Asian equities – four regions rolled into one
When investing in Asia, there are times when simply investing in the index will produce good results. However, when investing for absolute returns, it pays to be more selective. Fortunately, for the Managers of the Schroder Asian Total Return Investment Company (ATR), the Asian opportunity set is diverse enough for us to be extremely selective. Indeed, we view the Asian market as four separate regions with different drivers, and value can be added by transitioning between them as conditions evolve.
Hong Kong and China – a cautious stance
As Asia’s largest economy, China can dominate investor perceptions about the continent. Our outlook here has been cautious for some time due to concerns about returns, high debt levels and the travails of China’s property sector. Although China has superficially embraced capitalism in recent decades, large parts of the economy remain under strong state influence. Policy decisions are therefore hugely important and the most recent slew of stimulus measures announced in September demonstrate Beijing’s increasing cognisance of the country’s economic challenges.
While these measures are certainly supportive to near-term sentiment, the sustainability of any recovery will ultimately depend on the actual policy follow-through and the magnitude of economic improvement these policies can eventually deliver.
We will continue to look for tangible evidence of economic recovery. In the meantime, the ATR portfolio remains significantly underweight to this part of Asia, and our focus is on areas where market forces function relatively well, such as online gaming and select advanced industrial plays.
Australia and Singapore – strong fundamentals
A recent visit to Australia reiterated its many strengths, including its robust corporate sector and supportive economic policies. The country benefits from some of the most favourable demographics across Asia, with positive immigration bringing in a steady flow of skilled workers. Coupled with good infrastructure and high living standards, this leads to better long-term growth prospects than for many Asian economies. Meanwhile, Australian companies tend to pay good dividends, driven by the needs of the country’s unique pension system.
Singapore shares similar positive characteristics. Neither economy can claim to be the most exciting market in the world, but both look well placed to deliver attractive long-term total returns, driven by higher dividend pay-outs and strong governance. The ATR portfolio is overweight this region, with about a quarter of portfolio assets dedicated to it.
South Korea and Taiwan – technological powerhouses
The South Korean and Taiwanese stock markets are dominated by the technology sector. Semiconductor specialists like TSMC, Samsung and Hynix are critical players in the global technology supply chain and many investors consider them to be among the best stocks in Asia, driving substantial innovation and growth.
This has certainly been the case historically, and ATR shareholders have benefited from their past success. However, we are currently approaching this area with more caution due to the cyclical nature of the industry.
Although we have been taking profits in some IT holdings, TSMC in particular stands out as Asia’s strongest potential beneficiary of the ongoing boom in artificial intelligence (AI). Hence, it remains the largest holding in the ATR portfolio, and we maintain an overweight position to South Korea and Taiwan as a whole.
India and the ASEAN1 markets – growth and opportunity
The markets of India and the ASEAN region present a mix of rapid growth, structural changes and positive demographics. India's macroeconomic environment is notably strong, with positive policy developments enhancing its potential. However, the stock market has already priced in much of this optimism, and we have become increasingly circumspect about chasing the current high valuations.
Elsewhere in the ASEAN markets, we have focused on finding overlooked opportunities at reasonable valuations, in economies that offer improving political stability. Returns on equity are rising in the Philippines, Singapore and Indonesia, but these improving fundamentals are not yet reflected in share prices. Hence, we are overweight in these markets, with a focus on undervalued opportunities with strong growth prospects.
Conclusion – selective opportunities and a tactical overlay
In summary, even with a cautious stance on China, the broader Asian market offers ample opportunities for selective investment. There is more potential in the other three key parts of the region, where solid fundamentals, technological dominance and favourable economic conditions combine to present a diverse range of stock-specific opportunities with attractive potential.
By overlaying these individual investments with a ‘top-down’ tactical hedging2 strategy that uses derivatives3, we aim to deliver a smoother ride for investors. This should mitigate some of the broader risks associated with Asia, while providing the flexibility to deliver potentially attractive long-term total returns, through a combination of income and growth.
1 The ASEAN (or Association of Southeast Asian Nations) include Thailand, Philippines, Indonesia, Malaysia, Singapore, Vietnam amongst others.
2 Hedging is a type of investment that is selected to reduce the potential for loss in another investment in the portfolio, in order to offset the risk of adverse price movements.
3 Derivatives is the collective name used for a broad class of financial instruments that derive their value from other underlying financial instruments. Futures, options and swaps are all types of derivatives. The managers use quantitative models and a top-down overlay to analyse economic and market trends and assess near- and medium-term market risks. This informs their use of derivatives, which aim to protect the capital value of the portfolio or facilitate efficient portfolio management.
