New approach needed for investing in Asia
Investing in Asia is often seen as a high return proxy for global economic growth as Asian equity markets are seemingly dominated by macro-economic developments.
Investing in Asia is often seen as a high return proxy for global economic growth as Asian equity markets are seemingly dominated by macro-economic developments. Yet over the last 1, 2, 3 and 5 years the MSCI US Index in fact produced higher returns than the MSCI Asia Index. Coupling that with market illiquidity and volatility that periodically seem to beset Asia, this begs the question: is it worthwhile investing in Asia at all?
We believe this rear-view mirror on investing in Asia is both simplistic and myopic. Instead, investing in Asia is entering a "golden era" where a diligent fundamental approach guided by a genuine long-term mindset can generate substantial outperformance in spite of likely volatility.
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First, Asian capital markets have grown so much in depth and size that its aggregate market capitalisation now rivals that of the US and Europe. In this context, the emergence of global and local champions has created substantial investment opportunities. A decade ago, Samsung Electronics was a little known brand outside of Korea, but has now grown to many times the size of Sony and Philips combined. In China, banks and insurance companies did not even exist as listed entities 10 years ago, but are now the largest of their kinds in the world. Despite their lacklustre stock price performance of late, early investors made substantial returns.
Second, Asia is not a single homogenous market that can be subject to broad macro-economic conclusions. Instead, it is a diverse set of markets stretching from developed economies such as Australia, Japan and Korea to emerging ones such as China, India and Indonesia, bounded by intricate links and interdependencies.
Understanding and analysing these reveal powerful structural trends which can lead to investment opportunities, regardless of short-term macro-economic swings. For example, the industrialisation and emergence of the Chinese and Indian economies over the last and the next 10 years should continue to fuel demand for some classes of mineral resources from Indonesia and Australia. Companies able to service this need, such as in transportation links or mining services supply chains, will be long term winners.
Third, the boundary of Asia investing is no longer distinct. Many companies in the west are executing their corporate strategy by tapping into growth in Asia. For example, US-listed Mead Johnson experienced exponential demand from China for its high quality infant nutrition products; Swiss-listed luxury goods company Richemont which owns the famed Cartier brand has had remarkable success powered by rising affluence of emerging Asian consumers; and UK-listed Ashmore, an emerging market fixed income fund manager with an excellent long-term track-record, will continue to be a beneficiary of structural fund flows into emerging markets.
Lastly, the potential for outperformance in Asia is high precisely because the quality of management teams runs the gamut and the negative as well as positive impacts of structural trends tend to be amplified by scale. For example, the flipside of rising incomes is an immense cost challenge for Asian labour-intensive export-oriented manufacturing companies. Corporate governance issues, such as a lack of profit objectives of state-owned enterprises, dominant entrepreneur owner-operators with misaligned incentives or even outright fraud by company management, will haunt the stock price of many companies.
It is precisely these risks that will delineate between winners and losers, creating greater dispersion which provides substantial outperformance potential for talented fundamental investors. To illustrate, the spread in total shareholder returns between the first quartile and third quartile Asian stocks in the last three and five years is 30% and 20% respectively. The same spread for the EU stocks is lower at 25% and 16%. For US stocks is even lower at 20% and 13%.
Asian markets will continue to be a volatile asset class with periods of panic and euphoria over the market cycle. On the surface, it is tempting to take a "ro-ro" (risk-on-risk-off) approach to investing in the yo-yo Asian markets.
However, few investors will be able consistently to navigate short-term directional bets without being wrong-footed by Mr Market. A more constructive approach is to take an "over-the-cycle" multi-year fundamental view to investing in Asia.
Instead of thinking of the long-term as a series of short-term investment decisions, it is now possible to see the short-term as a series of contractions of the long-term horizon. Herein lies the real opportunity for Asian investing.
John Ho is the founder and chief investment officer of Janchor Partners