As investors shift their interest from the ASEAN markets to North Asia, our Asian equity panellists at the second Morningstar Institutional Conference in Hong Kong outlined their outlook for Asian equities, where they have been finding investment opportunities, and commented on some of the structural developments in the region.
Martin Lau, Director of Greater China Equities at First State Stewart, Flavia Cheong, Investment Director at Aberdeen Asset Management, and Dhananjay Phadnis, Portfolio Manager at Fidelity, shared their thoughts on the Asian equities market. Lau manages four funds with Morningstar Analyst Ratings of Gold, including the First State Asian Equity Plus Fund. Cheong is an important member of the team that manages the Silver-rated Aberdeen Global Asia Pacific Equity Fund, while Phadnis manages the Bronze-rated Fidelity South East Asia Fund.
Asian Equities Outlook
The panel kicked off with a live poll that revealed that the audience was cautious on the outlook of Asian equities on the back of a strengthening US dollar and potential rate hike from the Federal Reserve. Phadnis pointed out that a strong US dollar has historically been associated with weak commodity prices, which generally have had a negative impact on emerging markets. However, on a more positive note, he stated that Asian countries such as India and China have carried out a series of reforms since the Fed started tapering and that this put Asia on much better footing compared with other emerging markets such as Russia and Brazil.
Lau shared his views on interest rates, commenting that they have been “too low for too long” and that when they rise eventually, they would rise much quicker than expected. He and his team have therefore been mindful of countries and companies that would be badly affected by a rising rate environment, such as those that are overleveraged or have a foreign exchange mismatch. He added that while there have been rampant talks of a potential rate hike in the US, many countries around the world, including India and Korea, have been cutting rates. This reflected the lack of global demand and has caused his investment team to struggle when trying to find quality companies with good growth prospects trading at reasonable valuations.
Cheong agreed with the audience in that investors should proceed with caution when investing in Asia. She expected continued volatility across all Asian markets in a rising rate environment, particularly for those that are US dollar-linked, such as Hong Kong and Singapore. From a stock selection perspective, the Aberdeen team looks at companies with balance sheet positions and currency exposures that would best place them to weather the current macro environment.
Investment Opportunities
Our panellists then moved on to discussing where they have been finding investment opportunities in the region. Phadnis was encouraged by the strong demography and rapid urbanization in India and ASEAN countries, finding them to be the most interesting markets over the medium to long term. Conversely, he thought China was coming off a very weak investment cycle but presented short-term opportunities.
Cheong had a more negative stance on China, as reflected in the Aberdeen Global Asia Pacific Fund’s large underweight in the country relative to the MSCI AC Asia Pacific ex Japan Index. She commented that the Chinese stock market is dominated by financials such as banks, which have been plagued by issues such as shadow banking and non-performing loans. Instead, the Aberdeen portfolio has had long-term holdings in Hong Kong names such as HSBC and Standard Chartered. She noted how these banks have a valuable franchise and have been leveraging their growing network for trade financing to expand their core business. Although the two banks significantly detracted from performance in recent years, Aberdeen remained substantial investors and Cheong believed it was important to understand and support the management and board through changes.
Phadnis offered an alternative view and believed the Chinese banking sector had shown signs of improvement as shadow banking growth had been curbed substantially and LGFV bond swaps have been introduced to improve banks’ loan book quality. That said, he was concerned about net interest margin compression as a result of interest rate liberalization and was overall underweight in the sector.
Similar to Aberdeen, First State Asian Equity Plus had limited exposure to China. Lau agreed with Cheong and thought it was misleading to look at the index. Instead, he found China-related opportunities outside of China. For example, he invested in some Japanese automation names, given that automation is a major trend in China. Although consumer staples have generally been unpopular in recent years, Lau favoured a number of consumer staples stocks in India. He believed the young population, the rise of the middle class, and the under-penetration of basic necessities such as shoes and shampoo were all conducive to the sector.
Phadnis agreed with the structural tailwinds benefiting the sector and added that consumer staples stocks with strong brands can be long-term compounders. However, he found most of these stocks to be richly valued, pricing in a lot of the growth potential, whereas the cheaper second-tier stocks tend to have poor liquidity. This conservative view was reflected in the Fidelity South East Asia Fund’s small underweight in the sector relative to the MSCI AC Asia ex Japan Index.
Structural Developments
As the session came to a close, the trio talked about the future of Asian markets, with a focus on reforms. Cheong was constructive on the long-term prospect of India, observing that Prime Minister Narendra Modi has been delivering on his promises, such as the reduction in fuel subsidies and fiscal deficit. She believed the return-on-equity and fiscal discipline of Indian companies are superior to that of Chinese companies given tighter supply of credit in India. That said, she also expected a substantial improvement in China over the long term as the Chinese government has been committed to removing tariffs and deregulating the system, though at a slow pace. Nonetheless, she foresaw China becoming a much more investable market to stock-pickers in the next five to 10 years.
Lau was also a proponent of reforms in China and India, though he reminded the audience that reform, such as efforts to curb corruption, is negative for growth in the short term. He also warned against people having too much expectation on an individual politician. He was sceptical about state-owned enterprise reforms in China, as those that undergo reform tend to be poor quality loss-making companies to begin with. On the other hand, he was encouraged by the corporate governance reform in Japan but frustrated with reforms in South Korea.
Regarding Indonesia, Phadnis was optimistic about President Joko Widodo, though he acknowledged that the president has been slow to take action. Nonetheless, he was encouraged by the fuel subsidy reform implemented at the beginning of Jokowi’s tenure, and he hoped to see more reform in the labour market and infrastructure spending, such as the execution of the land acquisition bill.
Despite a seemingly unfavourable global economic backdrop for Asian equities, our panellists have continued to find opportunities in both north and south Asian countries and were optimistic about the long-term potential the region offered.
