IS ASIA STILL HOME TO THE CONSUMPTION STORY?
A week spent in Asia is rarely uneventful. Our research trip to Singapore and Hong Kong at the end of October was perhaps busier than any research trip I’ve been on. It included twenty manager meetings, three strategist meetings, three company meetings, including Alibaba and China Resources Beer, a visit to Shenzhen, a drone, and too much coffee. Since leaving, it seems like protests are escalating and the local economy is now in a recession. With the negative trade and global growth headlines we see over here, clearly there is more than one red flag from afar!
The mood of Asian investors
On the ground research helps to inform your opinion of a region in a way that charts, written research and reporting cannot. The general mood is cautiously optimistic. With the exception of one or two, many managers argued that although geopolitical and macroeconomic risks are real, the fundamentals of the companies they invest in remain intact, whilst valuations are relatively attractive – not least because of the current uncertainty.
As mentioned, however, there are some large red flags. The main fear is that the US-China trade quarrel will hurt Chinese consumer sentiment, including the potential consequences on employment, consumer income and spending. We also heard several examples relating to increasing control over individuals and private enterprises from President Xi and the Chinese Communist Party. This might not matter too much in the short term but some argue that increasing social control will undermine the kind of long-term innovation needed to drive growth. Our recent book review of George Magnus’ Red Flags looked at this argument.
Consumption growth outweighs all else
From a portfolio perspective, however, exposure to higher quality, local consumption-focused Chinese investments continues to be an overweight for most Asian managers. The reasons are perhaps pretty straightforward – China is not only the second largest consumer market in the world, it is also the fastest growing. Chinese GDP was estimated to be $13.6tn in 2018, up from $12.1tn in 2017. Of this $1.5tn increase, over 50% was driven by consumption – a bigger contributor than both exports and capital formation collectively.
China’s median household income is an eighth of what it is in the United States and growing about five times as fast, presenting significant opportunities. On the other hand, the risks are very clear: consumption has become the backbone of Chinese output. If employment and household income start to be affected by the ongoing trade issues, this could turn ugly.
While we are very much aware of these risks, so is the Chinese Communist Party. They have both the capital and willingness to ensure that the Chinese consumer is content, employed, and that incomes are growing. For this reason, we retain a positive view on the Chinese consumer, even in light of the material risks.
One country, two economies
With regards to Hong Kong, swimming against the tide is never easy. One question we have to ask is what the trajectory is for foreign and Chinese mainland tourism to the island. As confirmed in early November, Hong Kong has officially fallen into a recession. Global tourism, a mainstay of domestic output, has declined by over 50%, while tourism from the mainland – wealthy Chinese consumers coming to Hong Kong to buy cheaper branded goods – has fallen by as much as 90%. Increasingly, many mainland Chinese nationals would prefer to make an overseas trip to Tokyo, Seoul or Singapore, rather than taking the risk of a stand-off with a local in Hong Kong.
India: short-term difficulties but best long-term prospects
While you might assume Hong Kong has been the difficult market this year, Indian investors have actually not had an easy ride either, with the local stock market underperforming most Asian markets after a relatively strong 2018. Unless you held one of the dozen largest companies in the Nifty 50, your returns are likely to have been negative. Yet, most managers we spoke to are turning more positive on Indian economic growth and the corporate profit cycle, even if many say they will only enter the market slowly and selectively rather than trying to catch a falling knife.
Considering demographics and growth trajectory, India remains one of the most exciting and biggest long-term investment opportunities globally. The quality of Indian Equity managers we met on this trip, but also on our current shortlist of potential opportunities are indeed world class and we’ll continue our work to determine whether direct exposure is both suitable and attractive enough to justify the risk with a single emerging market investment.
For the time being, our broader emerging markets managers have done very well out of India over the last several years, with this being a significant source of alpha for many. We believe that managers across the board are likely to increase their exposure over the next twelve to eighteen months to India within their Asian and emerging markets portfolios.
Asia is more than just China or India
The ASEAN region (think south-east Asia and countries like Thailand) is full of opportunity. Frontier economies like Vietnam have attractive labour markets and their proximity to China make it a suitable alternative for many global supply chain and manufacturing companies.
The difficulty in markets like these seems to be depth and breadth. For example, many managers agree that on the margin Vietnam might be a beneficiary to the China-US trade issues, however, from a scale perspective it still will not be able to replace the Chinese manufacturing industry. In fact, collectively the whole Asia ex-China region is perhaps unable to replace it in the near term. So whilst cheap labour markets and supportive demographics ensure investment opportunities are real and attractive, in reality they are limited to a handful of the largest companies in these countries; and these are not cheap.
Investing from the ground up brings multiple opportunities
Besides the opportunity to get an on the ground perspective, meeting face to face allows you to build a long-term relationship with who we invest with. In most instances in Asia and Emerging Markets, we invest with people, rather than just funds. We build partnerships with investors that demonstrate an ability to sustainably deliver excess returns over their benchmark. Building a relationship has significant benefits, including trust, which more often than not leads to greater honesty and more meaningful conversations.
A long-term approach can also lead to more competitive fees, as fund managers value the stability that comes with a stable base of capital. However, underpinning all of this is our objective to find the best investment opportunities for our clients, and executing around these opportunities in a timely and disciplined manner. In doing this we believe that we are able to maximise the return on our investments, whilst also managing the risk of impairment of capital.
The way to play Asia continues to be through the consumer and a focus on local, regional winners! Whilst the risks themselves remain the same, the negative consequences of these, should they materialise, have increased. Investors will need to keep a close eye on developments in Asia, particularly given the region’s growing global importance.