Asia Now

Asia is also now leading in innovation as well. There are more patents filed in Asia in China, Japan, Korea, Taiwan and so on than in the US and Europe combined. And R&D spending also exceeds the US and Europe.

If there is any headwind right now I would say it is COVID-19. 

It is fair to say that the vaccine rollout in the US, in particular, is going quite well, and Europe is probably going to catch up fairly quickly. The lower income countries within Asia, such as Indonesia or India, will struggle in the near term, so this is a headwind.

GDP growth will in the near term be not as fast within the emerging markets, and this historically has led to a headwind in performance. But we believe this will be a short-term impact and towards the end of the year we  could see a catch up within the Asian economies and the Asian markets as well.

If we look at valuations, no major asset class is cheap compared to its history, and that includes Asian equities.

However, when we look cross-sectionally at Asian equities compared to other major asset classes, it is one of the cheaper of the major asset classes.

It pays to invest actively within Asia

Finally, I would like to end on the merits of active investing within Asia.

Asian equities are quite different from US or other developed market equities, and it is possible to have very high active returns. If you look at the performance of our Asian equity portfolio over the past six years, you can see the cumulative total return from our active portfolio has been twice that of the index.

If we look at small caps, it's even more dramatic over the past eight years. We had almost three times the return from our active portfolio compared to the index, so it really pays to be active within Asia and also within small caps.

This is driven by two effects. Firstly, the greater inefficiency within the Asian markets, especially small caps, but also Asia is a changing region - and that gives rise to big trends and themes. If you're able to identify the winners from these trends and themes and avoid the losers, you can make very strong active returns which can amount to very healthy total returns for your portfolio.

Good banks are actually quite visible because a lot of the time private sector banks gain market share at the expense of state-owned banks because they don’t have the burden of legacy and policy loans.

We are also quite excited about the semiconductor sector, which has been consolidating.

Two important events have reshaped the world and will probably continue to do so going forward. One is COVID-19, and another one is geopolitical tension between the US and China.

Both these events brought the importance of supply chain control for any region and country into sharper focus. Currently, there’s a semiconductor shortage affecting many products.

And that's why the US is encouraging the likes of Samsung and TSMC to set up factories in Arizona.

China, on the other hand, is actually increasing semiconductor investment because they need to catch up so that they would not always be beholden to sanctions by the US.

The most advanced manufacturing assets are actually located in Asia. The majority of semiconductor manufacturing assets are also located in Asia, such as in South Korea, Taiwan, China, and in Singapore.

So you can find good investment candidates for the semiconductor sector in Asia. That’s because China will likely be investing aggressively to try to catch up, and at the same time you can also already invest in global leaders in places like South Korea and Taiwan.

But why not invest in the pure play EV stocks in the large cap universe?

We are not entirely sure who will be the eventual winners as the industry matures. Also, if you look at some of these large-cap EV stocks, we struggle to make the valuations work.

We need to project our earnings up to and beyond 2030 to justify some of the valuations today and, actually, we can't really justify why to invest in a large-cap EV stock with a USD 70 bn+ market cap which today generates zero revenue.

So rather than invest through the large caps, we believe we can play the EV thematic through some small-and mid-cap stocks. Here are some examples.

Firstly, we invest in a South Korean company which is a material supplier to the Korean battery industry that is taking market share from Japanese suppliers.

Secondly, we also invest in a Chinese company becoming the global leader for battery housing for electric vehicle batteries. That company has defeated German peers to be the sole supplier for Volkswagen's electric battery platform in Europe.

The third company is a Malaysian company that is taking market share in the automotive lighting sector. If you think about what is important for EV manufacturers, they need to focus on three things: energy efficiency, unique design and product differentiation. We believe lighting is going to be a key part of that.

It's clear that in Asia we have gone through a V-shaped recovery.

While the rest of the world was cutting rates to zero and below, Asia has been cutting rates too. However, the most important thing is that in Asia they haven't reached the lower bound, so there's still a lot further to cut.

In places like India, South Korea, and Malaysia, there's still a lot more flexibility to both ease monetary policy across the board and still a lot more flexibility on the fiscal side.

Turning to the recovery, Asia is displaying a strong recovery and we believe it is going to continue in 2021 and into 2022.

So what does that mean for credit? It means that there is a higher growth trajectory across Asia relative to the rest of the world due to higher earnings power and the ability to pay back on debt.

Where does Asia credit fit relative to the rest of the world? Asia really stands out.

As a word of warning, a lot of credit markets now are getting longer in duration and we have not yet had a big volatile period where interest rates have tested the longer dated exposures.

Meanwhile, Asian duration has remained relatively low and stable, Asian bonds are offering substantially higher yields, and they’re less exposed to any volatility spikes.

When we look at Asia from a credit or yield perspective, we can clearly see that Asia in the red line here relative to US and Europe, on both the high yield side and on the investment grade side has a substantial pick up in yield gap.

When we look at other bond markets around the world today you’ll find either negative or zero yields and negative real yields. What's more concerning is that we can start to see some bond markets exhibiting equity-like volatility characteristics.

And the reason for that is, firstly, indices are just getting a lot longer in duration.

Secondly, as bonds move closer to 0 or negative yields, the sensitivity of the bond markets goes up.

So just to sum up. Asian credit looks like it offers a lot of value today relative to other markets. When we consider the risk as well, the assessment looks even better, particularly on the investment grade credit side.

With a huge structural change that's underway on the Chinese bond market side, both from an index perspective as well as from a normal and real yield volatility and correlation perspective, we think that Chinese bonds have a place in everybody's portfolio today.

Geoffrey Wong (GW): Increased regulation is a fact of life, especially in China.

It's clear that, philosophically, China’s government prefers a more activist regulatory regime, so we need to take that into account.

And we need to see for which companies and where this is a moderate hindrance and where perhaps it might be lethal.

Now taking the two sectors that we look at.

Starting with internet. We have already seen the fine on Alibaba. We are also seeing moves toward anti-monopoly laws being executed and enforced.

These are things which will no doubt slow the growth potential of some companies in the sector.

But we feel that their natural growth and potential arises not from the exercise of monopoly power, but from the basic natural laws of greater efficiency through the use of technology, such as network effects.

The government is not necessarily taking away the impact of these natural network effects. So companies in the sector can continue to grow - albeit at a slower rate compared to in the absence of regulation - but still they will make good profits and I would expect other countries might see similar regulations in the future.

Now education is also an area where China’s regulators have been active, and no doubt new regulations are going to hit the entire space. Education companies will have to pay more attention to anti-monopoly measures, like being careful about misleading advertising.

Regulators are also talking about restrictions on Saturday classes, so the public school system will supply some activities for Saturday, possibly supplanting some of the activities of the private education companies.

But the underlying driver for the tremendous demand for education in China is the desire to give children every advantage in getting into a good university, and this is common among East Asian cultures, and we do not believe it can be changed by regulations.

We've seen this attempted before in Singapore, for example, where there was concern about too much tuition. In the end, however, the natural desire of parents to do the best by their children remained a great driver.

We saw a bout of regulation in the education sector in 2018 as well. In some ways the stronger players were helped because the weaker players have a harder time dealing with the regulatory burden.

So we feel that the stronger players will face more regulatory pressure in the short term, but will actually gain a relative advantage and perhaps take market share faster than they would have in the absence of regulation.

GW: I won't attempt to predict the course of COVID-19. Many experts were confounded by the second waves that we're seeing in India and other countries as well, so that it's intrinsically hard to predict.

But when we look at the portfolio, there are number of things we have to do.

Firstly, avoiding companies that have any sort of a balance sheet or cash flow issue.

So we need companies that can withstand a prolonged lockdown situation. Now that means having good cash flow, low fixed costs, and not having too much leverage.

And when we form the portfolio we balance the so-called COVID-19 beneficiaries as well as the recovery beneficiaries.

COVID-19 beneficiaries are obviously in the online space, so online education, e-commerce, and social media streaming, which people need to consume more of if we have continued lockdowns.

And then, on the other hand, we do have some of banks that will benefit from the recovery, so we tend to hold a fairly balanced portfolio with strong companies that can withstand the buffeting of COVID-19.

HB: So we actually had quite strong currency performance across Asia over the last couple of months. Currencies have been appreciating against the US dollar as it started to get weaker. However, India has been on the weak side, so in a way it gives you opportunities in an active sense to leg into those currencies where the blocks are stronger.

I would then say on the credits we are avoiding consumer cyclical names that are linked to COVID-19.

Particularly in India we've been underweight, but we're now looking into it as an opportunity to get back involved in that market, as that's starting to look attractive to us from a valuation and risk perspective.

HB: Yes, it is relatively expensive to hedge. But there are ways to structurally hedge the portfolio today.

The RMB looks on the strong side. There are those that want to be active on the currency.

That doesn't necessarily mean you have to be 100% unhedged. You might want to be 50% unhedged.

We would use the trade weighted basket as a guide. If you're on a Bloomberg Terminal, that's called the CFETS basket and essentially that has been in a range from 92 to about 96, and we're sitting at about 97 today.

That index is the way that the Chinese manage their currency. They introduced a policy in mid-2016, which is to say that they want to have a very low volatility currency to their key countries that export food and energy to them.

So of that basket, for instance, South Korea would be 10% of it. So when it's up around 97, we know the currency is expensive. You've heard a lot of jawboning from the central bank already talking about wanting the currency to come back down.

When it's at 92, we would probably be fully unhedged and above 96 fully hedged to manage your portfolio if you think the hedge cost is too expensive, or to take some different views to the Euro or Swiss Franc in particular.

Shou Pin: Sure, let's talk about India.

For the largest personal care company in India, basically what they report is that across almost all their product categories, things like shampoo, detergent, tea, cosmetics and so on, their premium brands are selling at twice the rate of the more generic brands. You can also see that in the auto sector. Sales of larger premium brand motorcycles are actually selling better than the industry average.

Take a look at South East Asia, and Vietnam in particular. Maybe it's not a country that is investible right now, but if you look at what's happening there, the trends look clear and visible. In beer, for example, the premium brands or the mass premium brands are actually selling or taking market share from the mass consumption brands.

Raymond: I think we see this for example in cosmetics. It's not just Chinese people who want to buy better cosmetics, but actually across all markets people are graduating from the more mass market to the more premium brands.

Raymond: There have been certain periods when small-and mid-cap companies have been more risky than large caps, but at other periods of time actually they're not.

Importantly, having an investment in an active fund is probably the preferred approach to a passive index in this investment class.

Simply because, in an active fund, you're able to filter out some of the more risky stocks or risky companies in the universe and therefore able to control risk in the portfolio. So having a quality bias really helps in controlling that aspect of the investment class.

GW: There are a couple of reasons.

Firstly, I’ll talk about Iiquidity. The Vietnam stock market trades with a turnover of roughly USD 400 million per day. So it's hard to get big exposure.

Secondly, listed companies don't necessarily reflect the best parts of the Vietnamese economy.

For example, you may have a milk company and then a lot of state-owned banks which may not give you the full benefit of the dynamism of the Vietnamese market.

On the other hand, there are companies around the region that are making money selling into Vietnam, whether it's beer, cement, internet, or other services, for example.

So these companies may be better placed, but may also be listed in Thailand or even Singapore or Indonesia or elsewhere.

GW: We have always felt that ESG is important, so it has been part of our investment process for the past 10 years or so, certainly before it became as fashionable as it is now.

We think in a form of ‘corporate karma’ that the good companies are going to do better than the bad companies in the long run.

However, I would say for Asia, and in common with other emerging countries, there is still not a good appreciation of the importance of disclosure among the companies.

A lot of Asian companies may have reasonable practices, but they don't disclose it.

Certainly from a Western lens, the expectation is that your annual report, or specific ESG report, would actually have disclosures of all your policies.

Where some Asian companies are following ESG practices but not really talking about it we, as active fund managers, have to engage with the companies.

When we read an ESG report from a specialist, we will go to the company if there are any issues that are raised and flagged as a concern.

If it is a matter of disclosure, we will encourage the companies to get in contact with ESG specialists and then make the appropriate disclosures.

If there is in fact a material shortcoming on the part of the company, we do engage with them and encourage them to improve.

If there is a serious problem and the company is not showing progress, we may divest from the company.

So ESG has always been important to us, but certainly it's gaining much more importance in the entire investing world.