Embracing the elephant in the room

Asian equities look to be on course to deliver strong returns over the long-term and planners are starting to look beyond the stigmas that are attached to the region, Hope William-Smith writes.

Last year before taking office, Prime Minister Malcolm Turnbull suggested in a speech that learning to work effectively with the changes underway in the Asia-Pacific would be a challenge for regional economies worldwide.

Questions of sovereign instability and currency risk have historically plagued investor sentiment toward Asia, but industry experts believe now is the time for Australians to embrace the elephant in the room and allocate capital to attractive markets.

Despite the stigmas and taboos attached to Asian markets, planners are starting to view Asian equities in terms of domestic demand and local consumption, according to Macquarie Group head of investments Asian listed equities, Samuel Le Cornu.

"There is a significant trend towards international investing…so we believe that diversifying portfolios away from domestic [Australia] buyers is something that will only continue," he said.

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"Financial advisers are persisting more and more for their clients to achieve more diversification in their portfolios and Asia is certainly going to have a strong role to play."

With close to 50 countries and investment options no longer limited to one or two headlined economies, the region comes with a plethora of challenges.

When tackling Asian equities, the general consensus across the board was to proceed with caution, thoroughly assess risks, take on challenges when they arose, and embrace the growing yield benefits.

Morphic Asset Management chief investment officer and managing director, Jack Lowenstein, said: "You should know when to favour Asia over the world, and it's not all the time".

"There will be very good opportunities heading into Asia in 2017, but I don't think it will be as simple as to say Asia is a trend — there will be both winners and losers."

WHAT FLOATS YOUR BOAT?

Fidelity International investment director, Catherine Yeung, said that geopolitical tension and political shifts were consistent in altering how Australian advisers viewed Asia.

"Whether it's India, the Philippines, or China, you can't move too far away from policies because reforms and a proposed reform agenda across the region is really vital for future economic growth and development," she said.

"You have to be mindful of how those policies will impact industry dynamics and companies."

Antipodes Partners chief investment officer and portfolio manager, Jacob Mitchell, said there was gravitation away from emerging Asian markets, and equity investment opportunities were increasingly under economic scrutiny.

"We have seen views on Asian equities shaped by near-term macro concerns such as the Chinese economy, with advisers having a natural gravitation towards developed market equities due to these," he said.

"[Investors] have a tendency to stick to what they know — towards developed markets."

Mitchell said Australian investors were increasingly putting their money into Asia's markets and called Asia an "opportunity for resilient businesses at attractive valuations".

"Prevailing wisdoms and cultural differences are being re-examined; investors are finding that Asian corporates are fiercely globally competitive and leaders in innovation," he said.

"Being on the hunt for yield and buying predictability in the absence of growth have been large drivers for investors around the world. Asia has been no exception to that."

Mitchell said investors should increasingly look to diversify their portfolios into world leading Asian IT and technology companies in countries like Taiwan.

According to Pengana Capital fund manager, Vikas Kumra, while East Asia promised plenty of opportunities in equities, they should be treated with caution.

"There are a number of different ways to take advantage of the investment opportunities in the Asian region and traditional long only funds don't always do so," he said.

Willingness to purchase equities in Eastern Asia is largely controlled by the economic volatility in China, and planners have been cautious to open up to the sector.

"We continue to see advisers acting cautiously when considering Asian equities. Advisers have been worried about the slowdown in China and the volatility in these markets," Kumra said.

"Many advisers are concerned about the macro uncertainties in this region and see the Asian equity market as characterised by high volatility. When they think of Asia, they think largely about China."

THE DRAGON'S COUNTRY

Asset manager, BlackRock, believes a new approach is needed to tackle China, post the economic turndown.

According to Blackrock, the Yuan devaluation, market sell-offs, and the impact of the increasing middle class on market sectors could deter investors that were already concerned with the varying policy and economic trends in China.

Le Cornu said the most stable industries in China were those that fit the structural growth story of the burgeoning middle class — simple businesses with recurring earnings.

"We see very good reportings in industries such as healthcare, consumer discretionaries, staples, and services sectors," he said.

"It is an arm wrestle between the negativity of non-performing loans and the financial system in China, versus the growth in consumption and growth in services.

"The consumption story is winning and that's adding a lot of confidence for investors to come and invest in Asia."

According to Yeung, prior to the Global Financial Crisis (GFC), China and Hong Kong were viewed favourably by Australian investors, and currently investor interest is returning thanks to the transition of China's economic model.

"The Chinese are transitioning their economic model, so focusing less on fixed asset investments and exports, and looking at consumption and services. Hence, the attraction in China is more the tourists, not just resource demand," she said.

"We know the Chinese economy is slowing… as minority shareholders, you have to think, what does it mean for me? There is this concern about transparency when it comes to China."

Yeung noted that China's stance as an emerging market, with a relatively new capital market, translated to a small foreign access window, and a volatile equity market.

"As foreigners, you can start really looking at the Chinese market, because [investors] have really shied away over the past couple of years," she said.

"China is still having a big influence — everyone is trying to grab a slice of that pie."

THE JEWEL IN THE CROWN

Asian equity markets look to be on course to deliver strong returns over the long-term due to attractive values and easing monetary policy, and liberalising economies have begun to emerge.

Morphic Asset Management chief investment officer and managing director, Jack Lowenstein, said that India had provided a solid foundation for portfolio diversity.

"India now is really exceptionally promising. South East Asia… is about to enter the middle income bracket where traditionally fast-growing economies tend to slow," Lowenstein said.

"India is not yet rich enough to fall into the middle income trap, and so probably has quite a few more years of rapid growth ahead.

"In places like Thailand and Malaysia growth has slowed quite a lot and they are running into all sorts of complications in their economies as they reach that very difficult phase."

Le Cornu said that while smaller economies in South East Asia could pose risks, investments in Indonesia, Singapore, and the Philippines had recently yielded satisfying results.

"It has been a relatively volatile year to date and therefore I think the process of being bottom up and looking at companies through a microscope is the right way to risk-adjusted returns for clients," he said.

"Indonesia, Philippines, and Thailand are up and benefitting from the tourism dollar and the rise in their middle class. South Korea, India, and Hong Kong are lagging now but are strong long-term stories."

Anderson said that North East Asia was the most promising region, and that Taiwan and South Korea were now stand out markets over China.

"A lot of people shy away from China because a large part of their equities market is state-owned and not run for profit. State-owned enterprises don't care so much about shareholders," he said.

Anderson urged planners and investors to "look through the noise" and consider risk and return within each sector and market.

"There is little correlation between the GDP [gross domestic product] growth of a country and what actually happens in the stock market," he said.

"It is all about the underlying investment case, whether the valuation stacks up and whether the fundamentals stack up."

THE LAND OF THE RISING SUN

BetaShares managing director, Alex Vynokur, said global volatility had been reasonably subdued and created an impetus for people to buy equities, particularly across East Asia and in Japan.

"Japan in particular has started to come onto people's radar. Australians have always viewed Japan as that stagnant, slow market, but returns have been quite strong from Japanese equities," he said.

"In particular, if you hedge the currency, which a lot of Australian investors are now starting to really focus on, because Japan is pursuing a policy of devaluing the Yen."

Vynokur called Japan an under-appreciated investment opportunity and notes its strong diversification benefits for Australian portfolios.

"The economy in Japan is undergoing a stimulus program that is certainly creating a lot more energy and a lot more opportunity. For a market that really has been stagnant for the last few decades you are now seeing a significant pick up since the introduction of economics," he said.

"The hedge Japan index that we are tracking has risen 17 per cent and that is really off the back of improving fundamentals and improving confidence in the economy.

"It is very strongly over-represented in consumer discretionary industrials and IT where we have very little exposure, generally speaking, in Australian portfolios."

Anderson said investors were also flocking to Taiwan thanks to its burgeoning IT sector. The country's links to surrounding economies also provided strong benefits in domestic markets and this drove it to be labelled as one of the best emerging markets.

"You are not going to make money in opportunities that everyone else is on, you want to be where prices have fallen, valuations have become more attractive, like what has happened in Taiwan," Anderson said.

"You want to allocate toward those opportunities as opposed to trying to ride momentum in countries that have been doing well."

WHEN THE WINDS OF CHANGE BLOW

Anderson said thorough research and thoughtful consideration was needed before diving headfirst into emerging markets.

"Everything looks reasonably expensive. The one exception to that is emerging markets which look reasonably fairly valued to slightly cheap. It is where you will get a reasonable return for the risk you are taking," he said.

"In emerging market Asia, it's a big and diverse range of countries and it is hard to throw one generalisation at Asian equities. There are some countries that don't look very attractive at all, countries like Indonesia where it is very expensive, and also Thailand."

Vynokur also gave Thailand a red flag for the foreseeable future and said the way forward in Asian equities was through slow and careful navigation.

"If we look at a market like Thailand, it's been interesting to observe, but very few want to actually invest in a market like that," he said.

"Some economies are going through very significant challenges. We typically encourage investors to really look at developed economies as their first step and really be mindful of political risk and sovereign instability."

Lowenstein agreed that while Central Asia remained the most complicated region for investors to decipher, the new trend toward emerging market investment should be treated with caution.

"Planners should look for managers who have a range of cultural experiences. You need to find managers with a range of skills and I think it's important to let them make the asset allocation divisions between markets," he said.

Lowenstein was positive about emerging positions in Pakistan, but noted capital market challenges in India, and complexity and scale concerns in Asian Russia and Kazakhstan.

Yeung said that while trends and dynamic continued to evolve differently between countries, culture would continue to play an important role in the Asian equities space in 2017.

"Markets in Asia are cyclical, young and evolving, so there is a very different mindset to established markets like Australia," she said.

"Asia is not a homogenous region so the different economies, markets, and market dynamics… are all at different stages of the cycle."

Yeung pointed to the Philippines as the strongest macro market in Asia despite high cost, and that living and learning was the best way forward.

"The best thing that probably happened to Asia in hindsight was the Asia Currency Crisis of 1997-1998 because they really understand what it means to have austerity," she said.

"There are so many opportunities and risks, but true opportunities for investors is in this part of the world."