No mystery in value of Asian equities

Investing in stocks in Asia is not for the faint-hearted given the scope of the region and the range of investments on offer. However, as Jason Spits writes, accessing some of the most vibrant and growing economies in the world is not beyond the skill of financial planners. 

Financial planners looking to invest in Asian equities on behalf of clients who are unsure where to start have been given some simple advice — stick with what you know and then stay with it.

While the advice sounds rather simplistic, it is a valid strategy according to PM Capital Emerging Asia Fund portfolio manager Kevin Bartoli. He said that Asian equities have similar sectors and perform as well as Australian equities, except they are at an earlier part of their life cycle and thus offer growth potential.

"Comparing Australia with Asia shows the latter has the same type of investment sectors but they are further back in their life cycle. What worked here is likely to work in developing markets across Asia," Bartoli said.

"For example, we know how telco companies work here and what they offer and they are doing the same in Asia. These are the type of businesses we consider since they have large growth potential looking ahead."

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For Australian investors, and the planners advising them, it is worth keeping in mind that while sectors may mirror Australia there are still some unique aspects to the region that have to be kept in mind.

The first of these is that local stock and sector sentiment, particularly towards the banking sector, is actually the anomaly and not the norm around the world or throughout Asia.

Morningstar director of manager research ratings Tom Whitelaw said the Australian market "was a freak compared with other developed nations when it comes
to exposure to financial stocks" and this was not an aspect of markets in the Asian region.

The other large exposure in the Australian index — basic materials, ie: commodities drawn from the mining sector — also played a much smaller part in Asia than Australia while technology and cyclical consumer stocks played much larger roles in those markets than in Australia.

He said this was driven by a much younger demographic in many Asian nations as well as a growing middle class which had shifted their focus from producing goods to consuming goods, while also bypassing some stages of market development.

"Chinese manufacturing is a good example of this shift. It has shifted away from producing to consuming with the old adage of ‘made in China' becoming ‘made for China'," Whitelaw said.

"At the same time technology and population growth are bypassing the patterns seen in some sectors in developed markets. For example, landline telephone and internet services have never existed in some parts of Asia and consumers have gone directly from no phone service to mobile services."

"This has driven related sectors such as data suppliers, online commerce and hardware providers in a way that did not happen in Australia."

While this may sound like Asian equities are causing a paradigm shift in the way an investor or their adviser would approach Asian equities, AMP Capital head of Asian equities Patrick Ho said the fundamentals still need to be applied.

First among these is to remember that Asia is a region with multiple countries and investing in Asian equities was more than investing in China, even though that market seems to be the dominant concern for many investors (see: Can you afford to ignore China?)

Ho also stated that investors used to looking at Europe or North America had to shift from a single market approach to a number of separate approaches that considered the ten different economies, governments and currencies operating in the Asia region outside of Japan.

Ho stated that while sector selection was useful country factors were still the largest determinant on returns for Asian equity investments.

He cited the recent change of government in India as key example of a country-specific non-market related shift that had a flow on effect for investors.

"Which market an investor buys into is still very important. The recent election of Prime Minister Narendra Modi in India caused its share market to climb by about 30 per cent across the board after the election."

Ho said sector growth in Asia was being played out on a world stage with demand varying in specific sectors and even for specific stocks within those sectors that are performing well in their home markets.

"There are local stocks in Asia which perform better than the entire local market due to regional or global demand. In comparison other asset classes, such as property, can appear flat because the demand is local and limited," Ho said.

Whitelaw says this issue of global or regional demand is important to consider when investing in Asia because there are stocks which are truly Asian compared with those that are global but based out of Asia, Samsung being the most well known of the latter.

He says Asia is often considered an emerging market region but says this is a broad based term that needs to be applied in different ways in the region given its scope and range.

"We would expect more developed nations to have higher portfolio weightings as the less developed tend to be illiquid but developed companies in emerging markets blur these lines between country, sector and stock," Whitelaw said.

"There is a need to ensure investors access these markets via a fund structure because they are able to make the distinction between stocks that are suitable for Asian investors in their home markets and those suitable for foreign investors."

Given its growth profile does this mean investors in Asian equities should be seeking growth orientated managers ahead of value orientated managers?

Whitelaw said Asia was a growth managers' paradise, driven by China, but this also came with high levels of volatility and the growth/value issue was less clear and delineated in Asia than in other markets.

"The underlying style of stocks in Asia is fundamentally growth but value managers are still operating with success in the region," Whitelaw said.

Zenith investment Research investment analyst Quan Nguyen said differing market conditions in Asia made it less suitable to use labels such as growth or value and to instead focus on quality.

He said disclosure regimes varied widely across the region as well as with Australia and it was not always possible to get clarity around the fortunes of some companies and the equities on offer.

"Managers in Asia need to focus on quality and the levels of disclosure that are on offer. The question they are asking is if the companies they are looking at can be trusted with the investments the managers are seeking," Nguyen said.

"The separation into quality stocks can be defined by those in Asia and those operating out of Asia and this can limit the investments by fund managers. However as markets open up further and more companies are listed we can expect disclosure standards to move inline with those of developed markets."

Ho said investors looking for yield should not be deterred by the growth story inherent in Asian equities, nor the likelihood of volatility in the emerging parts of the region.

"There is a perception that Asia as an emerging market has higher volatility and that is true at a market level. However at the stock level it is not as bad as it appears. In fact Asia has been relatively stable in terms of performance and most people tend to be wide-eyed when I tell them it has returned seven to eight per cent over ten years," Ho said.

"At the same time dividend yield is about 2 to 2.5 per cent per annum but that is only a single number for the whole region. Yield in the banking sector is higher at 5 to 6 per cent. People have been skeptical of yield in Asia but it is more perception than reality."

Despite these positives Bartoli said Asian equities were not a short term investment and entering the region still required patience and timing.

"If investors are worried about growth and expense they will need to be patient. We advise people to ‘invest to be invested' and only to buy when growth is achievable," Bartoli said.

"At the same time many of these economies are mature in terms of their work forces and are being driven by fixed asset investments and high levels of GDP and population growth."

"You will see volatility in these sectors but as long as the equities are driven by underlying earnings from structural growth and not from macro-economic cycles the investors should benefit from a growing consumer culture which is being encouraged to drive Asian economies."

Can you afford to ignore China? 

China's scale and scope make it an attractive investment destination which investors should not overlook too quickly. 

Asia is not an homogenous region like Europe and has ten different economies, with separate currencies, government policies and levels of market development. For that reason, it can be tempting to avoid it in favour of something simpler. 

However, in doing so investors would miss out on one of the fastest growing, and maturing, markets in the world - China. 

According to data compiled by Morningstar the average country allocation to China by fund managers offering Asian equity products leads all others in Asia, at 22.64 per cent, well ahead of second place getter South Korea at 14.9 per cent 

AMP Capital head of Asian equities Patrick Ho said this focus on China is not out of proportion to the role it plays in the Asian region as a source of growth and returns and it was likely to continue. 

He said the new leadership group recently installed into the Chinese Government was pro-market and favoured reasonable economic growth and have been given the typical five year period in which to enact their policies. 

"The current leadership is more market friendly and funds flows to China has been favourable. We would advise investors looking at China specifically to keep their investments for five years which ties in with the length of office of the government, its current policies and economic plans, " Ho said. 

According to Ho, there was some merit in avoiding China in the past few years as valuations had become overpriced and gross domestic product (GDP) levels were not sustainable in the long term but both of these have returned to more realistic levels. 

"Price to earnings ratios have fallen from 30 times to eight times and GDP has dropped from 13 per cent, where it could not carry on, to seven per cent, as macro-trends die down with the new pro-market leadership. As such AMP Capital has taken an overweight position on China at 10 per cent higher than our normal weighting," Ho said. 

He believes the dominance of China in the region, but also among emerging markets, will continue to grow as its domestic equities market - called the China A market - is opened to further foreign investment. 

At present foreign access to Chinese equities is possible only for licensed institutional managers or via the Hong Kong and Shanghai stock exchanges but Ho said this market may be opened to foreign investors as well. 

If this does takes place China would become the second largest equity market in the global index by market capitalisation. 

At present it ranks sixth by full market capitalisation in the MSCI All Country World Investible Market Index but would trail only the United States if the China A-share market was also fully capitalised and included in the index.