Asian markets can be volatile, companies can inefficiently allocate capital and corporate governance issues remain prevalent.
China’s Singles’ Day (11 November) underscores the huge potential of the Asian growth story. Adopted and popularised by Alibaba (the Chinese Amazon), it is now a day when everyone, regardless of whether they are single, buys themselves gifts. This one day dwarfs its US equivalents, seeing $25.4 billion in the value of purchases last year. By comparison, US online sales for Black Friday and Cyber Monday combined came to just $14.5 billion in 2017.
These extraordinary statistics in part reflect the enormous growth and development over the last few decades of not only the Chinese economy, but also the Asian region’s economy more broadly; Asian growth is currently double that of the developed world, and this is expected to continue into the future.
The argument goes that strong economic growth, along with the positive effects of operating and financial leverage, should translate into returns in excess of nominal GDP over time. The reality is that this has not been the case, with the region’s equities struggling to provide a return greater than wider economic growth. The short-term nature of both the buy and sell side creates excessive stock volatility and offers opportunities for the long-term investor capable of looking through the cycle.
Cheap capital and evident growth opportunities throughout Asia encourage new entrants to set up and compete with established players, depressing margins and returns on capital. While good for the economy as workers are employed and factories built, the subsequent growth in investment and sales can result in profit and cashflow growth that significantly lags behind the nominal growth of the economy or the revenue line at a company level. In the end, growth for its own sake is of no use to the equity investor if it does not result in an increase in the cashflow available to that investor.
Whilst Singles’ Day demonstrates the remarkable growth in the Chinese consumer sector, the popularity of this date as a touchstone for potential investment returns can lull investors into a false sense of security.
In order to capitalise on Asia’s growth potential with minimised risk, we look to invest in sustainable businesses, focusing less on growth and more on companies with a franchise that can genuinely grow value. We seek to invest in businesses at a reasonable price, based on an in-depth assessment of their long-term potential. It’s important when these are found that a long-term capital commitment is made, therefore minimising costs and maximising the positive effect of compounding high returns from a good business.
Integral to our research process is a significant emphasis on understanding a company’s approach to corporate governance. We undertake extensive due diligence work to establish the extent that management will use its capital and cashflow in the interests of all shareholders to maximise long-term returns. The outcome is a portfolio that compounds returns over market cycles.
AIA is one example of a company on our portfolio which reflects this approach wholly. A Hong Kong-listed life insurer with a mix of profitable businesses that can generate capital to fund growth throughout Asia, its distribution capabilities, brand and strong balance sheet make it well placed to take advantage of Asia’s underpenetrated life-insurance market. Our expectations for the company are based on continued growth of premiums, written at attractive margins, and the maintenance of a prudent capital buffer to support that growth.
Ultimately, direct investment in Asia is challenging. Asian markets can be volatile, companies can inefficiently allocate capital and corporate governance issues remain prevalent. However, with the skill, experience and process to pick the right companies, investors are able to harness the long-term growth potential that Asia presents. Our concentrated, high conviction portfolio aims to do just that.
Andrew Graham is portfolio manager of Martin Currie Asia Unconstrained Trust.