain for bringing their forefathers here as indentured labourers and then leaving them in Malaysia, where they believe they have been marginalised.

The plan is to sue for £4 trillion which apparently works out at U$1 million for every Indian in Malaysia. I’m not sure what their chances are, but the (Indian) man who delivers my newspapers said he has no plans to resign from his job as I handed him a copy of the fund’s subscription forms.

The real issue is to highlight the plight of the ethnic Indians who allege they been left behind and discriminated against. The problem as the authorities see it is that this was a protest based on race which is rightly sensitive. The government’s response has been to detain the leaders without trial under the Internal Security Act (ISA). The use of such draconian measures is almost an admission that they haven’t done anything wrong, otherwise not why not charge them and put them on trial. Given the racial nature of the march the government will argue it didn’t really have much choice in its response, but its actions smack rather of shooting the messenger and it is definitely the last thing they needed ahead of expected elections early next year.

The market hasn’t let these issues worry it recently, preferring to take its lead from Wall Street. Rest assured that if markets do turn down then investors will take the politics a bit more seriously and begin to wonder why they are paying such high prices for developing nations’ stories.

Outlook

My past year-end newsletters have tended to be bearish on the markets and I see no reason to change my views now they are even higher. What seems odd is just how well things have held up given all the scary news we are getting from the US.

Worries about the state of banks and housing markets in the US and elsewhere seem to be dominating news bulletins. I have in the past compared financial coverage by CNN & CNBC etc. to weather reporting but, to reiterate, these broadcasters have worked out that reporting these issues costs virtually nothing; certainly much less than flying a journalist and camera crew etc. to a place where something is actually happening.

CNN recently aired a five minute report covering winter storms in Oregon that killed two people during a half hour bulletin of world news. That the weather is bad in Oregon in December is hardly newsworthy but it is cheap to cover. That is why there is so much on TV about climate change. It is just weather reporting, often costing nothing as viewers submit their own videos of heavy rain, and one reason why the media won’t drop this one. Each flood is treated as a calamity and the fallacies such as floods being the result of changing weather patterns rather than human activity is perpetuated.

So imagine you are the head of CNN’s news service. You have half an hour to fill (25 minutes net of adverts). Easy: 5 minutes on Iraq (journalists already in place); 5 minutes of George Bush and Osama Bin Laden sipping tea in the White House (journalists ditto); 5 minutes of calamitous blizzards at the North Pole (sent in by an Eskimo from his mobile).

Now what is the cheapest way of filling the remainder? Even easier: let’s get some investment bankers to talk about the sub-prime disaster, the collapse of the housing market and the forthcoming bankruptcy of all hedge funds for 5 minutes. And then let’s have another bunch of City sages giving us their latest guess as to whether interest rates will go up or down. Cost of the last 10 minutes? Not a lot. They’ll all come on the show for free.

The only risk is that one of these experts might say something like there isn’t much of a problem, that the measures taken will deal with it or that it is normal for stocks to fall a bit. If it isn’t a disaster there is no story so whatever you do, do not broadcast anyone who is not sensational.

I’m not saying there isn’t a disaster waiting to happen but I would argue it is at least possible that things aren’t as bad as they are made out to be.

As investors with a bottom-up long term approach we at Pangolin are not too bothered by falling markets. We aren’t particularly bothered by monthly performance and we certainly don’t invest with the month’s end in mind. In fact, conditions seen by shorter term players as challenging usually present us with the best opportunities.

As I have previously stated, there are plenty of great investment opportunities in the markets we cover. We consider our portfolio to be conservative, attractively valued and most importantly, that the businesses themselves can withstand any slowdown.

So, despite all the gloom and doom in on the telly, the region contains many well-managed companies with excellent growth prospects, trading at significantly lower valuations than their Western peers. An increase in M&A activity is beginning to unlock some of this value and we remain confident that the fund’s bottom-up approach has good chance of providing respectable long-term returns.

Lastly I would like to thank the directors of the fund and Management Company, my colleague Vinchel Budihardjo and my secretary Zubaidah for all their hard work.

Merry Christmas and happy New Year to all those who recognise them,

James Hay.