By Cherry Reynard.

Aberdeen New Dawn Investment Trust PLC has been investing since 1989, an investment trust investing in a concentrated and diversified portfolio of Asian equities, ex Japan, chosen for quality.

 

A tale of two Asias

Investors have two opposing narratives when looking at Asian markets: The first is growth Asia, where economic development, consumer spending and technological innovation create a fertile ground for companies to grow profits. The second is vulnerable Asia, which look set to suffer from increasing protectionism in the US, a stronger dollar and structural economic imbalances. Which is likely to win out?

Asia remains one of the strongest areas of growth within the global economy. The two major economies of China and India continue to show robust growth, in spite of higher debt levels in China, and the reform process in India. This growth ripples out to areas such as Vietnam, which has seen a steady growth rate of over 6%, forecast to continue until 2021 and beyond ¹. The Philippines, Malaysia and Indonesia can all boast similarly impressive growth rates.

Room for manoeuvre

Governments in the region have policy flexibility: debt levels are not inflated and governments have the ability to lower taxes and raise spending levels. There is capacity for interest rates to fall, as inflation remains under control. All of this creates a benign environment for companies to grow.

However, Asia has been seen as the area most vulnerable to any rise in protectionism in the US. Donald Trump continues to tear up international trade agreements and threaten higher tariffs on Asian goods. This affects some countries more than others: Considered particularly at risk are countries where exports comprise area such as IT, white goods or vehicle parts. These, the US believes, it could make domestically. This suggests countries such as Taiwan and Korea could struggle.

At Aberdeen, we do not make our investment decisions based on macroeconomic developments, and we are not re-positioning the New Dawn investment trust based on Trump/China relations or the likely rise in the US Dollar. Nevertheless, we believe a focus on quality naturally guides us towards growth Asia rather than vulnerable Asia.

Reform in India

We have a relatively high weighting to India. This is less a macroeconomic decision than a reflection of the strong, well-managed companies we can find there. However, India is also more insulated than much of Asia to the machinations of the global economy. More concern there is the domestic reform agenda, including the recent demonitisation programme from prime minister Narendra Modi. However, in the long-term we believe this will turn out well and is in the long-term interests of the economy.

We haven’t held many stocks in the vulnerable countries of Korea and Taiwan. Again, we didn’t design it this way; there simply aren’t many companies that fit our criteria in either country. Stocks in Korea in particular tend to fail our quality screens. However, it does mean that we are more insulated from Trump’s protectionist policies.

The China dilemma

There are areas where it is more difficult. For example, in China, ‘old economy’ areas are performing badly. Capital has been misdirected to weak and underperforming areas of the economy. There are areas of real strength: technology, for example, or the consumer. More than 50% of Chinese GDP is already coming from the services sector; the transition to a consumer-led economy is happening quickly and successfully.

However, finding companies to harness this theme is not easy. Corporate governance standards are poor. Where companies are strong, valuations are very stretched. As such, we often have to find an alternative way to invest in consumer growth in China: One example might be Korean cosmetics group Amore Pacific. It is growing its sales by 30-40% per year in China, but is not subject to some of the problems that have been seen in domestically-listed companies.

There are some exceptions, where valuations have not yet over-reached. We recently initiated a position in Yum China, which owns the KFC and Pizza Hut brands in the region. This has strong return on equity, net cash on its balance sheet and is well run by a capable management team. As such, we believe there will be room for growth.

The reflation theme

Elsewhere, Asia has experienced a similar reflationary trade to that seen in the West on the back of the improvement in global growth and expectation of fiscal stimulus in the US. A focus on quality has not stopped us participating. We have had some exposure through mining groups such as BHP Billiton, but more important has been our weighting in financials.

While the recent rise is US financials has largely been driven by the promise of deregulation, including the repealing of the Dodd-Frank Act, in Asia any gains have largely been made on the expectation of higher interest rates. This is an important distinction. There is a risk that any deregulation could diminish the quality of the banks, making them a weaker long-term investment. The Asian banks in which we invest, notably in Singapore, are likely to remain sound businesses.

As a big exporter, Asia is naturally vulnerable to any increase in protectionism around the globe. However, it is not a case of growth Asia or vulnerable Asia winning out – the region will always have to deal with these opposing forces. However, we believe that an emphasis on quality will always be protective.

Sources:
¹ the IMF

RISK WARNING
The value of investments and the income from them can fall and investors may get back less than the amount invested.

Please remember that past performance is not a guide to future results.