This week we would like to visit perhaps one of the most controversial topics in the investment world. That is the case for investing in Asia, specifically why? And why now? The experiences of many investors in the past, especially retail investors, have simply not been the best. So why is it now the place to be?
Issues ranging from corporate governance, liquidity and currency issues are just some of the plethora of factors that have acted as hurdles for good long-term investments in Asia. To this day, much of the shorter term return is almost always determined (to a large extent) by currency fluctuations, specifically USD. However, the environment is gradually changing. This is not least motivated by a desire by regulators and governments across the region to develop their own domestic capital markets in a gradual and sequential manner.
At TAMIM we are firmly in the camp that equity market returns and to a large extent even debt market returns have very little correlation with underlying GDP growth. If this were not the case then the Chinese markets should have been the best performing on the planet over the past two decades. This is especially true in emerging markets, such as China, where business investment is funded primarily through debt rather than equity. As such, historically the equity markets have been the purview of retail investors with very little scope for institutional money or enhanced liquidity due to capital controls and general government policies that encouraged what was effectively a transfer of wealth from the household to the corporate sector (i.e. low rate of return on household savings passed on through lower interest on corporate debt).
Thus in the last two decades or so, despite Asia being a powerhouse of global growth and the rapid digitalization of APAC economies more generally creating massive opportunities, this was unfortunately not reflected in equity market returns. Even the perceived “safe economy” of Japan has underperformed its global counterparts. Nevertheless, the changes to the global economic order (as shown in the graph) below make it a region that is hard to ignore. In fact, one could even go so far as saying that not having exposure to this region is rather detrimental from a risk perspective. In the same way as ignoring the banks on the ASX is ignoring 30% of the index, ignoring Asia is ignoring the most populous and fastest growing economic block on the planet.
Changing Demographics & Changing Economies
The first reason to invest in Asia is simple: the middle class. The past three decades of stupendous growth has seen a massive shift in the social order and nowhere has this been more evident than in the rise of the middle class which is set to grow at close to a double digit pace until 2030.
For western investors investing into Asia, this trend offers quite a unique opportunity given this scenario is the exact opposite of what most developed economies have seen. As the graph above shows, there has been a stagnation and in some cases a hollowing out of the middle-class in the western world. In time, we firmly believe that a transition from export-led to consumption-led growth will take place in Asia over the next few years. This creates opportunities in sectors ranging from consumer discretionary to infrastructure to luxury goods. This was most apparent in China where companies like Treasury Wines and A2 Milk saw their market capitalisations and revenue numbers skyrocket on the back of demand from Chinese domestic demand.
The transition towards consumption led growth is also apparent South East and South Asia including Thailand, Vietnam and India which, given its huge (and young) population, is starting to realize the futility of having an export led economy. All this is likely to be catalysed further through government policies as a result of the trade disputes. One of the key things that we will see as a result of the trade war is a recalibration of supply chains with Asia consolidating internally. This might be in the form of Chinese corporates making investments and doing more business with countries like Taiwan, South Korea or Indonesia, thus creating opportunities for investments across these countries which are likely to see significant tailwinds as a result of Chinese investment. The other elephant in the room is the perhaps overly ambitious OBOR (One Belt and One Road) initiative. This should create massive shifts in trade networks as well as a gradual industrialisation across South East and Central Asia where the initial focus will be on labour intensive industries that are no longer economic in China as a result of wage growth.
Ironically, we are of the belief that, depending on where one looks, the trade war is likely to be good for investors. This might sound a little counterintuitive but it is nevertheless true from our perspective. The increased expenditure on infrastructure, policies that stimulate consumption growth, the recalibration of supply chains ranging from semiconductors to high-tech will make the economies more inward looking (regionally that is) but create opportunities in certain sectors including financials (and insurance) and technology companies. However, this comes with the caveat that much of the short-term return will be hampered by volatility as a result of the USD and other currency fluctuations.
Corporate Governance: It’s no longer the Wild, Wild West (or East we should say…)
As mentioned, one of the key characteristics of corporates across Asia historically is their reliance on debt as opposed to equity to fund growth and expansion. For a plethora of reasons (mostly to do with government policy), this has remained the case until quite recently. The active policy of creating national champions through Chaebols in South Korea and Kieretsu firms in Japan has resulted in a reality where firms were hampered and in many case lagging exceptionally on issues ranging from corporate governance to shareholder protections. This has been changing gradually though, first in Japan but more and more so across the region with regulators putting greater emphasis upon bringing disclosure practices up to scratch with their western counterparts. This is also becoming increasingly obvious in Hong Kong, though the recent allowing of the dual-listing of Alibaba is rather disappointing (given the nature of the securities traded and the protections given to investors).
It must be recognised that these changes are likely to continue for the foreseeable future. The incentive for governments and regulators is now substantial. Not only are household savings some of the highest in the world but the development of equity markets and institutional capacity will mean a substantial decrease in the cost of capital and less reliance on credit to facilitate future growth (which is a substantial problem for the People’s Bank of China). Furthermore, the lack of liquidity and reliance on USD across most of the region, with the potential exception of Japan, creates a substantial headache and risk for the long-term sustainability of their own domestic markets. We firmly believe that the Chinese government now has an incentive to not only ease up capital controls but to encourage the development of capital markets through transforming some of the household savings into investment capital as well as domestic demand.
One of the biggest hassles with regards to Asia is the headache around volatility. We have yet to speak with an investor who does not know the rationale and attractiveness of having investments not only from a diversification perspective but the long runway for growth. The market is, in the medium term, going to be primarily driven by liquidity in global markets and currency fluctuations (i.e. when USD goes up money floods out of emerging markets to US denominated securities and vice versa). Given this to be the case, it might be surprising that we are making the call that Asia looks particularly attractive now. Simply put, here are some of our reasons: valuations, institutional money and, as previously mentioned, government policy.
In terms of the time frame, one of our best performing markets over the past year or so has been Japan. This is a market which, as mentioned in previous articles, is one of the few developed economies that has seen the futility of its QE policy and is now reversing course. What we believe is that, given it trades at a deep discount, we will not only see more interest from an institutional perspective but also a re-rating of the broad-based index. Investors often tend to forget that the Yen is the other safe currency of the world outside the CHF and USD. We continue to invest in Japanese companies with great supply chains and innovative capabilities as well as target markets across South East Asia. At the same time we are carefully picking value stocks across South Korea, Hong Kong (i.e. China) and Taiwan. The specific focuses across these markets is not so much the bigger names but sectors that focus specifically on domestic markets (as opposed to export led) and typically have a higher than average dividend yield. Companies like Ping An, China Lesso or Sojitz are particularly attractive given their valuations as well as significant catalysts that will cause a re-rating over a 24-month timeframe.
We also think that, at the very least, a surface level deal will take place for the trade dispute over the next four months or so. However, the damage has nevertheless been done and hence, even if a resolution does take place, the continued disentanglement of the economies will create opportunities for discerning investors across Asia. For example, the fact that Huawei can no longer source components from the US just allows it to look elsewhere, like Taiwan, or to build capabilities within the Asia Pacific region.
Markets & Commentary
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.