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4 October 2016

Investing in Asia's growing middle class

By Sharat Shroff, lead fund manager of the Elite Rated Matthews Asia Pacific Tiger

The Elite Rated Matthews Asia Pacific Tiger fund is run by a team of portfolio managers, supported by a broader 42-member investment division. Having joined Matthews Asia in 2005, I became the lead manager of the fund in 2008.

The fund seeks to invest in quality growth companies in the Asia ex-Japan region. Our goal is long-term capital appreciation without taking undue risk. Our disciplined process is anchored in an active, bottom-up approach to stock picking that is completely benchmark agnostic.

Quality of the underlying businesses is our first key focus. We need to understand companies' business models and their growth potential. Importantly, we look for durability of growth rather than just the rate of growth.

Secondly, we consider the capability and transparency of the management team. And we consider valuations – how is risk being priced? With an investment horizon of at least three to five years, we aim to find companies that can deliver above-average growth across cycles.

What do we invest in?

The three main biases in our fund are an emphasis on quality, a focus on domestic growth and, resulting from the latter, significant exposure towards domestic demand. Small- and mid-cap stocks have been a fertile area of idea generation over the fund's history.

Currently, approximately 44% of the fund is invested in small and medium-sized companies¹. We believe this all-cap approach is one that differentiates the fund not only from its benchmark but also from its peers, many of whom have a greater focus on large and mega caps.

Middle class consumers

In Asia, household wealth creation has been a major theme for two decades, particularly in China. We’ve seen personal wealth grow uninterrupted since the 1997 Asian Financial Crisis. The rate might have accelerated or decelerated, but we do not see the trend as being altered.

This growing middle class is increasingly an important driver of business activity in the region and source of new ideas for the portfolio. As increasing productivity eventually translates into higher wages, it is likely to foster growing consumption. By some estimates, Asia may account for nearly half of global middle class consumption by the end of the next two decades, and the majority of global middle class spending by 2050².

Opportunities in financial services

We focus on businesses that can generate sustainable, consistent growth and are not overly dependent on capital markets. Given the region's outlook for growing domestic demand, we're particularly attracted to service-oriented businesses in industries including consumer staples, healthcare and technology.

We also see financial services as providing long-term growth potential. Although it is still a somewhat alien concept today—most Asian entrepreneurs believe in looking after their own investments—the idea of getting financial advice could become its own industry in the next 10 years.

Another sector that provides some exposure to the financial theme is insurance, especially in parts of Asia such as China and Korea. The idea of preserving the quality of life, and providing estate benefits to the next of kin, is starting to resonate with consumers. Combined with benefits from deregulation and better policies, insurance firms may stand to benefit from these structural trends.

We tend to shy away from more cyclical parts of the market such as energy companies and commodities, as well as short-lived trends. This approach has contributed to performance, while our emphasis on growth has helped the portfolio navigate recent bouts of volatility.

Investing in growth is a theme that has become more prevalent in recent years and has led to valuations in some parts of the market becoming stretched, particularly in the types of sectors and companies that we focus on. We address this by adopting a 'go anywhere' approach that allows us to seek the best combination of risk and reward across the spectrum of Asian capital markets, regardless of what the benchmark tells us.

Asia outlook

It’s interesting to see that, for a change, Asia—and more specifically the Chinese economy—is arguably not driving global economic uncertainty right now. While the next steps and the fallout from Britain’s decision to leave the European Union remain unclear, the outlook for domestic demand in Asia is much more easily understood.

Countries such as India, Indonesia, and the Philippines have benefited significantly from growth in private consumption over the past two to three years, and continue to do so. While there is still much work to be done on structural reforms to boost productivity and ease the cost of doing business, progress is being made.

Combined with the size of the opportunity in many of these countries, I believe that a reasonable allocation to the Asian region is likely to provide both growth and diversification to investor portfolios.

Where to next?


¹As of 31 July 2016
²Organisation for Economic Co-operation and Development 2011, Perspectives on Global Development 2012: Social Cohesion in a Shifting World

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Sharat's views are his own and do not constitute financial advice.