Asia ex Japan equities lost value in Q3, primarily due to weakness in China. The MSCI AC Asia ex Japan Index generated a negative return and underperformed the MSCI World. Chinese equities were negatively impacted by escalation in trade tensions with the US. The US moved ahead with several rounds of tariff implementation and China retaliated with measures of its own. Meanwhile, Chinese macroeconomic data disappointed. The authorities announced a range of targeted economic support measures, including a shift to fiscal stimulus and credit easing. The central bank also re-introduced macro prudential measures to stabilise the renminbi. India underperformed by a small margin with rupee weakness a headwind amid rising inflation and concerns over the trade deficit given oil price strength.
Conversely, Thailand recorded a robust return with financials and energy stocks among the best performing names. The approval of laws required for a prospective election in 2019 was perceived as positive. Taiwan, where semiconductor stocks supported performance, and Malaysia also generated solid gains and outperformed.
The best performing sector in the region was energy on the back of a strengthening oil price. Conversely, the index laggards were consumer discretionary, healthcare and IT.
Following an extended period of low interest rates, the US Federal Reserve (Fed) continues to normalise monetary policy with more rate hikes expected in coming quarters and ongoing shrinkage in its balance sheet. Higher US dollar rates, more constrained global US dollar liquidity and a stronger US dollar have in the past usually proved to be headwinds for Asian and emerging markets, and this remains the case in 2018. However, in contrast to previous “taper tantrums”, most emerging Asian economies generally look better-placed today from a macro perspective. Current account deficits have been reduced, with most Asian countries running a surplus. Currencies have already weakened in recent years to competitive levels and inflationary pressures in the region remain benign outside of India and the Philippines, meaning real interest rates remain reasonably attractive in most markets. While we may continue to see “risk-off”-driven selling of assets and FX in emerging markets in response to any sharp US dollar moves, we do not expect this to escalate into any systemic problems on the ground in Asia. The greatest pressure today is being seen in India, Indonesia and the Philippines, all of which are running current account deficits and are oil importers, and are being forced to raise rates to support their currencies and constrain domestic demand.
Given these near-term pressures we have very limited exposure in portfolios to Indonesia and the Philippines, while our Indian investments are more concentrated in the strongest private sector banks like HDFC Bank, which is well placed to cope with tighter domestic liquidity.
In addition to the pressures exerted on the region by US policy tightening, politics and protectionism have more recently taken centre stage as key drivers of markets and investor sentiment, given escalating trade tensions between the US and China. Our base case this year has been that a wide ranging, very destructive trade war is not in anyone’s interest and that some sort of negotiated agreement is still possible in time, but recent moves by the US to escalate the tariffs on Chinese imports are not encouraging on this front. It seems things may have to ‘get worse before they can get better’ as the US tries to exert maximum leverage over China before any negotiations start. The direct risk from US tariffs to Asian equity earnings remains hard to gauge at this stage given the rapidly changing scope of the goods affected. But our portfolio remains heavily skewed towards more domestic companies, with the bulk of the export exposure concentrated in the Korean and Taiwanese technology stocks (whose products are outside the current scope of the tariffs), so the first order impact of the tariffs should be fairly modest. The broader risk to markets, however, is that the uncertainty over tariffs will cause a more general weakening in business confidence and reduced investment spending in Asia and further afield. This could impact GDP growth rates and, if prolonged for an extended period, could also impact domestic consumption more widely in the region. We continue to monitor these issues closely and have been discussing with companies their contingency plans in the event that they face much higher tariffs or other trade obstacles. We will reassess our positions on a stock-by-stock basis as more details emerge.
In China, meanwhile, the underlying economy has been showing signs of a gradual slowdown in recent months, even before the impact of the trade war really starts to bite. The slightly softer growth seems to be a lagged response to the slowdown in broader credit, particularly in the shadow banking system, which has been ongoing for the last 18 months or so. This will impact the property and infrastructure sectors as funding for more marginal players (public and private sector) becomes tighter. In addition, key consumer products such as autos and household appliances are seeing slower growth due to a very high base effect for sales in 2017. Although we have started to see signs of some policy loosening and selected stimulus from the Chinese authorities in response to the weaker macro outlook, these remain fairly modest in scale today, so we should continue to expect a gradual slowdown in momentum in China through the rest of this year.
Although in much of Asia today, the earnings picture has remained fairly healthy year-to-date, with consensus forecasts still looking for double-digit EPS growth for the region, equity markets have been very quick to price in a slowdown in growth for the reasons stated above. Aggregate PE multiples for the regional index have corrected from around +1 standard deviation above average in January, to slightly below average levels today. While for many of the more highly rated ‘growth’ stocks in the region, corrections have been even more severe as investors have sold their ‘winners’ from the preceding market upswing.
As long-term investors, we have not made any dramatic changes to our strategy in light of current market uncertainty and portfolio turnover remains low. We remain geared towards secular growth trends including domestic consumption and services related areas like internet and e-commerce, travel, healthcare and education. We may be seeing slightly slower growth in these areas in the near term, but the stronger businesses should still be able to compound at attractive double-digit rates for many years and over time this should help drive share prices upwards. In China, over the years we have preferred to focus on areas with strong secular tailwinds rather than try to trade the shorter-term mini-cycles in investment spending, which are far more vulnerable to shifts in policy stances. As valuations have corrected sharply in some of these areas in recent months, we have started to add very gradually to positions, although we continue to tread carefully given the difficult macro backdrop.
The fund (NAV) posted a loss and underperformed the MSCI AC Asia ex Japan (NDR) index over the quarter.
The main detractor from returns geographically was stock selection in China and, to a lesser extent India.
On a sector basis, an overweight exposure to the consumer discretionary sector dragged on returns, while stock picking in the sector was also negative. Stock picking in industrials, financials and materials also detracted. Positive stock selection in information technology and an underweight to consumer staples could only partly offset this.
|Q3/2017 - Q3/2018||Q3/2016 - Q3/2017||Q3/2015 - Q3/2016||Q3/2014 - Q3/2015||Q3/2013 - Q3/2014|
|Net Asset Value||3.3||23.3||41.3||-3.3||10.9|
|MSCI AC Asia ex Japan (NDR)||4.4||18.8||36.6||-6.0||8.4|
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.