Strategy Note /

The pulse of Asia investors in FM and small EM equities

    Hasnain Malik
    Hasnain Malik

    Strategy & Head of Equity Research

    Tellimer Research
    16 December 2019
    Published byTellimer Research

    The mood of investors in Hong Kong and Singapore is not as bright as in previous visits, but still significantly better than that we encountered recently in the US and Europe.

    Last week the biggest change we observed compared to our previous trips to see Hong Kong and Singapore-based institutional investors over the last few years was that the plague of fund redemptions, seen for years everywhere else globally, has now infected the Asia region.

    This is being seen both at the large regional Emerging market end of the spectrum (loss of share to passive funds) and in those funds prepared to look at the smaller regional emerging markets (poor performance or insufficient liquidity). This has led to an environment where most funds are focused on the most liquid stocks and markets alone. This is a contrast from our meetings historically, where asset gathering sounded relatively easy and good fund performance created the risk appetite to delve further into the smaller markets in the region.

    Similar to our conclusions from our recent
    US trip, we believe that funds able to keep investing in these smaller markets, despite the headwinds they are facing on asset retention, are likely to reap impressive rewards with merely a return to previously seen market valuation multiples, let alone an acceleration in corporate earnings. And waiting for the peer group of international investors to take the plunge is likely futile: local funds (perhaps driven out of bank deposits and government securities by falling interest rates and lower yields, respectively) are likely to provide the liquidity for market rallies.

    Valuations are generally very attractive (relative to historic averages), as most countries are benefiting from a subset, at least, of the following factors: export-led growth, diversion of purchasing or manufacturing from China, inflow of capital for infrastructure upgrades from China, interest rate cuts amid low or decelerating inflation, stronger domestic political mandates, better geopolitical relations and, particularly where some of these factors are lacking, structural reform. Relative performance of these markets should stand out as China, India and mega-cap EM Tech decelerate.

    After a week of meetings with institutional equity investors in Hong Kong and Singapore we heard the following (we acknowledge, of course, that our own agenda in meetings likely prompted some of these remarks):

    (1) Big funds, benchmarked to MSCI EM or Asia ex-Japan, no longer care about the regional markets outside the big-4 (China, India, Korea, Taiwan). Even the likes of Indonesia, Malaysia, Philippines and Thailand are considered too small. Note that the big-4 already account for about 65% of the MSCI EM index (prior to further weight increases for China A-shares) and about 90% of MSCI Asia ex-Japan. 
    (2) There was a sense of denial (or complacency) among bottom-up, fundamentally driven larger funds about the potential distortion to their investment process from passive EM fund inflows to China A-shares. In a much smaller region, the Middle East, we have seen how this investment process was repeatedly blown off course by the index weight increases seen in Qatar, UAE, Saudi and Kuwait.

    (3) The valuation case for the smaller Asian markets has opened up as all of them have been tarred unfairly with the US-China trade war brush. While manufacturing supply chains across the region are integrated with China, most of the smaller Asian countries have lower labour costs (particularly Bangladesh and Vietnam) and should see relocation of purchasing and capacity the longer the trade war drags out. Furthermore, it is not clear to us why the commodity exporters should be any less impacted by the growth slowdown that results from the trade war (yet most commodity exporters, eg in LatAm and the GCC, have outperformed these smaller Asian markets this year).

    (4) Frustration that Vietnam appears to have lost interest in addressing foreign ownership limits which are limiting capital inflow and distorting the market (inhibiting upward re-rating of the stocks at foreign ownership limit and prompting too much inflow into poorer run companies which happen to have foreign room). We suspect that this will not change until the Vietnam government is again worried about fiscal deficits or capital adequacy in the banks (both pressures have alleviated after years of high economic growth) and political succession is worked though (Trong, who has suffered from poor health this year is the leader of the party and the President).
    (5) Middle-income trap concerns come up often in discussion of Malaysia and Thailand. Most agree that politics is not settled in either country (Mahatir succession in Malaysia and the reconciliation of “Yellow” and “Red” shirts in Thailand) and how this inhibits the structural reform (infrastructure, labour flexibility) needed to drive the next phase of growth.
    (6) Disappointment with government policy in Bangladesh (eg tax harvesting of mobile telco Grameenphone and crowding out in the banking sector) was recurring. While the de facto one-party state of the Awami League should enable structural reform, it appears instead to be fostering institutionalised corruption (legacy non-performing loans in the government-owned banks, the VAT exemptions for politically protected commercial interests, the over-valued exchange rate). The patience of many investors appears to be wearing thin. In our view, valuations of the major stocks reflect this sub-optimal policy context, exports are still sufficiently competitive to drive the overall growth story and, with remittances, de-risk the FX rate.

    (7) There was little confidence that in Indonesia President Jokowi can marshall his disparate coalition to implement structural reform, although this was offset by relative optimism on near-term palm oil prices (which should provide a tailwind for the economy). In our view, valuation of Indonesian equities already reflects the difficulty of accelerating macro-structural growth beyond the current c5% run-rate.

    (8) Pakistan interest was piqued by the recent rally, with many prepared to debate the structural reform thesis (better security, geopolitical relations, fiscal management) in a way completely lacking at the start of this year. In our view, valuations, with both equities and the real effective exchange rate near ten-year lows, still offer adequate compensation for the tail risks (eg oil price spike, India military conflict, key man risk with both PM Khan and Army Chief Bajwa, FATF blacklist).

    (9) Sri Lanka debate centred around whether better growth from improved security and fiscal loosening would be undermined ultimately by sovereign debt and FX rate concerns. We think it does and that is why we are cautious on Sri Lanka but we found plenty of investors enticed by very cheap equity valuations (in the conglomerates more than the banks).
    (10) There was a broadly positive consensus on the Philippines (President Duterte’s tax and infrastructure reform is on the right track and the combination of cheap equity valuation versus history, undervalued FX rate on a real effective exchange rate basis and good enough growth, fiscal and current account balances is attractive). But there is frustration that free floats and new IPO activity remains limited.