Emerging Asia was one of the best performing regions in the five years leading up to the financial crisis, delivering a 20 per cent return per year in sterling terms. And despite the fact that, over the past two years, the region has underperformed developed markets, it remains a favourite place for UK investors to put their money. In aggregate, Asia looks a cheap buy at the moment. But this is distorted by some very low valuations of Chinese banks and Korean technology stocks.
We think these cheap valuations will persist. Chinese banks are under pressure from collapsing commodity prices and weak property markets. Prices are falling by 5 per cent on average across 70 Chinese cities, while Korea’s complex cross-holdings still make overseas investors wary. Investors buy Asian stocks for growth. High-performing economies, rapid income growth and an emerging middle-class consumer are attractive features.
But the main growth engine in Asia is spluttering. Chinese growth has shifted down from 10 per cent in the pre-crisis boom years to around 7 per cent now. Other indicators suggest that growth is even weaker than official statistics imply. With policy moving away from “growth at all costs,” driven by investment and exports, such high rates are unlikely to be achieved again.
However, Asia is one of the biggest beneficiaries of the collapse in oil prices. Not only does the fall in energy costs boost profits for Asia’s manufacturers, but the impact on inflation (i.e. pushing it lower) allows Central Banks to keep interest rates low – or in some countries, to reduce them. China and Korea cut interest rates late last year, followed by India in January and Indonesia this week.
Lower interest rates are good news for stock markets in the region. But the real impetus to equity market gains is coming from structural reform. India, historically regarded as a laggard in the emerging world, is now starting to catch up. In January, The World Bank named it as the fastest growing big economy. It expects growth to rise to 7 per cent by 2016. This expansion may seem fast, but in 2010, the pace of growth was over 10 per cent. Indian growth now outpaces China, albeit by a very small margin.
Similarly, in Indonesia, the new reformist president Joko Widodo has already made good progress in removing fuel subsides – a key hurdle to increased spending on infrastructure to boost growth. And a new consumer society is building in both economies. Ikea launched their first store in Indonesia last year, and are planning to open their first one in India this year.
The hope – if not the reality – of reform is to be rewarded by investors. Indian stocks produced a return of 40 per cent in 2014, while Indonesia’s gained 23 per cent. Both markets look expensive compared to broad Asian stocks, but we believe the prospects of reform and stronger growth are worth paying a premium for. With a combined population of over 1.5bn people – about equal to that of China, but with around 60 per cent lower per capita income – they have a lot of catching up to do.
Investors who don’t want to pick where to invest themselves can buy a broad-based fund, which gives exposure to a wide range of Asian markets. A popular choice with private investors is the First State Asia Pacific Leaders fund.
For the more adventurous, single country funds are a useful way to take a more focused approach to investing in Asia – particularly as some markets often have a very low weight in many equity funds. With a population of 250m, Indonesia makes up less than 4 per cent of emerging Asia’s stock markets.
Investors wanting simple, low-cost exposure to selected Asian equity markets can buy exchange traded funds (ETF) traded on the London Stock Exchange. Possible options include the db x-trackers MSCI India ETF and the HSBC MSCI Indonesia ETF.