What advisers should do about the Asian downturn
It's no secret that Asian equities are in for a rough 2016 – there will be more volatility and more uncertainty. But should financial advisers disregard the asset class? Or seize the buying opportunity that the downturn presents?
THE ASIAN story is one of long-term growth. The demographics are favourable, reform is underway and the economies within the region are beneficiaries of the falling oil price. India is also emerging as a bright-spot, with significant potential for patient investors who have an eye for growth. But Asia's benefits as a long-term investment destination are seemingly being overlooked in the face of a slowing China and tightening US monetary policy.
"It's going to be a very dynamic year with a lot of moving parts, which makes it that more challenging," says Saxo Capital Markets director and global macro strategist Kay Van-Petersen.
The numbers don't help either.
The MSCI AC Asia ex Japan Index was down -7.72 per cent as at October 2015 – underperforming the MSCI World Index by over 9 per cent, according to investment management firm T Rowe Price.
While it's easy to get distracted by short-term pessimism, the buying opportunity that the downturn presents should not be discounted.
Anh Lu, portfolio manager at T Rowe Price, is confident that Asian equities will bounce back.
"If earnings growth improves in 2016, as we expect they will, this could support an upward rerating of the Asian index," she says.
With this in mind, now could be the time for advisers who are willing to execute a long-term investment strategy to allocate to the asset class and position for growth.
The value in volatility
For a value-focused investor with a long-term mandate, now is the time to buy. Peter Sartori, head of Asian equities at Nikko Asset Management, says favourable Asian companies are trading at a discount to intrinsic value.
"This is a real opportunity to buy the best Asian companies at really attractive valuations. While sentiment is so poor and valuations are so attractive, it's the perfect time, at the very least, to consider getting some exposure [to Asia]," he says.
AMP Capital's head of dynamic markets, Nader Naeimi, agrees and says that if advisers have portfolios to diversify, buying assets "cheap and un-loved" makes sense.
He argues that the Asia-related positives, which are currently ignored, will return to have a broad- based and positive impact on the asset class.
"When it comes to Asian demographics and investment returns, the long-term story for Asia is still quite positive," Mr Naeimi says.
Sam Le Cornu, head of investments for Asian listed equities at Macquarie Investment Management, is also confident that the fundamentals, not negative sentiment, will prevail.
"What we're seeing at the moment is fundamental value, so we believe the patient investor that has a buy and hold mindset, over the long-term, should do reasonably well," Mr Le Cornu argues.
Standard Life Investments fund manager Alistair Veitch reinforces the notion that the downturn should be looked on as favourable from an investment entry perspective.
"For investors with a long-term investment horizon the current market volatility is resulting in good investment opportunities.
"Market valuations on an asset basis are at or near crisis lows. Short-term volatility is likely to continue but investors with patience should be rewarded," says Mr Veitch.
It is impossible to ignore the influence of China when evaluating Asian equities. Considerable attention has been paid to the country's slowing growth rate, with official GDP growth coming in at 6.9 per cent for 2015 and 6.8 per cent for the fourth quarter of 2015.
But while China is slowing, JP Morgan Asset Management vice president, Kerry Craig, says it's important to remember that growth is not collapsing.
"There's still a large portion of the Chinese economy – that is consumption and services – that are still working quite well," he says.
Mr Le Cornu reiterates Mr Craig's argument: "We believe strongly that China's not faced with a hard landing; it is slowing, [but] it is slowing at a pace which is manageable," he says.
China, Mr Le Cornu points out, is transitioning its economy away from one that is import-orientated to one that is consumption-driven. As a result, sectors and stocks that benefit from Chinese consumption are bound to do well over the long-term.
Advisers can find opportunities in businesses such as healthcare, consumer discretionary, local products and services, he adds.Meanwhile, chief investment officer of Asia Pacific ex Japan at AllianceBernstein (AB), Stuart Rae, says the negative sentiment applied to China should not be extended to the "new China" or consumption-driven China.
"The new China of consumption and services... is benefitting from the government's attempt to increase these sectors' share of the economy. We see, for example, opportunities in companies involved in the internet and education."
Hedge the risk
David Sokulsky, head of investment strategy at UBS Wealth Management, believes China still makes sense from an investment perspective.
"There is risk to the downside but fundamentally the economy is still going to be okay and when you look at the valuations they look pretty attractive," he says.
However, Mr Sokulsky reminds advisers that investing in China, and Asian equities more broadly, is a client-specific exercise.
"For an adviser, they've got to weigh up what their client's risk profile is and understand whether taking risk in [China] is for them. Advisers need to look at the risk, which is heightened at the moment, and look at the return potential."
For advisers who are willing to take risk in China, it's important to hedge against it – "play it in a two-pronged attack", he says.
According to Mr Sokulsky, investing in fundamentally strong companies that will benefit from falls in the Chinese market is a good way to mitigate risk and protect capital.
"If you are going to go outright into China on the long-side, you probably want to add some European or US equities as well.
"If China comes down, the Australian dollar comes down, [therefore] US and European equities will benefit from the lower Australian dollar," he explains.
India is a "long-term structural play", with "high risk and high reward", says Saxo's Mr Van-Petersen.
"From what I look at, it's macro, it's top-down and all you're trying to do is find strong winds to put behind your back, strong currents to basically go down river with and India just has a layer cake of all of these different things," he says.
Research by Saxo Capital Markets indicates that 50 per cent of India's population is under the age of 25, with 65 per cent under the age of 35. The country's prime minister, Narendra Modi, also has significant political capital and is on track to follow through on much needed reform, notes Mr Van-Petersen.
India is Nikko Asset Management's largest overweight at a country level, says Mr Sartori, adding that from a macroeconomic point of view, it remains favourable.
"[India] is interesting because it's starting to realise some of its potential. In recent decades India had underwhelmed on the macro side, but some very well managed companies emerged... [and] these companies are now operating in a better macro situation," he says.
Mr Sartori explains that in a regional and global environment where growth is slowing, India stands out as a market where growth will likely accelerate.
Mr Van-Petersen adds that when considering investing in India, advisers need to understand that capital will remain "locked up".
"You have to sit on it – it's not even a one-year trade, it's at least three, five, 10 years. You have to go in with a perspective that it's not going to happen overnight."
US monetary policy: a key risk
One of the most significant risks for advisers to consider when evaluating Asian equities is the influence of US monetary policy on the region.
Macquarie Investment Management's Mr Le Cornu says that when considering the impact of US monetary policy on Asia, it must be looked at relative to what the People's Bank of China (PBoC) is doing. Although the US Federal Reserve has only raised its federal funds rate by 25 basis points, the PBoC has cut interest rates four times since November 2015.
The impact on Asian equities has "been severe", he says, with capital fleeing the region in the search for yield.
"Money is always attracted to where [it] can get the best returns," he says.
T Rowe Price's Anh Lu agrees: "When interest rates do start to rise [further], markets may suffer a mini sell off as the hunt for higher yields pulls money out of [Asia]," she says.
According to Pimco executive vice-president and portfolio manager Luke Spajic, companies throughout Asia are suffering in the face of a tightening US monetary regime. Companies that have borrowed in US dollars are now required to dedicate more cash flow to cover their debt, he says, arguing that this will hit company profit over the long-term. Moreover, "the more the [US] dollar goes up, the more the Fed hikes and the more [Asian economies] keep cutting, this divergence will debilitate the credit market".
While divergent monetary policy is one of the most significant risks to Asian equities, according to Ms Lu it's not all negative.
"If [US] rates move moderatelyhigher because the US economy is doing well, that would be good for the global economy, including Asian markets," she says.
An active environment
The fund managers and consultants approached by ifa were largely in agreement that an active approach is currently the most viable for Asian equities.
Mr Sartori points out that through using an active approach, advisers can access stable sectors of the market, while avoiding sectors that present neither growth nor value opportunities.
"Asian equities are very well placed for active managers to do very well because there's large parts of the Asian equity market that are the "old Asia", and to us are poor investments, and a lot of them tend to be large in the index," he says.
Meanwhile, Ms Lu indicates that "old-fashioned stock-picking" is pertinent when it comes to investing in Asia. An active strategy allows investors to invest around a specific idea or theme, she says.
"[In particular,] we continue to look for and identify companies that have been able to diversify outside of the domestic markets in search of growth. We are concentrating our exposure on companies that are expanding, or have the potential to expand, their market share, either locally or abroad," Ms Lu says.
Macquarie Investment Management's Mr Cornu says an active approach allows specific stocks to be included or disregarded in a portfolio.
"The philosophy in these types of conditions is ... keep it simple and with that go back to basics. What we're looking at is the cash flows, the quality of the earnings, and the consistency of margins," he says.
He concludes that businesses that are seeing an increase in earnings or expectations need to be the focus for advisers.
Pimco's Mr Spajic remains convinced that active is ideal: "Is there deep, long-term value in [Asian] equities? The answer is yes. But you have to do a great deal of stock selection," he says.
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