Putting aside the short term noise in the market at the moment, Asia represents a huge opportunity both for investors and the Australian economy at large over the next decade.
A growing Asian middle class is changing the way it consumes and increasingly demanding everything from higher quality food to online shopping products and top class education for their children.
According to Forbes’ most recent rich list there are now over 300 billionaires in China, which is over half the number of billionaires in the US. This number has swelled from just 64 billionaires in China in 2010, indicating the size and scale at which the Asian powerhouse economy’s number of high net worth consumers is rising.
This trend also has significant impacts for the Australian economy, with China being Australia’s largest inbound market for overseas visitor arrivals, and largest market for total tourist spend and nights stayed per trip, according to 2018 Tourism Australia figures. The local economy also benefits from rising Chinese demand for quality education, with 10 per cent of all Australian university students now hailing from China, according to the ABC.
But opportunities to tap into the Asian growth story don’t just stop at China. Economies such as Vietnam, which have benefited significantly from rising Chinese manufacturing labor costs, are expected to double in size by 2050, according to PwC statistics. Malaysia is now the third wealthiest nation in Southeast Asia after Singapore and Brunei, and is growing at around 5 per cent GDP per year, according to the World Bank.
All this is at a time where decent yields and capital growth opportunities in developed markets are becoming increasingly harder to find. With Australian interest rates predicted to hit 0.25 per cent in 2020, retirees are becoming increasingly tempted to move up the risk curve in order to satisfy their income requirements. Putting aside current volatility as a result of Coronavirus impacts, valuations around ‘safe’ blue chip stocks are also becoming increasingly stretched as interest rate cuts continue to inflate asset prices in developed economies.
So beyond the clear economic benefits for Australia as a whole, could there also be opportunities for adviser clients to boost portfolio returns by tapping into markets, sectors and companies with exposure to the Asian middle class? While investors should be cautious about expecting immediately easy money from emerging Asian economies, there is also a longer term growth story that warrants a considered look at the way client asset allocations are structured from a strategic perspective.
An increasingly sophisticated consumer
When it comes to long-term growth trends, there are two in Asia to take note of - overall population growth, and the growth in sophistication of the consumer. This second trend may be of the most interest when it comes to investment opportunities, says Fidelity cross-asset specialist Anthony Doyle.
“If you think about the next 1 billion people to enter into the global middle class, 90 per cent will reside in Asia, [and] by 2030 65 per cent of the global middle class will reside in Asia,” Mr Doyle says.
“This is a growth story that is firmly in place, and the type of sectors and strategies that we like are those companies that are likely to benefit from that theme of consumption growth, for example online education service providers, online grocery, e-commerce and express delivery, and innovative health care solution providers.”
With middle class population growth shifting so far in favour of Asia, even small changes in the lifestyle of populations in Asian markets can have massive effects on the dynamics of the global economy, Mr Doyle says.
“As people grow wealthier and move up the consumption chain, the first thing individuals tend to do as they move up from low to middle income is improve their diet,” he says.
“You could see demand for protein grow as these countries get wealthier, and at every point in the agricultural food chain you will see companies that stand to benefit from that theme. It has implications for land use, infrastructure, agricultural machinery, even implications for marketing products and getting them into supermarkets.
“That’s why you see so much growth in Asia in particular as the population is growing wealthier and they are starting to consume items we take for granted in the more developed economies. They are growing at a pace we haven't seen before in history.”
Hexavest portfolio manager for global emerging markets Jean-Christophe Lermusiaux says Chinese and Indian consumers have grown so sophisticated in some cases that these economies are likely to overtake developed markets in terms of the products they are both demanding and producing.
“Whilst the Western world should keep technological leadership over the next 10 to 15 years, Asian countries are already making breakthroughs, and should continue to do so, in several key domains such as telecommunications, biotechnologies, advanced computing, rockets and satellites,” Mr Lermusiaux says.
“Importantly, the most advanced Asian countries will drive new kinds of consumption such as e-education and new forms of online leisure. Indeed, China and soon India will take advantage of their huge installed base of internet users and rising middle-class to overtake the West in some segments.
“For instance, having a credit card is already considered obsolete by millennials in China – they have already been paying with Alipay or WeChat pay for years, with everything they need being integrated in super-applications.”
Indeed, China in particular has grown to be such an important driver of economic growth across the globe that its trade wars with the US during 2019 and the recent outbreak of Coronavirus have had implications for global market volatility that have not been seen before, Mr Doyle says.
“We had SARS in 2003-4 and certainly there wasn’t the same sense of market reaction as today for example in terms of the coronavirus, that goes to reflect China’s increasing importance not only in term of size but as a driver of economic demand, its place in the global supply chain,” he says.
“You’ve seen in terms of the last 24 months trade tensions between the US and China, and in terms of the importance of Asia and the region to our growth in coming years it will be of increasing importance - that is not too difficult to see when the majority of the world's population resides in the region.
“In terms of Australia, the reason we’ve had 29 years of uninterrupted economic growth is because we’ve been close to this powerhouse of economic growth in terms of Asia.”
Look beyond China for opportunities
However, China isn’t the be all and end all when it comes to economic growth and opportunities for investors. Mr Doyle says trade tensions between China and the US in particular have shifted economic benefits more evenly across Asian markets as other players have come in to play a bigger role and fill gaps in the supply chain.
“It’s been interesting to see as trade tensions developed over the course of the last couple of years, supply chains started to move out of China so that export into the US didn’t attract tariffs, and the beneficiaries were countries like Vietnam” he says.
“Equally with producing low-end manufacturing items like clothing and textiles, it is cheaper to manufacture in a country like Bangladesh where wages are lower than China. As China moves up the manufacturing scale in terms of low-end to high-end manufacturing like TV and cars, the other regions are starting to step into that gap being vacated in terms of the lower end of the manufacturing scale.”
ETF Securities chief executive Kris Walesby agrees that some of the macroeconomic challenges faced by China could see other populous nations such as India eclipse the Chinese market in terms of the growth opportunities offered.
“Traditionally, China has been the primary focus [for investors] but its economic slowdown as it moves to a consumption-driven economy, as well as the challenges it faces managing the coronavirus outbreak, have led many to look to alternatives,” Mr Walesby says.
“India, for example, is expected to see the percentage of households in poverty drop from 15 per cent to 5 per cent by 2030 and its population is set to overtake China by 2024.”
Malaysia is another key market which is expected to be boosted by incoming flows of capital from international investors as it officially reaches ‘developed’ market status, according to Mr Doyle.
“Economies like Malaysia are wealthier and on some metrics they are more advanced in terms of their journey to developed markets,” he says.
“Malaysia is expected to be a developed market by 2021, and what that means is as these markets move in classification from EM to developed they find it easier to attract capital and foreign inflows, so international investors are more willing to invest.
“So it’s a bit of a misnomer to classify Asia as China because it's a lot more diverse and the opportunities are extensive, but that’s not to underplay the importance of China.”
Mr Lermusiaux also identifies several Asian economies outside of China, including India, Indonesia and the Philippines, as well positioned to benefit from population demographics that are shifting in favour of young people rather than the ageing populations surfacing in developed nations.
“There is a tremendous growth potential in those countries, provided that they are able to provide jobs to young people entering the workforce – which will be a challenge for some of them,” Mr Lermusiaux says.
“As for China, the active population has already started to decrease, which is a long term negative for economic growth; however, this should be mitigated by the ongoing migration to cities and by the proportion of families entering the middle class, which is rising fast.”
Putting the Asian growth trend into practice
So what do these trends mean in a practical sense for investor portfolios? Mr Doyle says advisers may need to examine their clients’ strategic asset allocation and look to include greater allocations to Asia in the long term, in order not to miss out on the strong returns that should characterise the explosion of the middle class in the region over the next decade.
“I think Australian investors are far too underweight the region - in strategic asset allocation or tactical allocations I’ve seen, youre talking about an allocation to EM of three per cent,” he says.
“Whereas if you look at the Future Fund asset allocation, they have a long term time horizon and they have a higher weight to EM equities than they do to Australian equities.
“You should never have 100 per cent of your portfolio [in Asian markets], especially if you are entering the decumulation phase, but to have a minimal allocation is an error that people might look back on in 10 years time as an error in allocation because they weren’t aware of changes going on structurally within the region.
Van Eck head of emerging markets bonds Eric Fine agrees that China in particular is becoming “a centre of gravity” for the world economy, which could bring about drastic shifts in global capital by 2030.
“The economy has already moved [towards China] - the next decade will be about the money and finance moving that way,” Mr Fine says.
“The end of that story could be China as a key financial capital and a preeminent reserve currency.”
However, Mr Fine similarly cautions that it’s important to diversify when looking at Asian exposures, particularly in the fixed income space.
“[Asian market] fundamentals are so strong that it is often hard to find high yields in Asia. As a result, most of our portfolios are diversified to include higher-yielding Latin America, a wide range of yields in EMEA, and even the lower yields of Asia, as long as there’s value in the yield relative to the fundamentals,” he says.
Mr Doyle says there is still a common misconception lingering from the Asian financial crisis of the early 2000s that many large Asian companies have poor governance standards, but policy changes since that time have ensured the country a bigger slice of global investor capital, with China having been added to MSCI’s global benchmark indices for the first time in 2018.
“The institutions and policy frameworks in place in these economies are vastly different compared to what was over 20 years ago,” he says.
“I fundamentally believe in a world of low interest rates and low future expected returns from asset classes like fixed income, corporate bonds will increasingly look to those parts of the world that can generate that sustainable growth in revenue and the potential to generate higher returns for the long term investor.”
RWC Partners co-head of emerging and frontier markets John Malloy says the increasing sophistication of the Chinese government when it comes to managing the country’s economy means the Chinese market is well placed to manage any short term challenges.
“The Chinese government has been very disciplined with monetary policy and credit growth, even during the trade war with the US. There was a big increase in credit after the global financial crisis, and the market was flooded with liquidity, which led to over-investment in steel and other industries. But this has changed over the last two to three years,” Mr Malloy says.
“This means China has the flexibility to increase liquidity through monetary policy and fiscal stimulus if it needs to, especially if there’s a downturn from coronavirus. Any stimulus from China would also add to flows from other central banks, which would all add up to an uplift in global growth.”
Mr Fine agrees that economic fundamentals in key Asian markets have progressed closer to developed market standards, meaning there are significant opportunities to be had for investors chasing higher income.
“As a bond fund manager, the opportunity emanating is that EM countries offer investors higher yields, but this is due to the incorrect perception that EM countries’ fundamentals warrant these higher yields. Their fundamentals are fine, so the higher yield is a very attractive opportunity for investors,” Mr Fine says.
While investors used to consider Asian markets a high-risk investment, many economies have now developed to such a degree that fixed income assets in these markets operate on a closer level to developed market bonds, Mr Fine explains.
“A lot of these EM Asian economies have graduated economically, so their local bond markets rally just like US treasuries during big risk-off moments,” he says.
“Currently, Thailand and even Indonesia have done well in the year to date, despite the global risk-off [sentiment].”
This is also the case with Asian equities, which often trade at a discount due to the perceived governance concerns associated with emerging markets, and offer unparalleled exposure to the Asian consumer demographic trend, says Maple-Brown Abbott head of Asian equities Geoff Bazzan.
“Within China, reform of State Owned Enterprises (SOEs) offers an opportunity for investors,” Mr Bazzan says.
“Long standing corporate governance concerns at many of these companies have meant they often trade at a discount to their western peers. Progress has been in fits and starts, however more market oriented reforms (including shutting down excess capacity) would boost productivity, improve capital allocation and lead to a re-rating in many sectors.”
Risks do still remain when it comes to emerging market investing, which is why it’s important for investors to be selective and potentially engage an active manager with the expertise to fully assess any governance risks of Asian companies on the ground, Mr Lermusiaux says.
“There is a key question mark about how to balance higher growth and potential reward with the higher risks involved in emerging markets,” he says.
“Indeed, whilst growing and learning fast, emerging markets will remain more vulnerable for a while, having not reached the same degree of transparency as developed markets and being less efficient (and sometimes less liquid) than developed markets, which is a reason why we believe in active investing in emerging markets.”
When it comes to what the future holds for Asian economies and the impacts for advisers, the key is that while clients should not rush in, allocations to these economies may need to be gradually adjusted up to take account of the growth prospects that have been built in to these markets in the long term.
While the onset of coronavirus can be expected to have a short term impact, it’s likely these economies will bounce back better than ever once the immediate threat of the outbreak has been contained.
However, as fast as many of the Asian markets are progressing in terms of the sophistication of their consumers and improvements in economic policy and governance practices, because these economies are still emerging, individual company risks still exist, meaning investors need to be more selective in their exposures than when allocating to developed market assets.
When it comes to the Asian growth story, the opportunity for adviser clients is immense, but taking advantage of manager expertise, rather than a ‘do it yourself’ approach, is recommended.
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