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):
(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).
(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).