Argument in favour of investing in Asia through emerging markets
Asian Investment Market Series 2/3
By Willem le Roux, Principal Investment Consultant and Actuary
As we explained in the previous article, there is no doubt that China has been growing its economy at a staggering rate and that the runway for continued superior growth is expected to be long. However, China is a very big economy and it cannot continue to grow at above global GDP levels forever – mathematically, this would imply that China will eventually account for the entire global GDP if this trend does not slow.
At the same time, there will always be some countries that grow their economies more rapidly than others. The entire Asian region – particularly the emerging Asian nations – is growing extremely rapidly by global comparisons. Some countries are benefiting from China’s growth. Most still have much more runway for growth than mainland China. This is because their economies are still small. Take India as an example, which has a population not far off China’s numbers, but an economy that is only a shadow of China’s.
Source: World Bank, data as at January 2019 GDP (constant 2010 US$)
Source: World Economic Outlook (Oct 2018), GPD, national currency, constant prices. There is no guarantee the forecasts highlighted will materialise.
Source: Investing in Asia through Private Equity (article by Brian Lim from Pantheon)
The charts above show that GDP growth rates in the Asian and Pacific regions are expected to substantially outstrip that of the “old world” – the US and Europe – having grown at approximately double the pace over the last two decades. This trend is expected to continue over the next decade, at least.
Asia is enjoying a demographic dividend due to population size and growth. About a third of the global population reside in India and China alone (approximately 2.5 billion people). Both have large labour markets, which are young and growing. This implies higher productivity and consumption. Technological innovation is also a catalyst for rapid change.
Many of the big Chinese trends highlighted in the previous article apply to the rest of Asia. Take a look at the chart below showing the increase in US dollar billionaires from 2010 to 2020 and note the Asian and Pacific countries – China, India, Hong Kong, Singapore, Australia, Taiwan, South Korea, Thailand and the Philippines – most growing from a very low base.
Sources: Forbes.com; Datawrapper
In the previous article, we argued that investors should consider exposure to China in line with its contribution to global GDP, which is underestimated by listed equity markets. At the same time, Asia and countries bordering the Pacific Ocean demand attention. The chart below shows the substantially lower price/earnings ratio generally applicable to the Asian and Pacific regions’ equities, compared to the S&P 500. Coupled with very high growth expectations, this signals much higher potential returns from Asia than from the US – firstly, from earnings, but secondly, potentially from rerating (or increasing) price/earnings ratios as the market reviews what price it is prepared to pay for Asian stocks compared to US stocks. It is worth pointing out that there does remain a risk of persistently lower price/earnings ratios – reflecting any number of factors, such as responsible investment issues, regulatory risks, lack of transparency and actions which may be driven by national agendas rather than the interest of shareholders, which typically are more prevalent in developing economies than in developed economies.
Source: Investing in Asia through Private Equity (article by Brian Lim from Pantheon)
Similar to how we compared the size of China’s market capitalisation representation in the MSCI All Counties World Index to that of Apple in the first article, the illustration below shows the total market capitalisation, as at September 2020, of the stock exchanges of some emerging markets (Brazil, India, Indonesia, Philippines and Thailand) compared to the market capitalisation of single businesses (Facebook, Apple, Nvidia, Netflix and Tesla, respectively). These market capitalisations do not fully align to the countries’ weights in the MSCI All Countries World Index (the latter being lower). Four of the five economies are in Asia.
Source: http://www.visualcapitalist.com/emerging-markets-a-growing-set-of-opportunities/
Global investors have been seeking growth in a low growth world and finding it in the technology companies which have been “eating the lunch” of old-economy companies. These technology companies cannot continue to grow at the same pace unless they are able to find new customers. They can achieve incremental growth in profits from the same client base, but significant growth cannot be sustained ad infinitum. These businesses have done very well to capture the lion’s share of the global population and it is not clear how they will be able to grow their customer base. They have also been successful in monetising their offerings – there may be some room for improvement in this area, but it is unlikely that the exponential growth trajectory will be sustained by improved monetisation. Therefore, as these businesses’ share prices have been bid up further and further, driven by investors’ appetite for growth, the risk of that growth slowing has increased. Any disappointment in earnings growth expectations will likely place significant price pressure on these technology stocks.
Sometimes the best opportunities are hidden in plain sight. Growth is in Asia. There is a vast population, developing at a rate of knots, with a lot more runway to continue growing. This is where investors should seek growth investment opportunities.
Principles to keep in mind:
- The risk of investment in developed markets tends to be lower than the risk associated with emerging markets, which in turn tends to be lower than the risk in frontier markets. This is due to regulation, access to information and the state of development of financial markets. Higher perceived risk comes with higher expected returns.
- South Africa is an emerging market economy – does it make sense to diversify to other emerging markets from South Africa?
- China offers substantial diversification to South African equities, as shown in the first article.
- Asian emerging economies are more geared to technology than South Africa, which implies further diversification.
- Economic growth does not always translate into superior returns in capital markets. Typically, this is where the value of active asset management comes to the fore. There are very good investment opportunities hidden between sub-par businesses. A good active manager can find such opportunities.
- The Chinese investment case can be “the next gold rush” as these markets open up and offer more opportunities, until there is a stabilisation through foreign investors exploiting opportunities. Consider the real yields offered by South African inflation-linked bonds when they first came out (more than 5% above inflation) – such opportunities do not come around often, as market demand and supply forces stabilise over time.
- Focusing on China alone holds a significant risk of underestimating the growth potential of other emerging economies.
The recurring theme emanating from the deliberations around China and Asia is to seek active asset managers who are experienced and skilful in selecting investments in the high growth region, and to give them as wide an opportunity set as possible.
As was mentioned in the first article of this three-part series, the recent Chinese government crackdown on businesses with perceived (national or social) sustainability concerns, once more points to the importance of skilful active asset managers who understand the Chinese investment landscape.
Emerging Asia makes up about 83% of the MSCI Emerging Markets Index excluding South Africa, which would imply that the most logical way to find exposure to China and the wider emerging Asian region is through an allocation to active asset managers into a global emerging markets mandate. It is important to include managers that demonstrate a willingness to invest in China and surrounds.