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Home to more than half of the world’s population, the continent of Asia is economically diverse and dynamic, with many attractive investment characteristics. After a period of challenging performance, the economic outlook for the region appears to have improved in recent months. Here we explore how the Schroder AsiaPacific Fund is positioning to benefit…
The outlook for China has improved…
Concerns about China have dominated sentiment towards Asian equities over the last couple of years. Investors have been focused on geopolitics, with China’s relationship with the US and Taiwan under scrutiny, as well as more domestic issues. Government policy has become more restrictive in certain parts of the Chinese economy such as residential real estate, education and for the powerful internet platforms. Meanwhile, the government’s ‘Zero Covid’ policy has also hindered economic activity, leading to calls for the removal of the policy towards the end of 2022.
In recent months, however, there are signs that some of these cyclical headwinds are retreating. Abbas Barkhordar assistant fund manager of the Schroder AsiaPacific Fund, explains:
“The outlook for the Chinese economy, at least in the short-term, has clearly improved recently. The end of the Zero Covid policy is the most obvious reason for this improvement, given the huge impact it was having on economic activity and business and consumer confidence. In addition, signs of an easing in the tougher domestic regulatory environment for several important sectors, including the internet platform companies, have also improved investor sentiment.”
It is clear that the Chinese economy is re-opening faster than had previously been expected, and the stock market has rallied, with China outperforming the region significantly since these policy changes were announced. Schroders’ economics team now anticipates growth of more than 6% in 2023 compared to just 3% last year.
…but structural problems are still a concern
Nevertheless, longer-term risks remain. Recent policy measures are supportive, but the underlying economy still faces significant challenges, which are perhaps most tangible in China’s real estate market. Property transactions remain at multi-year lows and, although government policy may stimulate some recovery from here, it is hard to see a meaningful sustainable recovery in property and the domestic economy more broadly, while unemployment and household savings remain so high. Meanwhile, China no longer benefits from the positive demographics that assisted growth in recent decades and geopolitics will also likely represent an ongoing risk, as reflected in the recent ‘spy balloon’ incidents.
China - Reopening will reduce cyclical headwinds
Source: 1PBOC, NBS, JP Morgan, January 2023. 2Factset, October 2022. 3IMF, Refinitiv Datastream, Schroders Economics Group. 2 December 2022.
Countries and regions shown are for illustrative purposes only and should not be viewed as a recommendation to buy or sell.
On balance, we believe that the improved economic outlook in China is positive for Asia as a whole. The region benefits from a broad and diverse opportunity set, and you don’t need to be invested directly in China to be exposed to some of its positive attributes. At the end of 2022, China represented less than 20% of the portfolio, compared to more than 36% of the index. Although the managers are looking for new names in China, given the improvement to the economic outlook there, opportunities remain relatively scarce with valuations in some of the better quality names not yet at attractive levels.
Broader positive implications of China’s upswing
While many Asian equity funds have a large proportion of assets invested directly in China stocks, the Schroder AsiaPacific Fund casts its net further to find the brightest growth prospects across the region with the managers employing a bottom-up stock picking approach. They favour building exposure through markets such as Hong Kong, as Abbas explains:
“The absolute weighting of Chinese stocks in the portfolio has risen in the last few months, though this is largely a result of the rally in the market, rather than significant trading activity. We have however added to several holdings in Hong Kong – stocks there tend to trade at more attractive valuations than Chinese ones, and the local economy will also benefit from increasing travel across the border with the mainland.”
Indeed, as the chart below illustrates, outbound tourism has become a key engine of growth for many of the economies that surround mainland China, including Hong Kong, Vietnam and Thailand. So, the resumption of travel from China should have broader implications for the Asian region, which astute investors can capture.
China - opening up will benefit Hong Kong and elsewhere in Asia
Source: UNWTO, World Bank World Development Indicators, China outbound tourism institute, national authorities, Oxford Analytica, January 2023.
Countries and regions shown are for illustrative purposes only and should not be viewed as a recommendation to buy or sell.
How is the fund positioned to benefit?
Overall, the Schroder AsiaPacific Fund portfolio has a significant overweight exposure to Hong Kong, as a more attractive way of accessing the benefits of China’s recovery. The fund is also overweight in Singapore, and has exposure to Australia and several other ASEAN markets such as Indonesia, Philippines, Thailand and Vietnam.
From a sector perspective, the fund’s key overweight positions are in the Information Technology and Financials sectors. Within Information Technology, the key focus is on semiconductor companies, where Asia is a clear world leader, especially Taiwan and South Korea. The industry should continue to benefit from long-term structural drivers such as digitisation, cloud-based services, AI, the global roll-out of 5G mobile telephony and the ‘internet of things’. There is short-term cyclicality, however, which didn’t help in 2022, but that makes the current opportunity even more attractive, particularly when you consider the difference in valuation between Asian technology stocks and those domiciled elsewhere.
The Financials exposure is made up of a combination of banks, exchanges and insurance names, with selective holdings from across the region including Hong Kong, Singapore, India, Thailand and Indonesia. Although the financials sector is a diverse one in Asia many of the banks, in these markets, have the attraction of being well capitalised with strong deposit franchises. Richard points to a combination of improving near-term fundamentals for the banks, which make up over half of the financial exposure, alongside solid long-term structural growth drivers:
“Rising rates have been broadly positive for bank profitability but this does not yet appear to be appropriately reflected in bank share prices in Asia. We are mindful about the impact that a more challenging global economic environment may have on asset quality and have been focused on identifying banks that are attractively valued and well represented in growing markets that should benefit from increased adoption of financial services over time.”
Elsewhere, given the current environment, the team is focused on companies that possess pricing power and the ability to innovate. Key investment themes include identifying world-class exporters, and more domestically-focused companies that can access the long-term structural growth on offer across a number of Asia’s economies.
A bright outlook for growth
Powerful structural trends continue to drive the Asian growth story and create a growing number and variety of world-leading companies across the region. The Schroder AsiaPacific Fund aims to achieve long-term capital growth by investing in a diversified portfolio typically of around 60 of the best high quality but undervalued companies that the managers can find.
Overall aggregate valuations in Asia are now trading at or below long-term averages, which provides strong valuation support to the investment proposition. Meanwhile, from an economic perspective, Asian economies are not seeing significant wage pressures, which suggests that looser, more supportive monetary policy is possible than in developed markets. Asia is also well placed compared to the rest of the world in terms of economic growth potential.
This all sets up a more constructive backdrop for Asian markets currently, than has been the case for some time. It is worth bearing in mind, however, that Asian equity markets are incredibly diverse and inefficient, which makes it a region where experience and stock picking expertise is vital.
With more than 40 years of investment experience between them, Richard and Abbas, also have the support of a highly experienced team of nearly 40 analysts on the ground in Asia. In managing one of the largest and most liquid Asian investment trusts on offer for UK investors, they are confident that the Schroder AsiaPacific Fund is well-placed to capture the region’s long-term growth potential by selectively backing the brightest growth prospects in Asia.
Fund risk disclosures
Schroder AsiaPacific Fund plc
Emerging markets risk: Emerging markets, and especially frontier markets, generally carry greater political, legal, counterparty and operational risk.
Currency risk: The company can be exposed to different currencies. Changes in foreign exchange rates could create losses.
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, which may adversely impact the performance of the company.
Gearing risk: The company may borrow money to invest in further investments, this is known as gearing. Gearing will increase returns if the value of the investments purchased increase in value by more than the cost of borrowing, or reduce returns if they fail to do so.
Counterparty risk: Investments such as warrants, participation certificates, guaranteed bonds, etc. will expose the company to the risk of the issuer of these instruments defaulting on paying the capital back to the company.
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