Q&A Marlborough Far East Growth (March 2018)

Sally Macdonald, Marlborough’s Head of Asian Equities, marks five years of managing the Marlborough Far East Growth Fund with an assessment of Asian equity markets and the opportunities they offer.

How would you assess the outlook for Asian equities?

“The outlook for Asian equities is pretty positive. Valuations did look a little overstretched at the end of last year but since then we’ve seen the market correct and there are now some really interesting pockets of value.

“I think people have been preoccupied with politics and they haven’t been paying sufficient attention to stock fundamentals and valuations, which are significantly cheaper in Asia than many other regions.

“If you look at price-to-earnings multiples, for example, the US S&P 500 is on about 15.6 times and the Nasdaq is on 19 times. Japan, the FTSE 100 and Europe are not bad on 13, 12.7 and 12.1 times respectively, but the Asian region is on 11.8 times.

“If one feels happier looking at assets, rather than earnings, Asia looks even better. In the US, the Nasdaq trades at 3.8 times its book value and the S&P is on 2.8 times, whilst the global average is 2.1 times. To buy Asia though, you pay just 1.4 times.

“Factoring in the different political threats faced by regional economies, the picture is clear. Investors used to fear Emerging Market political volatility, but until we see some kind of reasonable trade deal, Brexit is causing uncertainty in the UK and Europe. As for US politics, the situation is highly unpredictable. We prefer the relative stability of Asia.

What do you see as the single most important investment theme emerging in Asia?

“It’s undoubtedly China’s ‘One Belt, One Road’ (OBOR) project. One of the largest mega-projects in history, this will provide infrastructure to connect China to 65 countries and almost two thirds of the world’s population.

“The ‘Belt’ will connect China by land with countries in central Asia, west Asia, the Middle East and Europe and the ‘Road’ will be maritime trading routes connecting China by sea to South-East Asia, the East coast of Africa, the Red Sea and the Mediterranean. At the last count, this will link China to roughly 4.5 billion people and approximately 29% of global GDP.

“OBOR provides the physical infrastructure necessary to trade, such as roads, railways, ports and airports, which creates great investment opportunities in construction, road, rail and resources companies.

“Then, at the same time as all of this construction is getting under way, the proposed RCEP agreement and the Euro 16+1 grouping are putting in place the legal and tariff frameworks to support that trade.

“The project will hugely increase China’s international influence and political and economic power. But the wider region will reap the rewards too, with major beneficiaries likely to include Malaysia, Thailand, Myanmar, Indonesia, the Philippines and Pakistan. However, it may be negative for countries such as Taiwan and Korea, if they remain excluded from the plans, as they are now.

“Alongside these two moves, with the launch of oil futures priced in Renminbi, we are seeing the first moves towards a new PetroYuan currency, extending Beijing’s influence in the Middle East and Latin America.

“As the West squabbles and divides, we think it is time to regard Asia as core rather than satellite. It’s time for investors to dust off their copies of the Little Red Book and start learning Mandarin!”

What risks do you see in the region?

“The elevation of Xi Jinping to a position of supreme dominance and the decision to extend his term of power indefinitely concentrates all the firepower of a newly resurgent China in the hands of a single man. At the moment, his focus appears to be free trade and a cleaner environment, but make no mistake, this is a Communist leader and negotiating the investment skies in his new world will need experienced pilots.

“Central banks in Asia, as elsewhere in the world, are beginning to tighten monetarily, and there is a risk that the pace will be too fast, especially as some countries are also planning to narrow their fiscal deficits too. We expect rising interest rates to create significant headwinds for consumer discretionary companies, smaller banks and SMEs.

“Deleveraging by companies and households could last for a very long time. Investors are worried about China, but, actually, corporate net debt to equity is highest in India, the Philippines and Thailand, while in terms of household debt, it is South Korea, Singapore, Hong Kong and Thailand that have the greatest exposure.

“New US tariffs on imports from China, and those announced by Beijing in response, have generated a lot of headlines and the possibility of the situation escalating into a trade war is a concern, but the amounts involved are at the moment relatively insignificant – 3% of the respective nations’ exports. More worrying for those investing in Asia is Beijing’s suggestion that it might buy more US semiconductors, as a way of reducing the US trade deficit with China. That could have a negative impact on Taiwan and South Korea.

“Meanwhile, the media seem to have overlooked India imposing tariffs of 10-50% on all consumer imports, and test-firing both short- and long-range nuclear-capable missiles.

“The situation with North Korea understandably commanded a lot of attention last year. But now that the US has signed major arms contracts with Japan, South Korea, Singapore, Thailand, India and Australia, halving its trade deficit with South Korea in the process, we should see a calmer year in 2018. Additionally, with talks between the two Koreas apparently progressing and the mooted meeting between Donald Trump and Kim Jong-Un, there is potential for this risk to turn into something really quite positive.

“We don’t expect reunification of the two countries, but the road to warmer relations – albeit in the context of more stringent sanctions – now appears open and we’ve already seen encouraging developments. At this very early stage though, sensible investors will not make decisions based solely on the expectation of better relations with the North. A more prudent approach is to ensure the fundamentals of any potential investment are attractive in their own right and North Korea could be added icing on the cake.”

What investment opportunities have you identified for the year ahead?

“Gas consumption is likely to increase significantly in Asia. New rules allowed the US to start exporting shale gas last year and the primary destination is likely to be Asia, where a shift to environmentally cleaner fuels and strong GDP growth are both driving demand. In the short term, we expect significant oversupply of liquefied natural gas (LNG), before demand networks develop fully, as Australia will also be increasing gas exports to the region. This should favour the carriers and infrastructure developers and allow Asian countries to take advantage of lower gas prices.

“Countries particularly benefiting from the higher volumes of gas should be Korea, Taiwan, China, Malaysia, Indonesia, Thailand and Myanmar.

“We’re also seeing opportunities in infrastructure outside the OBOR project, in part because of elections. The construction and infrastructure sectors in Indonesia, for example, are likely to benefit as the government seeks to complete key projects ahead of next year’s presidential vote. The accelerated completion of large-scale projects is likely in Thailand too, ahead of the general election there (albeit recently postponed).

“Elsewhere, substantial infrastructure programmes announced in the Philippines, Taiwan and domestic China are moving from announcement to implementation stages, which should boost demand for many basic materials.

“As inflation starts to rise globally, Asia is well-placed to offer a range of cost-reduction options, from automation to traditional outsourcing. This offers a host of potential opportunities, especially in companies whose products cut costs for their customers.

“Overall, we’re seeing interesting opportunities in a range of sectors, with a diverse range of drivers, and these are all the more attractive when you consider the challenges faced by many Western economies.”

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