Jayson Forrest is the managing editor of Money & Life Magazine.
With Asia accounting for 60 per cent of the global population, Geoff Bazzan answers some commonly asked questions about why Asian equities should be part of any well-diversified portfolio.
1. Why should investors diversify their exposure to Asian equities?
Australians have always had a strong home bias. And even when we do invest offshore, the tendency is to stick with the familiarity afforded by the U.S. and Europe.
Investors and planners tend to stay with these regions based on the comfort and familiarity they derive from already knowing the brand. As a result, Australian investors are ignoring some of the most dynamic companies and economies in the world.
Asia makes up 60 per cent of the world’s population, with the major equity markets comprising nine emerging market countries (China, Korea, Pakistan, India, Thailand, Taiwan, Philippines, Malaysia and Indonesia) and two developed market countries (Hong Kong and Singapore).
From a sector perspective, the Asian region offers a higher exposure to the technology, global industrials and vast domestic consumer sectors, and less exposure to energy and materials. From an Australian investor perspective, this is likely to be an attractive feature.
When you consider that resources are already well represented in most Australian equities portfolios, from a total portfolio allocation, these sectors bring the benefits of diversification to a portfolio.
2. What are the pros and cons of investing in Asian equities?
As a pro, investors are spoilt for choice among the very large number of Asian stocks that are exposed to powerful secular growth forces. Meanwhile, Asian markets have lagged U.S. equity indices and average equity valuations are notably amongst the most attractive globally.
The real opportunity is recognising that while the economic backdrop is a plus, we expect huge divergence in the range of returns over time from individual stock names. With over 1,500 companies having a capitalisation in excess of US$1 billion, it is a Herculean task, even for experienced Asian investors, to distinguish among the most suitable portfolio candidates.
However, Asian corporate investor relations and disclosure standards are in many cases not yet on par with that of developed markets, which many investors see as being a negative. But this is changing. We have witnessed continuous improvements since the early 2000’s in the engagement of companies with minority investors.
3. What are the key themes likely to shape Asian equities in 2020?
The standout observation about this asset class is just how neglected it remains, with low participation by international investors. The narrative of U.S./China trade tensions and civil disobedience in Hong Kong is presently consuming the news headlines, which unreasonably displaces the otherwise healthy outlook for the region and its long-term potential.
Meanwhile, there is fear of fading growth prospects across the OECD (developed markets). The fact that Asia is the established growth engine of the world economy – when a lack of growth elsewhere is most feared by markets – yet it is populated by deeply discounted stocks, deserves logical re-evaluation by planners and investors.
4. what are key considerations investors should be making in their asian equities portfolio?
A mindset change is long overdue in asset allocation tactics. Asia ex-Japan equity markets have a market capitalisation that exceeds that of either Europe or Japan and is equivalent to about half that of the United States.
In fact, Asia ex-Japan is around 10 times larger than the value of the Australian equity market.
No sensible and adequately diversified portfolio would choose to be absent from exposure to U.S. or European stocks. Yet, established investment behaviour dies hard, and many sophisticated equity portfolios are not directly invested in Asia.
Moreover, Asia is responsible for over 50 per cent of world GDP growth and will likely be so for decades to come. The size of this market and its growth prospects deserve recognition. The time is well overdue that ‘investing in Asia’ should be anything other than a permanent allocation in sensibly constructed portfolios. The logic to invest in Asia is no longer ‘in’ or ‘out’, but rather ‘how to’.
Equity indices are partially responsible by ignoring market capitalisation and focusing only on ‘free-float’, which accounts for the non-traded component of a firm’s capital base (usually controlling shareholders).
We believe exposure to Asia via foreign multinationals is a well-worn path. Instead, if you want better exposure to Asia, you get this through strong, dominant and localised companies that have been operating in their market for a long period.
Asia presents big thematic opportunities for investors with technology leaders, rising consumer spending and agriculture all well represented.
5. How do you include Asian equities as part of a well-diversified portfolio?
MSCI’s decision to increase the weighting of China A-shares in its indices is a pivot towards Asia that many Australian investors have so far ignored. The MSCI is increasing the inclusion factor of all China A Large Cap shares in its indices from 5 per cent in May to a target inclusion factor of 15 per cent in November 2019.
This change will have an immediate impact on passive investments in the asset class, because as soon as the benchmark changes, passive allocations will move in line with the benchmark.
This is why we believe investors, planners, asset consultants and superannuation funds should be more active when setting their allocation to Asian equities. Whilst a target allocation is an individual decision for every investor, which should be based on a long-term view of fundamentals, an allocation to Asian equities in the range of 5 per cent to 10 per cent could provide diversification benefits from a total portfolio perspective.
With China now Australia’s largest trading partner, Asia’s economic rise is a continuing trend that remains in its infancy.
Just as Australian investors allocate to global portfolios that are dominated by the U.S. and Europe, Asia’s relevance does demand a re-evaluation in the allocation of Asian equities in investment portfolios.
Asian stocks have lagged the now decade long bull-market in the U.S. and are demonstrably cheaper, making the timing right to take a deeper look at Asian equities.
Geoff Bazzan is Head of Asian Equities at Maple-Brown Abbott.