Schroders: Investing in Asian equities in 2015

At the beginning of 2014 brokers in unison were recommending clients to buy North Asian markets (China and Korea) over Southeast Asian markets. We learnt long ago not to follow such market advice, and felt that given the generally superior quality of companies in Southeast Asia, these recommendations should be completely ignored. Sure enough Thailand, Indonesia, the Philippines and India have significantly outperformed Korea and China in 2014. The point is that making money on Asian stockmarkets as ever requires skilled investing in quality companies providing consistent shareholder returns, including dividends, trading at sensible valuations. 

This means ignoring as much as possible a lot of noise around politics and macroeconomic data which can often be used to encourage poor investment decisions. Given the slowing global growth picture, a strong credit cycle in China and across the region, and high valuations for decent companies, we are sanguine about the outlook for Asian markets in 2015. Longer-term, we believe the region continues to hold many significant advantages. Let us start by considering two structural factors that do worry us, as opposed to GDP statistics.

Technological change in Asia  

In a fast-changing world where technology and the ‘digitisation’ of economies are becoming more commonplace, businesses around the world will have to adapt. Asia is no exception. The vertiginous drop in the cost of processing power, combined with the rise of ‘intelligent machines’, means many current jobs may become redundant. For a region that has traditionally been seen as both a source of cheap labour for manufacturing and having a young and rising middle class, the implications will be wide-reaching.

Machines are increasingly replacing workers as industrial robots continue to simultaneously tumble in price and advance in intelligence. Decisions on where to locate manufacturing hubs are now based on proximity to the end market and where legal, tax, red tape and finance costs are most favourable. Asia (bar Hong Kong and Singapore) does not do well when it comes to ease of doing business. The days of Asia as the cheap workshop of the world are not sustainable.

As a result of this, growth rates in Asia will likely disappoint over the coming years. Sluggish investment and cautious consumers will mean that growth rates will be slower than historic levels. What does this mean for investors? We are cautious about overpaying for Asian consumer names, with many still trading on extremely high premiums. In addition to this, we are also wary of traditional labour intensive manufacturing businesses and commodity-intensive industries. 

Asian corporate governance

A lot of recent commentary on Asian markets has focused on the promise of state-owned enterprise (SOE) reform in China as well as prospective corporate governance improvements in Korea. There has even been talk of a re-rating of some markets on the back of a positive shift in corporate governance. We were doubtful based on past experience that corporate culture, in particular in Korea, was about to change and recent events have proved us right. 

Firstly, Sinopec, a Chinese state-owned oil & gas major, was identified as a candidate for reform. The marketing arm, which has excited potential investors given its potential to expand into retailing, was supposed to bring in strategic investors in the retail sector with experiencing of exploiting this. Instead, 25 Chinese investors bought 1-2% stakes in the business in what looked suspiciously like an act of national service with investors ranging from banks to steel companies. 

Meanwhile, in Korea, market commentary has focused on the hopes that Korean companies will start increasing miserly dividend payouts and share buybacks following the Korean government’s plan to tax excess corporate cash holdings. Again, questionable investment decisions dashed hopes as Hyundai announced its plan to spend just over US$15 billion acquiring new corporate headquarters in Seoul – with the land price alone costing US$10.5 billion (almost three times the market estimate for the site). Share prices in both of the above duly fell as shareholders were, understandably, left unimpressed.

Where are the current opportunities in Asia?

There are markets in Asia where the interests of minority shareholders are upheld and this is why we continue to favour listed companies in the likes of Australia, Hong Kong and Singapore and parts of South East Asia. These markets offer established franchises with professional management, strong balance sheets and cash flows, along with broader regional exposure.  Our preferred areas for investment are globally competitive Asian industrial companies, select technology names, ASEAN  and Indian retail banks, healthcare and some cheap Hong Kong and Singapore property companies. Asian consumer and internet stocks are generally overbought and overvalued.

With disruptive technologies impacting businesses everywhere, this means that, as always, it is imperative to invest in companies based on their individual merits and current share price, amidst an increasingly uncertain world. On this basis, we believe Asia continues to provide many strong investment opportunities.