Asia ex-Japan equities delivered a positive return in sterling terms in the fourth quarter, supported by easing geopolitical risk as the US and China reached a ‘phase one’ trade deal, to be signed on 15 January. Sterling’s strength over the quarter, however, reduced the returns available in local currencies.
Against this backdrop China, South Korea and Taiwan all outperformed. In Taiwan, strong performance from technology sector companies boosted returns, as earnings expectations were revised upwards following solid third-quarter sales figures. In South Korea, the central bank cut interest rates by 25 basis points to 1.25%. Pakistan was the best-performing index market, led higher by banking stocks.
By contrast, Thailand recorded a negative return and was the weakest index market as third-quarter gross domestic product (GDP) growth remained subdued, at an annual rate of 2.4%. The Philippines and Malaysia also finished in negative territory. India was also down on the quarter, negatively impacted by higher crude oil prices, rising fiscal pressure and concerns over slowing growth. Hong Kong was marginally weaker.
We expect moderate returns from the region’s stock markets in 2020 as the major engines of global growth (China and the US) are both slowing and US-China tensions are likely to rumble on, keeping sentiment in Asia subdued.
The events of the past year or two have made Asian markets feel less bound by economic fundamentals and more hostage to unsettling political developments. Many of the long-held assumptions underpinning our Asian investments – such as the merits of global free trade or the rule of law and stability of Hong Kong – are being radically challenged.
The ongoing US-China trade dispute has sapped momentum in many regional economies and we do not expect any major upswing in economic growth as both the Chinese and the US economies are slowing. As a result, microeconomic, rather than macroeconomic, factors will drive stock selection. This involves seeking companies that have the ability to achieve growth based on their competitive advantage or ability to grow market share, rather than due to the economic cycle.
China offers the best opportunities for stock pickers. Headline growth in China has slowed considerably in recent years, with nominal GDP now around 6-7%, compared with between 15% and 20% at its peak. However, there has been a dramatic explosion in the growth of “newer” parts of the economy as the service sector takes over the baton for economic development.
E-commerce continues to grow many times faster than underlying retail sales. At the same time, sectors such as healthcare, education, travel and leisure now account for a greater share of consumer spending, with growth rates much higher than the wider economy.
Meanwhile, the “upgrading” trend is set to continue, with Chinese consumers spending more on high-end products. So, even if volumes are not growing as fast, selling prices and margins are being boosted for companies exposed to these trends. With the opening up of the A-share market in the last few years, there are now even more opportunities to gain exposure to these trends. We, therefore, continue to see China as the most exciting stock-picking opportunity in the region.
Disruption is here to stay. Technological developments, changing business models, environmental pressures and changing consumer tastes are powerful drivers of disruption in Asian markets. And while these trends have enabled the creation of innovative new businesses, such as Alibaba, they also wreak havoc in many of the more traditional stocks in which we invest.
Traditional retail and media stocks have already been decimated by the onslaught of e-commerce. The disruption is now spreading, with the revenues of banks being weakened by new “fintech” companies, and automakers struggling to cope with the shift from petrol to battery technology.
Worries over disruption have caused share price falls in some traditional sectors and stocks can appear cheap on headline valuation multiples. However, we think these kinds of business model disruptions are potentially more damaging than trade wars or cyclical economic slowdowns. We continue to view many of the out-of-favour sectors as “value traps” and are cautious on banking, automotive, cyclical, heavy industry and commodity names.
Inflation and interest rates are likely to remain low. Against this backdrop, equity dividend yields offer attractive returns that are now well above risk-free rates in most Asian markets. Payout ratios remain modest, aggregate balance sheet leverage is below international averages and returns boosted by buybacks have been limited.
As a result, there is considerable potential for payouts to increase as companies become more willing to distribute surplus case to shareholders. In a low-growth world, we are happy to hold stocks where the bulk of the return is likely to come from dividends, provided we see the potential for dividends to be sustained or, ideally, grow.
Many technology stocks have been out of favour for the past two years as global smartphone sales have flattened in the absence of any new must-have software application prompting consumers to upgrade. However, the digitisation of the global economy continues to accelerate, which will be positive for key Asian technology stocks. The imminent launch of 5G networks in many Asian markets over the next two years should bolster demand and we see attractive opportunities for our preferred names in the IT sector.
Our strategy for Asian equities remains balanced as we move into 2020. Overall market valuations in Asia look reasonable against historical comparisons. However, this masks the fact that sectors such as banking, automotives and commodities drag down the headline valuations. The valuations of stocks we want to own are definitely not cheap, so we anticipate moderate returns from the region. However, we have a strong long-term conviction on where the best opportunities are in Asia. These include stocks in sectors such as Chinese consumption, insurance, technology, real estate in Singapore and Indian private-sector banks.
The fund (NAV) posted a gain over the fourth quarter of 4.1% and outperformed the MSCI AC Asia ex Japan (NDR) index, which gained 4.0%.
Geographically, the main driver of fund performance was stock selection in Taiwan and to a lesser extent India. The negative impact of an underweight exposure to China partially offset this.
On a sector basis the fund benefited from stock selection in and an overweight exposure to consumer discretionary. An underweight to consumer staples was also beneficial. On the other hand, stock selection in financials and real estate detracted.
|Q1/2015 - Q4/2015||Q1/2016 - Q4/2016||Q1/2017 - Q4/2017||Q1/2018 - Q4/2018||Q1/2019 - Q4/2019|
|Net Asset Value||-1.0||27.6||38.7||-11.7||15.0|
|MSCI AC Asia ex Japan (NDR)||-3.6||26.1||29.5||-9.1||13.6|
Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.
Investors in the emerging markets and the Far East should be aware that this involves a high degree of risk and should be seen as long term in nature. Less developed markets are generally less well regulated than the UK, they may be less liquid and may have less reliable arrangements for trading and settlement of the underlying holdings.
The trust holds investments denominated in currencies other than sterling, investors should note that exchange rates may cause the value of these investments, and the income from them, to rise or fall.
The trust Invests in smaller companies that may be less liquid than in larger companies and price swings may therefore be greater than investment trusts that invest in larger companies.
The trust may borrow money to invest in further investments, this is known as gearing. Gearing will increase returns if the value of the investments purchased increase in value by more than the cost of borrowing, or reduce returns if they fail to do so.
Investments such as warrants, participation certificates, guaranteed bonds, etc will expose the fund to the risk of the issuer of these instruments defaulting on paying the capital back to the fund.
Gearing will increase returns if the value of the investments purchased increase in value by more than the cost of borrowing, or reduce returns if they fail to do so. Investments such as warrants, participation certificates, guaranteed bonds, etc will expose the fund to the risk of the issuer of these instruments defaulting on paying the capital back to the fund.