Mike Kerley, manager of Henderson Far East Income trust, explains how he is looking at Asian opportunities in a new way.
The Asian market is showing signs of life again, after seven years of flat earnings growth. The tiger economies are waking up and are on the prowl, led by a resurgent China. Asian stocks excluding Japan outperformed the world in 2017, and many analysts believe the region is likely to continue its growth story through 2018 and into 2019 – though of course, analyst forecasts are by no means a guarantee of good performance.
We believe now might be a good time to invest in Asia, but the way we thought about the region in the past is not the way we should think about it in the future. Gone are the days when local companies supported the growth of global brands through their manufacturing and production lines, only for western companies to stamp their logos on the final products.
Most of my investment career has involved looking at Asia in a particular way. Asia has historically been pretty cyclical; it has been geared into whatever the rest of the world has been doing. So if the world was growing quickly, Asia was growing quickly, because it was making products and selling them to the rest of the world. That’s the old story of exports and outsourcing, from which Asia has done very well. The problem, we think, is that this story is probably at an end.
There are two principal reasons for this. First, low-cost labour is not low-cost anymore, especially in China, where wage growth has been quite rapid. Secondly, Asia’s market share of world-produced goods is so high that it can’t gain any more market share. As of May last year, Chinese companies accounted for more than 25 per cent of the global manufacturing industry, while the country was the leading producer of 220 of the world’s 500 major industrial products, according to the Chinese Ministry of Commerce.
So in terms of growth, where does China go from here? We think the country may see a new kind of growth coming from within China, and Asia generally, with local brands eating into the market shares of multinational companies in local markets. _ e next growth leg in Asia will then come from increasing the value of the goods sold to the rest of the world.
China standing on the cusp of substantial change
Historically, companies in the US have grown strongly over the years because they have been at the cutting edge of new technologies and new areas of growth. Asia has been associated with the low-cost stuff. That’s changing.
China is at the forefront of this change. For the first time, we believe China will spend more on research and development this year than the US, and within five years we think it may spend more than the EU and US put together. This is a huge shift, and it’s into new areas such as electric vehicles, renewable energy, healthcare, artificial intelligence and virtual reality – things that we will embrace in years to come and that have the potential to become part of our day-to-day lives.
Our belief that China will lead Asia’s cutting-edge growth story stems from the increasing number of patents filed from the country and across the Asian continent. Even on the manufacturing side, China is working to improve its efficiency and productivity.
Of course, filing patents does not necessarily equal growth or economic success, but China is producing more robotics each year than South Korea and the US put together, and we believe the efficiency of its manufacturing over time will continue to improve.
So what does all this mean for investors? Historically, Asian growth has been accessible for investors via western firms selling goods into the region – think HSBC, Louis Vuitton and BMW. That’s probably not the way we can look at it going forward. Local companies are targeting the market shares of global brands as the quality of their goods and services improves.
Take ANTA, a Chinese sportswear brand with ambitions to take on behemoths such as Adidas and Nike, both at home and in international markets.
The Chinese brand has been the official sponsor to the country’s Olympic teams since 2012, but it started life in 1994 as a little-known manufacturer for other brands. Global market leader Nike has a larger market share in China than ANTA, but although Nike is still enjoying growth in the Chinese market, its growth is slower than ANTA’s, whose market share has been consistently increasing in recent years.
Asian brands to compete globally
This is part of a familiar pattern developing across Asia in different sectors. The next step is to be competitive internationally. How many Chinese brands are we going to start seeing in our shops? Some of these brands already have a sizeable presence in western markets. For example, Chinese video surveillance company Hikvision has grown to become the largest CCTV hardware provider in the world – although not many of us would recognise the name.
A more familiar brand, perhaps, is Alibaba. The e-commerce platform was founded in 1999 in Hangzhou, China, and it has grown from humble beginnings to become a global enterprise worth around $480 billion (£353 billion) at the end of 2017, according to Bloomberg data.
Alibaba’s success has a similar look and feel to US rival Amazon’s. The Seattle-based giant’s shares jumped 58 per cent in value in 2017, turning founder and chief executive Jeff Bezos into the world’s richest man. The US online retailer broke its single-day sales record during the online sales holiday Cyber Monday, which saw Americans spend about $6.6 billion through online channels. But this was dwarfed by the Chinese equivalent occasion, which takes place on 11 November and is referred to as Double Eleven or Singles Day.
In 2017 Alibaba generated $25.3 billion worth of sales on Singles Day. At the peak of the event, Alipay, the online payment system created by Alibaba, was processing 256,000 transactions a second. Some 800 million parcels were delivered on the back of this, the first within 12 minutes.
Economic and political headwinds
This gives you some idea of what is happening. China is embracing change. That’s also true of Asia as a whole, but change is most marked in China. People have been worried about China’s colossal spending on infrastructure, but we believe it is improved infrastructure that is facilitating change.
Of course, growth in the region is still vulnerable to economic and political risks. For most investors with interests in Asian markets, the war of words between US president Donald Trump and North Korea’s leader Kim Jong-Un will, quite rightly, have been a cause for concern. But the thawing of relations between North and South Korea is a positive story for investors in Asia.
North Korea’s most likely act of war would probably be to hit the South Korean capital, Seoul. But in light of the two countries’ cooperation during the 2018 Winter Olympics in Seoul, and the North Korean leader’s visit to the South’s capital in May, we are taking some encouragement that the situation is improving.
Another major risk to the growth ambitions of local Asian companies is the protectionist strategy outlined by Trump during his presidential campaign. One of his first major acts in the White House was to withdraw the US’s signature from the Trans-Pacific Partnership, a multilateral trade agreement between 11 countries. Since then, however, the former reality television star has not delivered on a number of promises, and his speech at the World Economic Forum’s meeting in Davos in January adopted a much more conciliatory tone.
Nevertheless, Trump’s recent imposition of a 25 per cent tariff on steel imports and a 10 per cent tariff on aluminium imports makes some investors nervous. From China’s perspective, however, exports have become much less important to the national economy. The contribution of exports to China’s GDP dropped from 37 to 20 per cent in the 10 years between 2006 and 2016.
In our view, this all points to sustained growth in Asia and the likelihood that local companies will facilitate this growth, rather than western brands selling goods into Asia.
We believe there is significant earnings growth potential for local Asian brands and we hope this will be matched by dividend growth.
RISK WARNING: The information in this article does not qualify as an investment recommendation. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Prospective investors should be aware of the risks of investing in shares listed on emerging markets, which may be more volatile than more developed stock markets. Changes in the rates of exchange between currencies may cause your investment/the income to go down or up.
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