Emerging Markets: Where to look for investment opportunities in Asia

Where next for Asia? As companies and countries across the continent adapt to China’s slowdown, opportunities are emerging. Portfolio managers ADA CHAN and SAMIR MEHTA explain

• Asia’s companies rapidly adapting
• If liquidity improves, Asia could be “well set for a decent run”
• Find out more about the Global Emerging Markets Opportunities Fund
• Find out more about the Asian Share Fund

ASIAN economies are shaking off China’s slowdown and showing signs of renewed vigour, sparked by a wave of tech innovation and a global trend to supply-chain diversification.

Renewed optimism for Asia is a reminder to avoid the trap of assuming temporary challenges are here to stay, says Pendal portfolio manager Samir Mehta. Companies tend to actively adapt and evolve during difficult times, he says.

Mehta and emerging markets portfolio manager Ada Chan were speaking in an Asia Reborn webinar which examined the drivers of the improving outlook for Asian equities.

“When a country goes through significant challenges, you don’t expect companies to remain static,” says Mehta.

“Headlines about tariffs and geopolitics are all we hear of. But each and every company we meet with is reacting in a very different manner, adjusting and getting more competitive to deal with these challenges.

“All the company meetings we do and the managers we meet make us reasonably confident that if liquidity conditions do get better — which is the potential in the next 12 to 18 months — Asia could be well set for a decent run in terms of economic activity and potentially even stock market performance.”

Mehta manages Pendal Asian Share Fund, an actively-managed portfolio of Asian shares.

Find out about

Pendal Global Emerging Markets Opportunities Fund

Read more

Chan co-manages Pendal Global Emerging Markets Opportunities Fund which takes a top-down, country-driven approach to stock selection in emerging markets.

China: pockets of strength

Beijing’s crackdown on excesses in the real-estate sector sent Chinese credit growth tumbling to multi-year lows, says Chan.

“The property sector, which is a pillar of growth in China, has slowed down because the Chinese government was concerned about the balance sheet of property developers. Hence, we’ve seen this credit deterioration,” says Chan.

However, the overall decline masks a more nuanced story. As real-estate credit growth plummets, credit in China’s industrial sector is rising sharply.

“The government needs to take care of over-leverage — so spending is going into other industries.”

This reflects a deliberate policy choice.

Ada Chan, far right, a co-manager of Pendal Global Emerging Market Opportunities fund

“China is very government driven,” says Chan. “Even though the overall economy might be weak, there are pockets of strength, and we want to try to align with what Beijing wants.

“To sum it up in a simplistic way, the Chinese government wants people to spend domestically, and that’s one of the themes we have in our portfolio: domestic consumption and domestic travel.”

Taiwan and Korea: strong tech outlook

Taiwan and Korea are pivotal players in global technology and the big tech exporters are benefiting from the rapid adoption of artificial intelligence, says Chan.

“Within technology we want to position in the leading-edge technology.

“We think AI will be an important growth driver for many years. The timing might be uncertain, but if you own the leading-edge technology companies, we think you can play it through the cycle.”

Chan says her portfolio is underweight Taiwan and Korea overall, but with investment in those leading-edge technology firms.

Mehta says investors could also look beyond the leading firms to capture growth from a potential AI-inspired upgrade cycle for both corporate and personal technology devices over the next few years.

“That replacement cycle will require a lot of the expertise that Taiwanese manufacturing companies have, even below the leading-edge technologies.

“That’s where we have some of the stocks in our portfolio, reflecting that potential for growth.”

But he says in his view the potential for gains in Korea is somewhat clouded by an inheritance tax regime that discourages the big family-owned chaebol conglomerates from realising the full value of their businesses as they seek to hand down control to the next generations.

India: valuation concerns

In contrast to China, the Indian economy has performed very well in recent years, driving equity markets strongly higher.

Mehta says the outperformance is driven in a large part by a dramatic improvement in the country’s Incremental Capital Output Ratio — a measure of the efficiency of capital use in an economy.

“One of things investors are trying to understand is if there are any fundamental drivers that could justify some of the elevated valuations in India,” he says.

“ICOR is how much incremental capital investment is required in an economy to generate additional marginal $1 of GDP growth.

“For the period between 2005 to 2014, China and India were relatively similar. But since 2015, so much of the investment in the mainland Chinese economy went into unproductive assets, which has led to a stark deterioration in the ICOR in China.

“Whereas in India, which is a country that has perennially been starved of capital, when you had this growth come through, returns on capital employed for the economy as a whole, and therefore for companies that are listed on the stock exchange, have done exceedingly well.

“That partly, we think, explains the elevated valuations.”

Chan says the high valuations have led her to tilt towards businesses exposed to infrastructure spending and away from export-related businesses and those exposed to domestic consumption.

“We think the valuation is too rich. The economy is growing and economically strong, however with that kind of valuation, we are a bit concerned — it’s basically pricing for perfection.”

‘China plus one’ strategy

Indonesia’s decade-long ban on raw nickel exports has helped position its economy to capture a larger share of battery manufacturing for electric vehicles, says Chan.

This is driving a rapid improvement in the country’s trade balance and attracting attention from foreign investors.

But Mehta says what is less known is that a similar story is playing out throughout South-East Asia.

“Overall, I’d say ASEAN is in a much, much better position and all these countries are very well-suited to take advantage of the ‘China plus one’ strategy that is at the heart of geopolitics.”

Adopting a ‘China plus one’ business strategy means keeping a Chinese supply chain but adding parallel suppliers elsewhere to build redundancy.

“And it’s not just the multinationals,” says Mehta.

“In fact, some of the largest Chinese manufacturing enterprises also want to de-risk the tariffs that might come through — and so they’ve set up operations, not just in ASEAN, but in Mexico and other countries.”

Mehta highlights Thailand’s expertise in auto-manufacturing.

“Some of the leading companies out of China have taken one of the biggest parcels of land ever bought in an industrial estate in Thailand.

“A number of Chinese workers and management are moving into Thailand to run these operations. That requires a lot of services to be provided for them and their families and so there are opportunities that Thai businesses are taking advantage of.”

About Ada Chan and Samir Mehta

Ada Chan is a co-manager of Pendal’s Global Emerging Markets Opportunities Fund.

The fund’s top-down allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.

Samir Mehta manages Pendal Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia.

Ada and Samir are senior fund managers at UK-based J O Hambro, which is part of Perpetual Group.
 
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

Contact a Pendal key account manager here