Asian equities – four distinct regions rolled into one

According to Robin Parbrook and King Fuei Lee, portfolio managers of the Schroder Asian Total Return Investment Company plc (ATR), one of the most effective ways of investing in Asian equities is to disregard the benchmark. With more than forty years’ experience investing in Asia between them, they’ve been around for long enough to acknowledge that 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, the Asian equity opportunity set is large enough and diverse enough for investors to be extremely selective. Indeed, the managers view the Asian market as four separate regions, each with different drivers, and value can be added by transitioning between them as conditions evolve.

1. Hong Kong and China – a cautious stance

Between them, Hong Kong and China make up approximately 30% of the MSCI AC Asia Pacific ex Japan Index. As Asia’s largest and arguably one of the most diverse economies, China can dominate investor perceptions about the opportunity in Asian equities. The reality is a lot more nuanced, which is helpful in the current environment, given China’s considerable macroeconomic challenges.

The trust’s outlook on this part of the Asian equity universe remains cautious 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 to the outlook, and the Government continues to try to offset the problems in its property sector through further significant industrial investment. The knock-on impact of this, however, is likely to mean more over-capacity, more inefficiency, and ultimately, the risk of further prolonging this period of lower returns.

It would be wrong to think of China and Hong Kong as entirely uninvestable, however. There are areas where market forces function relatively well, and the ATR portfolio focuses on these, including sectors such as online gaming and select advanced industrial plays. Nevertheless, the portfolio is currently significantly underweight to this part of the region, with c. 15% of assets invested, split roughly equally between China and Hong Kong.

2. Australia and Singapore – strong fundamentals

Australia and Singapore together represent about 20% of the index (MSCI Asia ex Japan), and ATR is currently overweight in this segment. A recent visit to Australia by the portfolio managers highlighted its many strengths, including its robust corporate sector and supportive economic policies. Perhaps often under-reported by the financial press, Australia actually 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 many Asian economies.

Meanwhile, Australian companies tend to pay good dividends, driven by the needs of Australia’s unique pension system. A significant proportion of long-term total returns stems from dividends, so the high starting yield available from many Australian businesses gives them the potential to deliver continued outperformance.

Singapore shares similar positive characteristics. Neither economy can claim to be the most exciting growth opportunity in the world, which perhaps explains why market strategists are relatively cautious about their prospects. Nevertheless, both look well placed to deliver attractive long-term total returns, driven by higher dividend pay-out ratios and strong governance. The ATR portfolio is overweight this part of Asia, with about a quarter of portfolio assets dedicated to it.

3. South Korea and Taiwan – technological powerhouses

The South Korean and Taiwanese stock markets are dominated by the Information Technology (IT) sector, or to be more precise, the semiconductor industry. Companies like Taiwan Semiconductor Manufacturing Company (TSMC), Samsung Electronics and Hynix dominate these markets, making them critical players in the global technology supply chain. Indeed, many investors consider these semiconductor giants to be among the best stocks in Asia, driving substantial innovation and growth.

This has certainly been the case historically, and the ATR portfolio has benefited from their past success. However, the portfolio managers are currently approaching this area with a degree of caution due to the cyclical nature of the semiconductor industry. While the portfolio still holds significant positions in TSMC and Samsung, Parbrook and Lee have been taking profits to manage risk, believing that the current cyclical upswing is now well advanced.

More positively, TSMC stands out as Asia’s strongest potential beneficiary of the ongoing boom in artificial intelligence (AI). Although not directly comparable to Nvidia, the US company that has become the AI “poster child”, TSMC's role as a primary fabricator of Nvidia’s advanced chips places it in a strong strategic position within the industry. Hence, it remains the largest holding in the ATR portfolio, and the portfolio managers maintain an overweight position to South Korea and Taiwan as a whole.

4. India and the ASEAN¹ markets - growth and opportunity

The markets of India and the ASEAN region present a mix of rapid economic growth, structural changes and positive demographics. India's macroeconomic environment is notably strong, with positive policy developments enhancing its growth potential. However, the stock market has already priced in much of this optimism, leading to ATR’s portfolio managers taking some profits in this area. With the benefit of hindsight, the decision to reduce exposure to India looks a little early, but the managers remain cautious about chasing the current high valuations.

Elsewhere in the ASEAN markets, the Managers have focused on finding overlooked opportunities at reasonable valuations, in economies that offer improving political stability. For example, returns on equity are rising in the Philippines, Singapore and Indonesia, but the trend of improving fundamentals is not yet reflected in share prices. Hence, the managers are overweight in the ASEAN region, confident that the opportunities they have unearthed have the potential to perform well as the broader market begins to recognise their value and future prospects.

Conclusion – backing selective opportunities with a tactical overlay

In summary, even with a cautious stance on Hong Kong and China, the broader Asian market offers ample opportunities for selective investment. There is more latent 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 long-term return potential.

By overlaying these individual investments with a ‘top-down’ tactical hedging² strategy with use of derivatives³, ATR’s portfolio managers aim to deliver a smoother ride for investors, by lowering volatility to preserve capital. This should mitigate some of the broader risks associated with investing in Asia, while providing Parbrook and Lee the flexibility to deliver potentially attractive long-term total returns, through a combination of a rising stream of dividend income and capital growth.

Source: Schroders
Past performance is not a guide to future performance and may not be repeated

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.

Schroder Asian Total Return Investment Company – Fund Risk Considerations

• Concentration risk: The Company may be concentrated in a limited number of geographical regions, industry sectors, markets and/or individual positions. This may result in large changes in the value of the company, both up or down.
• Counterparty risk: The Company may have contractual agreements with counterparties. If a counterparty is unable to fulfil their obligations, the sum that they owe to the Company may be lost in part or in whole.
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• Derivatives risk: Derivatives, which are financial instruments deriving their value from an underlying asset, may be used to manage the portfolio efficiently. A derivative may not perform as expected, may create losses greater than the cost of the derivative and may result in losses to the Company.
• Emerging markets & frontier risk: Emerging markets, and especially frontier markets, generally carry greater political, legal, counterparty, operational and liquidity risk than developed markets.
• Gearing risk: The Company may borrow money to make further investments, this is known as gearing. Gearing will increase returns if the value of the investments purchased increase by more than the cost of borrowing, or reduce returns if they fail to do so. In falling markets, the whole of the value in such investments could be lost, which would result in losses to the Company.
• Liquidity Risk: The price of shares in the Company is determined by market supply and demand, and this may be different to the net asset value of the Company. In difficult market conditions, investors may not be able to find a buyer for their shares or may not get back the amount that they originally invested. Certain investments of the Company, in particular the unquoted investments, may be less liquid and more difficult to value. In difficult market conditions, the Company may not be able to sell an investment for full value or at all and this could affect performance of the Company.
• Market Risk: The value of investments can go up and down and an investor may not get back the amount initially invested.
• Market risk: The value of investments can go up and down and an investor may not get back the amount initially invested.
• Operational risk: Operational processes, including those related to the safekeeping of assets, may fail. This may result in losses to the Company.
• Performance risk: Investment objectives express an intended result but there is no guarantee that such a result will be achieved. Depending on market conditions and the macro economic environment, investment objectives may become more difficult to achieve.

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Share price risk: The price of shares in the Company is determined by market supply and demand, and this may be different to the net asset value of the Company. This means the price may be volatile, meaning the price may go up and down to a greater extent in response to changes in demand.

Smaller companies risk: Smaller companies generally carry greater liquidity risk than larger companies, meaning they are harder to buy and sell, and they may also fluctuate in value to a greater extent.

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