What’s so special about Asia?
Did you know every other day a new billionaire is minted in Asia? Wealth is surging, consumption is rising, the market is relatively cheap, and land, corporate and economic reforms under way. But there are plenty of hazards, and ESG practices are inconsistent. However, the bigger risk may be not investing* there.
Who are the players in the Asian markets?
When most people think of Asian sovereign wealth funds they think of Singapore, but there are numerous SWFs in Asia, totalling nearly USD 3 trillion. This paper from the San Francisco Federal Reserve charts the rise of the Asian SWF.
The Society of Actuaries breaks down the life insurance sector in Asia, specifically their allocation decisions. The study shows low global yields weighing on Asian life insurers forcing them to increase allocations to riskier asset classes such as equities, real estate and private assets. There are also signs that regulators are gradually loosening investment strings on riskier assets which could mean the trend continues for some time yet.
Activist investors have historically shied away from Asia, but this is changing. In 2015, Elliott Management targeted Samsung, Korea’s biggest company which is deeply intertwined with the establishment. Although Elliott lost the proxy battle, it may have won the investment war by demonstrating to markets that it has a shot of winning in Asia after the activist lost the shareholder vote by just 3% of votes cast. JP Morgan* calculates that in 2017, there were 106 activist campaigns in Asia as the region embraces the concepts of shareholder value. Elliott is still at it, of course, and recently called for a restructuring at Hyundai.
INSEAD presents a case study of Credit Suisse’s innovative approach to establishing its impact investing business in Asia. By partnering with a local venture management group, which had experience in investing in growth stage companies, the impact fund operated efficiently, had good deal flow, and better transaction due diligence, allowing Credit Suisse to focus on its core competence of acting in an advisory capacity rather than manage day-to-day operations.
Where are the opportunities in Asia?
William Blair discusses the opportunity of investing in China A shares. One of the key reasons is the underrepresentation of China in most global equity indices that could lead to ongoing institutional buying of Chinese stocks for years to come - something we’ve written about extensively in this edition. It’s a similar story for China’s bond market, with foreign investors underexposed. It’s partly to do with the difficulty for overseas entities to purchase Chinese debt but the Bond Connect programme, launched last year to simplify foreign investing in China, should help.
It’s no secret that Japan faces an ageing population and dwindling birth rate. Normua predicts this will lead to a greater role for private pension plans and explains the various reforms needed to support it. The paper is perhaps not the most riveting for the average investor, but for those with a keen interest in pensions infrastructure it provides some important development areas in the Japanese pensions landscape such as having higher contribution levels on defined contribution plans, allowing unused contribution portions to be carried forward, eliminating employer and employee matching requirements, and enabling early pension withdrawals,.
Asia mezzanine real estate debt is the hot area* to be invested in according to InfraRed Capital Partners. They argue that mezzanine’s hybrid debt and equity characteristics can offer cash income returns of 15% in high growth countries of Southeast Asia such as Vietnam, Indonesia and the Philippines.
Academic work on the subject
New York University’s Aswath Damodaran publishes his now annual review on country risk*. The paper sets the standard for thinking about country risk given its updated figures and assessment of risk from multiple angles and across asset classes. Damodaran argues that a country risk factor should be incorporated into equity risk premiums because he thinks country risk cannot be adequately diversified, and betas and cash flows do not reflect it in practice. He also finds that outside developed markets, Asia has the lowest monthly equity risk premium, suggesting it is lower risk than other emerging market regions. In terms of overall property rights, Damodaran concludes that Asia is only slightly worse than the EU and better than the rest of Europe.
The Asian Development Bank studies whether the rapid demographic shifts in Asia could lead to the middle income trap, where countries reach a certain income only to become stuck at that level with growth plateauing. For many decades Asian countries benefitted from a demographic dividend through higher labour supply, but in more recent years this has reversed in countries such as China and Korea. This report finds that Asian countries generally have the conditions for a demographic-driven middle income trap, and this phase could last decades rather than years. The authors recommend extending the retirement age and increasing human capital investment (e.g education spending) without increasing the relative cost of having children versus income.
A legitimate concern for minority investors in developing markets is the expropriation of their rights by other stakeholders. This paper analyses whether that fear is justified in East Asia. The study finds that controlling shareholders may expropriate minority shareholders, but importantly, there is no evidence to suggest that state entities or widely-held corporations expropriate form small shareholders indicating that governance is perhaps more robust than many investors believe.
Books on the subject
Easternization by FT writer Gideon Rachman argues that Asia’s rise and America’s slow decline will transform the international balance of power. Not a finance book as such, but it provides great background on secular global trends for the Asia investor.
Rogue Trader charts the fall of Singapore trader Nick Leeson, and the once venerable Barings Bank that he brought down with him. The book gives an impression of just how ‘fast and loose’ some parts of the Asia market were in the late 1990s, and how much they have developed since.
Alibaba, The House That Jack Ma Built*, is the story of an exceptional man who created an internet giant despite never having written a line of code nor made a sale. The book also provides useful insight into China’s business environment and the political and cultural skills required to navigate it successfully.
Something lighter - film and fiction
Shantaram*, a tumultuous adventure by Gregory David Roberts, paints a vivid, compelling and brutal image of Mumbai. A film adaptation starring Johnny Depp has stalled but we have faith it will eventually be made.
Empire of the Sun, the novel or movie, are both recommended. Set in the expat community in Shanghai during the Second World War when Japan invades, it provides a glimpse into the different cultures in extreme circumstances through a boy’s eyes. Watch out for a young, but no less intense, Christian Bale playing the protagonist in the firm version.
China Hustle is a documentary looking at the darker side of investing Chinese companies. It tells of dubious business practices and outright corporate frauds that short sellers uncovered, centred around Chinese companies, which were not permitted to trade on US exchanges directly, using reverse mergers with US shell companies to gain listings. The problem was that some of the companies were little more than run-down factories masquerading as large multinationals. As ever, buyer beware.
Highly recommended list
- Yes, investing in China carries risks…but the bigger risk is NOT investing there - Neal Kimberley, South China Morning Post
- Shareholder Activism in Asia - JP Morgan
- Why China A, Why Now? - William Blair
- Why investing in real estate mezzanine debt in Asia makes sense - InfraRed Capital Partners on CNBC
- Country Risk - Aswath Damodaran
- Alibaba, The House That Jack Ma Built - Duncan Clark
- Shantaram - Gregory David Roberts
- China Hustle - Directed by Jed Rothstein