India in particular is benefitting from investors’ desire for a more diversified approach to Asian equities.
Familiarity with local markets and what wealth managers refer to as a cultural, “rooted home bias” have historically led Asian families to invest primarily on their own doorstep, with China a core holding in portfolios.
But US-China geopolitical tensions, regulatory changes, macroeconomic headwinds driven by the Chinese property downturn, realignment of supply chains, and weak global trade data have together prompted investors to re-evaluate allocations.
“Over the past few years, there has been growing focus on risk stratification [in China] and increasing client interest in a more diversified Asian market exposure,” says Cheuk Wan Fan, CIO Asia, HSBC Global Private Banking and Wealth.
China’s disappointing post-pandemic reopening at the start of 2023 also strengthened investors’ desire to find opportunities elsewhere in Asia, as return dispersion increased within the region because of growth divergence.
“Hotspot” investment opportunities are now to be found in those firms seen as “Asian industry leaders that have successfully adapted to the new world order”, after emerging from global supply chain reorientation, says Ms Fan.
The reshaping of global supply chains is the result of US trade tariffs and Covid-19 pandemic disruptions, as well as increased progress in automation, says Ms Fan. She highlights “Asian and Chinese structural growth leaders” that have gained from strong foreign direct investment (FDI) inflows or have moved up the value chain, capturing market share.
Key beneficiaries are India and Indonesia, where multinational corporations, as well as Chinese manufacturing companies, have built new production facilities, with many international companies adopting a so-called ‘China plus one strategy’.
Over the longer term, India and the Asean economies of south-east Asia offer “promising secular growth opportunities”, benefiting from strong foreign and domestic private investments, young demographics, the technology boom and green transformation, adds Ms Fan.
She recommends clients have an overweight exposure to Indian and Indonesian equities. South Korea has also been recently upgraded to a “mild overweight” to capture the “upside potential in the Asian technology sector” and ride the “AI investment boom”.
Driven by rising Asian wealth and middle-class consumers, the consumer discretionary sector also stands out as a “bright spot”, thanks to select Chinese internet leaders, Asian consumer discretionary companies and AI-driven and digital consumption, as well as Asian financial services providers.
The rise of India
The shift away from Chinese allocations by asset managers and wealthy families – with India one of the main beneficiaries – has been heavily influenced by economic and political transparency considerations, believes Nakul Beri, senior managing director, global client origination and coverage at Mumbai-based Waterfield Advisors.
This trend will continue as China goes about its long-term repositioning to win back the world’s confidence, while India continues to benefit from the Chinese slump, he says.
Having overtaken China as the world’s most populous country during 2023, India is now one of the fastest-growing large economies, set to expand by 6.3 per cent this year. It currently accounts for 15 per cent of global growth, predicted to grow to 18 per cent over the next five years, according to the IMF.
The country has “taken strides” in becoming an investor-friendly destination for people to access either through markets or direct investment opportunities. Policies have been India-centric, but this has not prevented tech players like Apple from venturing into the country. “All major global banks like JP Morgan, Goldman Sachs and Morgan Stanley are now placing their bets on India,” states Mr Beri.
India’s National Stock Exchange is on track to become the world’s seventh largest, taking Hong Kong’s spot, following a surge in share prices this year. Other countries like Japan, Taiwan, South Korea, and to some extent, Vietnam have also generated interest among investors, he adds.
Looming elections
While the prominence of the India investment narrative is supported by “strong macroeconomic fundamentals”, the main concern lies with market valuations, currently trading at a premium compared to the rest of the region and historical levels, argues Vincent Ee, head of investments, Schroders Wealth Management, Asia.
There are also other risks and challenges for investors to consider. India, as well as several other Asian countries including Indonesia, are scheduled to hold elections in 2024, which may have long-term implications for the economy and stockmarkets.
The country has enjoyed relative political stability since BJP, the ruling political party under the incumbent prime minister Narendra Modi, came into power in 2014. This has allowed the government to carry out an important reform programme, including indirect tax reform, while improving digitalisation and physical infrastructure.
The next election in spring 2024 will be “a key factor to monitor”, says Mayur Nallamala, head of Asian Equities at RBC BlueBay Asset Management. However, he says: “Whilst the results will undoubtedly have an impact and lead to heightened volatility should the BJP not be reinstated, in the past India’s growth has not been dampened by political instability.”
Other risks are associated with the country being at an early stage in its lifecycle. Events such as the Adani scandal earlier this year have “the potential to shake-up India’s reputation as a reliable investment destination amongst global investors”, believes Mr Nallamala.
Active management and being on the ground can help to mitigate so-called “emerging market risk”, he adds, highlighting that the key story for India is one of GDP growth. “The country is only just where China was 15 years ago, and the potential for economic expansion is enormous.”
Asian and global investors are also finding appealing opportunities further east. The Japanese equity market has experienced robust inflows, contributing to its impressive performance over the past year, even when measured in US dollar terms.
“After enduring decades of deflation, the current mildly inflationary environment has brought a welcome change to the economy,” explains Mr Ee at Schroders.
The country also benefits from “heightened focus on shareholder returns by Japanese corporations”, resulting in improved return on equity, stronger labour productivity compared to developed markets worldwide, rising inward direct investments and private capital expenditure.
Moreover, the Bank of Japan’s monetary policy remains accommodative relative to other developed countries. Similarly, attractive comparative market valuations, relative to historical levels over the past decade, also contribute to a positive market outlook for Japanese equities, adds Mr Ee.
In terms of risks, a key factor to monitor in Japan is the government’s response to rising inflation, with recent months showing the strain this is putting on households, and subsequently on the popularity of prime minister Fumio Kishida.
Structural issues
Attempts from China and the US to rekindle diplomatic ties, and increasing support from the Chinese government for the domestic economy may drive sidelined investors to return to China, believe some investment professionals. But it is likely to be a bumpy road.
“China is facing and will probably continue to face very significant structural issues,” argues Jean-Louis Nakamura, Vontobel Asset Management’s head of the Zurich-based Vontobel Conviction Equities boutique. The country’s long-standing issue of “excess savings” is a key hurdle to the Chinese government’s aspirations to shift the country from an export-oriented to an internal demand-driven economy.
This problem got worse in recent years, as “growth in international demand and consumption started to break even before the pandemic, in late 2019”, says Mr Nakamura, pointing to the export slowdown, reduced need of infrastructure and “broken” real estate market.
President Xi Jinping’s government is “rewriting its policy playbook”, to make the economy more efficient in the longer term. This means reflation of the economy, through a “massive stimulus plan” or “bazooka” like the one used in the 2008 financial meltdown, is highly unlikely. And the many “sub-scale” initiatives may not be sufficient to boost corporate and consumer confidence and address investors’ fears.
While the risk of a Chinese market collapse is remote, “it will be difficult for the country to enjoy a very substantial cyclical rebound in the short term”, predicts Mr Nakamura.
Even China’s “very good quality companies”, including those supported by the 14th five-year plan – such as those promoting clean mobility and infrastructure, and involved in “digital financialisation” of the economy – will find it challenging “to monetise through stock returns their high level of profitability”.
Too big to ignore
Yet, the world’s second largest economy cannot be ignored by investors, as it contributes 35 per cent to global growth, more than double the contribution of India, the second largest contributor. While its expansion has slowed from pre-pandemic levels, China’s economy is still projected to grow at 5.4 per cent in 2023, and between 4 to 5 per cent in 2024, one of the fastest growing globally, according to the IMF.
China retains its leading global export market share, and despite challenges, it is unlikely to lose its manufacturing edge. “Decoupling from China will be a daunting task for multinational companies given the country’s excellent infrastructure and connectivity, and extensive networks of reliable suppliers,” says Eastspring Investments’ head of growth equities John Tsai.
“Besides, China is also moving up the manufacturing value chain facilitated by huge investments in technology, big data, robotics and artificial intelligence,” he says. It also remains the dominant supplier of industrial components to manufacturers in other parts of Asia.
Moreover, markets that have benefited from flows out of China, such as India and, to a lesser extent, Indonesia, albeit home to very good companies, enjoy much shallower liquidity, a challenge for larger investors. The Philippines’ stockmarket, which has also been performing well, is even harder to invest.
Additionally, several Asian markets, including India, Korea, Taiwan and Vietnam, are “highly restrictive for wealthy individual investors, often limited to a handful of companies that have actively traded ADRs or GDRs”, explains Schroders’ Mr Ee. Many wealth holders can only access these markets through ETFs or actively managed funds.
This picture makes clear China’s position as a major investment destination. “While current sentiments are probably driving investors to look away from China, China is the largest market in terms of size, market cap, liquidity and the sheer number of listed companies,” says Rishi Patel, portfolio manager, emerging markets growth and India growth at Polen Capital.
There are 34,000 stocks listed in Asia-Pacific providing “great breadth and depth for long-term investors across sectors ranging from tech to commodities.” But the investible universe of market caps of more than $2bn and liquidity of more than $1m in the Asia-Pacific region narrows down to 2,449 companies, with China accounting for 40 per cent of market capitalisation and 46 per cent of these listed companies for this cohort (see table).
“At best, there can be incremental allocation to markets like Japan, India, Taiwan and South Korea. In fact, the sum of the next three largest countries in Asia-Pacific is less than the market cap and number of listed companies in China,” notes Mr Patel.
“Like those manufacturers who have a China+1 strategy for their supply chain, we also prefer ‘China+1’ as investors, rather than a ‘no China’ approach,” he says.
While there is a “commonly held perception of massive rebalancing in equity portfolios away from China,” this is not supported by data, states Alex Wolf, Asia head of investment strategy, JP Morgan Private Bank in Singapore.
Given their large allocation to home markets and most likely, overweight exposure to China, Asian investors have “simply rebalanced” their portfolios, as a result of revaluation of growth prospects of markets around the world.
In Asia, China’s growth has been structurally revised downwards, while India, for instance, “presents a very high potential nominal growth rate, closely correlated to equity returns, which is uncommon in emerging markets”. While representing a small share of the global equity benchmark, India is an appealing opportunity for global clients, many of whom have “zero allocation” to this economy, says Mr Wolf.
The rebalancing of portfolios is also a natural consequence of declining valuations, likely to have brought ‘China overweight’ down to a benchmark neutral weighting.
The reshaping of Asia’s supply chain, the tech investment boom and rising investment in the high value asset manufacturing industry have enriched the opportunity set in the Asian market, says HSBC’s Ms Fan, seeing an expanding market cap and new investment opportunities emerging across the continent.
But she urges investors not to get carried away with the current popular narrative. While clients have a “strong need” to diversify their exposure across the region in terms of both sector and geography, they should keep a neutral position on Chinese equities, suggests Ms Fan. Even with its current “uneven recovery outlook”, China is and will remain a key investment story within the Asian market.
This article is from the FT Wealth Management hub
