Why active investing can solve the argument over Asian equities

In early October, the World Bank issued a tough assessment on Asia, warning that the region’s economies could be dragged lower by the difficult outlook for China*. In contrast, its supporters suggest that it faces few of the problems that weigh on its Western counterparts, such as high debt, inflation, or demographic headwinds; while its growth prospects are far brighter. Which of these competing narratives is closer to reality?

There is undoubtedly a problem with Chinese growth. The World Bank forecast that China’s economic output would be just 4.4% in 2024, a long way from the giddy heights of 6-7% that it enjoyed until recently.*. It believes this will have a knock-on effect on the rest of Asia. Certainly, China’s economic might has historically helped power the rest of Asia. The International Monetary Fund estimates that for every percentage point of higher growth in China, output in the rest of Asia rises by around 0.3%**.

However, there is a counter argument. Asia is diverse. At one end is Singapore and Taiwan, each with high GDP per capita, mature, well-established global companies in specialist areas such as banking, real estate or semiconductors. At the other are the fast-growing emerging economies of India, Indonesia and Vietnam. Not all are equally affected by China’s weakness – and some may even benefit from it.

The China Plus One strategy – where global companies diversify their supply chains away from China – has built up steam since the pandemic. The key beneficiaries are low-cost manufacturing hubs such as Vietnam and India. Foreign companies invested $22.4bn in projects in Vietnam in 2022, an increase of 13.5% year on year, according to government data***. The Indian government has put $24bn in incentives in place to tempt businesses to set up there****.

Equally, countries such as Indonesia have their own independent growth trajectory. The government has made a virtue of its strength in key natural resources for the energy transition – such as nickel – to establish itself as a key manufacturing hub for electric batteries. The country also has an ambitious infrastructure programme to sustain growth.

Why China is not a write-off despite ongoing concerns

Economies are not stock markets and everything has a price. After a long run of weak performance, Chinese equities are cheap and prices may be nearing a level where risks are more than fully reflected. The MSCI China is on a forward price to earnings ratio of 9.7x, compared to 16.1x for the MSCI World index. It also looks stronger on its price to book ratio^.

There is also the argument that China’s woes may not be as bad as the Western press envisages. Growth may yet recover – the Chinese consumer has had a profound. shock and was always likely to take longer to revive than Western equivalents. Asia Pacific funds with strong exposure to the region include the likes of Matthews Pacific Tiger (45%^^), T. Rowe Price Asian Opportunities Equity (35%^^^) and Ninety One Asia Pacific Franchise (39%)^^.

Matthews’ head of portfolio strategy David Dali and portfolio manager Vivek Tanneeru, believe there are an abundance of quality companies for investors to get exposure to in the region.

“Let’s not forget that China remains at the heart of global economic growth and its equities represent around 30% of the MSCI Emerging Markets Index. Concerns over geopolitics, regulatory crackdowns and real estate sector challenges have weighed considerably on shareholder returns.

“Most of the three-year loss of the MSCI China was attributed to multiple contraction–or the fall in valuations due to factors not related to stock fundamentals such as earnings or dividends. But if we strip these away, these external and sector-specific factors, the fundamentals of many Chinese companies are robust and the potential returns are attractive,” they said in a recent market update^^^^.

“One way is by investing in lower profile, innovative companies that aren’t in the crosshairs of Chinese regulatory scrutiny or the negative sentiment stemming from geopolitical tensions between China and the West,” they added.

At the other end of the scale is the Jupiter Asian Income fund, which currently has a zero weighting to China*^, with managers Jason Pidcock and Sam Konrad struggling to find companies that meet their quality criteria there. Pidcock is also concerned about the direction of domestic politics in China, particularly the deterioration of relations with the US, and believes government interference will hold back economic growth*^.

They prefer areas such as Australia, which is a useful source of dividends in the region and is experiencing strong economic growth. They like the blend of developed and emerging growth and also have exposure to India and Taiwan^^^.

Why active investing is the only solution amid growing dispersion

Anthony Srom, manager of the Fidelity Asia Pacific Opportunities fund, comes in somewhere between the two. He believes a cyclical rebound in China is possible, but believes there are long-term structural issues that require caution. In his view, there are interesting stock-specific opportunities, particularly in the consumer staples and discretionary sectors. He holds companies such as Focus Media, a media business specialising in digital signage and Skshu Paint, a waterproof system service provider and paint manufacturer^^.

JPMorgan Emerging Markets Trust investment specialist Emily Whiting says the recent challenges highlight the need to invest in active managers, rather than just back the China story. She says while the heightened political sensitivity is having a material impact on industries and sectors, there remain a number of companies which are growing their margins and market share**^.

She says: “Ultimately it comes down to whether we as investors feel comfortable paying a certain price for a company and if we believe its thesis remains intact. By contrast, other countries are benefitting, take India as an example, it may look far more compelling, but you are having to pay a lot more for companies as a result.”

All of these funds will provide a different trajectory, depending on whether China revives. For example, the Jupiter fund is likely to provide a more defensive route into Asia, with the cushion of a higher yield, while the Fidelity fund may capture more of the region’s growth, should it materialise. Either way, all are skilled stockpickers, who will make the most of the Asian opportunity set.

It’s also important to note things can change quickly, and that time in the market – rather than timing the market – is usually the best recipe for success.

For example, while the World Bank has warned that east Asia’s developing economies may be set for one of the lowest rates of growth in five decades, it was only as recently as May that the IMF pointed to Asia as the principal driver of global growth in 2023 – contributing around 70%***^. Things can just as easily turn positive again – but investing through active managers can help investors take advantage of opportunities across the various countries and sectors while they wait.

*Source: FT, October 2023

**Source: IMF Blog, February 2023

***Source: FT, Vietnam becomes vital link in supply chain as business pivots from China, July 2023

****Source: NDTV, India News, January 2023

^Source: MSCI Index Factsheet, September 2023

^^Source: Fund factsheet, 30 September 2023

^^^Source: Fund factsheet, 31 August 2023

^^^^Source: Matthews Asia, October 2023

*^Source: Jupiter Asset Management, August 2022

**^ Source: JPMorgan, September 2023

***^Source: IMF Blog, May 2023

_{Photo by Charles Postiaux on Unsplash}