- Although economic growth was suboptimal in CY2019 at 5.3%, 2020 began strongly with PMI data in Q1 reaching 8-year highs
- Coronavirus has delayed this turnaround, but not destroyed the green shoots emanating from rural areas
- The government stimulus package remains underappreciated by the stock market
- Reform momentum has restarted
- Although there are risks to our thesis, we believe that they are well-managed at this juncture
- Our primary focus remains on companies that will benefit from domestic, particularly rural, opportunities providing exposure to an uncorrelated source of growth versus the expected recession in Developed Markets
- The increasing geo-political tension between China and USA could provide economic opportunities for India over the medium term
- Given the favourable structural characteristics of India (e.g. demographics, and the shift from the informal to formal economy), the positive near-term outlook and compelling valuations, we believe that this is an exciting, less-correlated opportunity for the long-term investor
- China was the first to suffer with coronavirus, and we expect China will be the first to exit the crisis
- Although China is a major global manufacturing hub, exports only account for 20% of GDP and domestically driven demand is more important
- Government stimulus has already been significant, but the incremental nature of the announcements has led to an underappreciation of the magnitude of the package
- China is the largest part of our portfolios, representing 29.7% of Alquity Asia and 28.4% of Alquity Future World. We are invested predominantly in domestically-driven stocks
In this article, we examine the investment case for Asian small cap stocks which have recently been out of favour with investors. We start with an analysis of the key drivers that resulted in small cap Asian stocks delivering stronger returns than large caps at various points in time after the Global Financial Crisis (GFC). We use the FTSE Asia Pacific ex Japan ex Australia ex New Zealand All Cap and Small Cap indices for the analysis.
We find that the Chinese yield curve has been one of the most prominent drivers of the (out)performance by small caps. There is a strong parallel with the current environment, where we expect that central banks will continue to shift to an increasingly accommodative monetary policy stance, which will contribute to the strength of domestic economies and in turn benefit small caps once again. This is combined with compelling valuations and increasing signs of deglobalisation, further strengthening the arguments for investing in Asian small caps.
Mike Sell and Kieron Kader spent 10 days of December in India travelling to Delhi, Mumbai, Chennai, Lucknow and Kanpur. The team visited 38 companies including 20 of our fund holdings. In addition, they conducted a range of channel checks and also met one of the Transforming Lives Awards winners, Phool, where they held a consumer survey panel.
We had said that we expected to see growth from the festival season onwards. Despite the last two GDP prints of 5% and 4.5% which were worse-than-expected and caught everyone by surprise – our initial view has been confirmed by our detailed on-the-ground meetings. The short-term volatility has been pervasive and worse than expected, but the stimulus provided by Modi’s government, the accommodative monetary policy and the strong monsoon has started to buoy the economy from November, and we should thus see improving growth and sentiment. There have also been delays in the construction sector, which have now started to subside even in the key state of Maharashtra which has experienced a change in government. The Kharif crop harvest between January and March will be a strong support for the rural economy. Overall, our expectation is for growth to follow a U-shape recovery rather than a V-shape, with the financial sector a noticeable laggard. Thus, we expect GDP growth of 3.9 – 4.7% in Q4 followed by 5.1% in Q1. Longer term, our view is that the liquidity issues, demonetisation and GST are ultimately positive, as they leave better quality companies in the system and refocuses them on proper capital allocation.
Overall, we remain positive on India and combined with current valuations (especially in the mid cap space, which are compelling, see figure 11 and 12 below), we believe that this market has the potential to deliver one of the best performances within the EM space over the coming years.
Mike Sell, Alquity’s Head of Asian Investments and Kieron Kader, Asia Investment Analyst spent 11 days in Greater China visiting 18 companies in Hong Kong and 12 across Shenzhen, Hangzhou, Nanjing and Shanghai.
Mike and Kieron visited existing holdings to reassess the outlook for corporate earnings. They also visited competitors to understand the overall environment, as well as brand new investment ideas. This was a valuable opportunity to discuss the effects of the trade war on the Chinese domestic economy, and reactions to the stimulus packages issued by the Chinese government.
The main conclusion to draw from our trip is that there are areas of brightness – particularly in our domestic growth focused sectors.
Our long-standing view that the Chinese domestic economy continues to perform well has been confirmed by the key industries. However, some corporates (particularly in exporting industries) expressed uncertainty for the near term, but also mentioned that government stimulus may provide support (e.g. further reserve requirement rate cuts, tax cuts, as well as industry-specific policy). Selective domestic growth driven sectors that we invest in (property, beer etc.) showed confidence for the short and medium term. We have also identified a number of high quality domestic-focused companies that are worthy of further due diligence.
Whilst overall growth is reasonably healthy, some areas are challenged and remain undesirable. However, there are areas of outstanding growth and we remain positive. Combined with the fact that valuations are attractive, we maintain a substantial weighting to the market.
Mike Sell, Alquity’s Head of Asian Investments, spent a week in Indonesia for his regular on-the-ground meetings with local companies. Mike had 16
meetings and 33 store visits in 3 cities with the goal of re-assessing the macroeconomic and business outlook ahead of Presidential elections in April, and to discover new potential ideas for the portfolios. As a result of the trip, followed by further desk-based analysis, we have already increased our weighting across our portfolios and expect to continue to do so.
Indonesia has been largely ignored by investors despite the country’s sound inherent characteristics and its solid economic prospects. The country perfectly encapsulates our key investment themes of monetisable structural growth opportunities thanks to its young and steadily rising population, ongoing urbanisation and the roll-out of structural reforms. Reforms by President Jokowi’s government have already improved the country’s growth prospects. This has not been appreciated by markets, which is also proven by the fact that investors’ aggregate exposure to Indonesia is at historical lows. The re-election of Jokowi should result in capital flows targeting Indonesia again.
Consequently, we are of the view that the Indonesian market offers an attractive entry point from a risk-reward aspect, since there are some excellent companies, who sustainably benefit from the country’s structural domestic growth momentum. Such stories can be found in industries such as cement, consumer or financials. We have already increased the weighting across our funds and expect to continue to do so.
Mike Sell, Alquity’s Head of Asian Investments, spent nine days in India for on-the-ground meetings with local companies. He met with 33 company managements in total, as well as undertaking a day of retail store visits in Patna (in the state of Bihar). The goal was to meet with the majority of our existing holdings and to reassess the outlook for corporate earnings following the second quarter results and recent macroeconomic gyrations.
In addition, we wanted to stress test the sustainability of our holdings’ competitive advantage through meeting with challenger brands particularly in the financial and retail sectors.
Our on-the-ground meetings with 33 companies were very fruitful, as they reaffirmed our longstanding view that the domestic economy is in a solid shape. Furthermore, economic activity has not been derailed by spiking oil prices or trade tensions, and thus the structural domestic growth will continue without being adversely impacted in a meaningful manner. Once elections are behind us, idiosyncratic sources for asset price volatility should subside. Any volatility before then will provide opportunities for investors.
Specifically, we believe that there are three key trends that investors are missing: the accelerating growth in the rural economy, rising margins across certain industries, and the re-emergence of the private sector capex cycle.
Overall, we remain extremely positive on India, as the economy is on a firm footing and has the potential to deliver one of the best performances within the EM space over the coming 3-5 years.
Mike Sell, Alquity’s Head of Asian Investments spent ten days in Greater China visiting 22 companies in Hong Kong and four in Taiwan. He was joined by Dan Billis, a new addition to the Asia Investment team. Despite being caught in Typhoon Mangkhut, Mike and Dan visited both existing and new potential holdings. Our regular on-the-ground meetings in September provided a good opportunity to discuss the relentless negative news relating to the global trade war with the companies we met; whether and to what extent the imposition of tariffs impacts the Chinese domestic economy.
The view from all our company meetings regardless of sector was undoubtedly positive. Overall, we returned with our conviction on the macro outlook reaffirmed. As a result, we sustain our long-standing view that the Chinese domestic economy is in a solid and much better shape than most people believe, which also strongly implies that trade woes and the imposition of tariffs are very unlikely to derail the underlying economic momentum in China. Once the majority of market players realise that the domestic economy is well-insulated from external shocks, the high quality stocks of domestically-focused companies (of which we have successfully identified a number) will continue to deliver, despite recent sentiment-driven poor share price performance. We have been increasing the weighting of China across our portfolios and will continue to do so.
Senior Investment Analyst Aaron Armstrong has just returned from a three day conference in Mumbai.
Having met with representatives from 23 companies, as well as a host of other market participants, he shares his latest thoughts on the investment case for India below.
Placed in the context of the last four years, since the Alquity India Fund was first launched, this is among the most positive set of insights we have ever come away with from an investment trip. With harmonised positive outlooks for economic growth, corporate earnings and political developments, we maintain conviction that India offers one of the most exciting investment opportunities anywhere in emerging markets at present.
Delivering a return of 41%*, Vietnam has been the strongest performing Asian market during 2017. Representing over 13% of the Alquity Asia fund and 8% of the Alquity Future World fund, the country is a key differentiator versus our peers.
Mike Sell, Alquity’s Head of Asian Investments, has just returned from a trip to the country to assess the prospects for continued growth in 2018.
During his trip Mike visited existing and prospective fund holdings to gain insight into Vietnam’s market, the macro economic outlook, the implication of long-term themes and the companies best placed to benefit from them.
* Data in USD, correct as of 15 December 2017
Overall, I returned from Vietnam with our conviction in the macro outlook and core positions reaffirmed. Although we will remain alert for risks of overheating and stress in the fiscal or external accounts, these certainly do not appear to be on the horizon at the moment. While the market has risen over 40% this year, I believe valuations are proportionate given the growth outlook and the risk-reward trade-off remains favourable.
The major challenge lies in discovering attractive new ideas, in companies where the values of management align with values of minority shareholders. Over the course of my trip, I have identified some candidates with this potential, either now or in the medium term, and fully expect upcoming listings to create additional opportunities.