The covid crisis has been very different from past downturns and recessions in many ways. Its onset, its driving forces and the global response to it have significantly set it apart from previous crises and it’s thus not surprising that the recovery from it might also present some interesting and historically unusual opportunities too. These investment opportunities will exist in several areas, but in this issue of the InSights we would like to discuss one of them in more detail: Asia. And when we talk about Asia we don’t limit ourselves to China. We’re also looking at markets like Vietnam, India, and Indonesia that, unlike China, haven’t received the investor attention they arguably merit.
For a long time, conventional wisdom held that it was wise for investors to largely steer clear of Asia during crises and recessions. Historically, the impact tended to be more severe and the destabilizing effects much more pronounced, so this skepticism was entirely prudent and justified. In past crises, many economies in the region saw their domestic currencies collapse, while massive capital flight further amplified the impact of any recession and ensured a protracted and painful path to recovery.
There were also serious vulnerabilities and concerns around institutional integrity, inadequate infrastructure and political instabilities that shook investor confidence, while the legal frameworks and business protections were also seen as insufficient, especially amid a crisis.
However, the outlook this time has substantially changed, with the region presenting some very attractive opportunities and numerous good reasons to expect above average growth.
Long-term trends and reforms
A lot has changed in the Asian region since the last global recession and the developments over the last decade have successfully transformed its position and outlook in the aftermath of the Covid crisis and beyond. The most important of these changes are found in the progress and improvements made in local infrastructure, supply chain shifts, workforce skills, and productivity.
Growth in household income ($35,000+)
Source: Fitch Connect
Many nations in the region also now offer a more stable and business-friendly legal environment. Corporate and investment protections were established, along with many other important reforms, as noted in the “Doing Business 2020” report published by the World Bank. Furthermore, a 2020 analysis of more than 36,000 businesses in 17 Asian economies conducted by the Asian Development Bank revealed that strong property rights and rule of law enabled and motivated entrepreneurs to formalize their businesses, and that this growth in formalized businesses was also associated with increased innovation. Political stability, along with supportive policies that encourage international investments, also helped improve investor sentiment and promote trust in government and regulatory institutions.
This wave of modernization, liberalization of domestic economies and capital markets and solid advances in the private sector has been evident in varying degrees in many countries in the region, but the net result was the creation of a much more supportive environment for international business, as well as domestic entrepreneurship and innovation.
This also contributed to the emergence of a vibrant and competitive corporate ecosystem, with many Asian companies now raking among the world’s largest. A considerable share of revenues still comes from international exports, but as Asian economies evolved, they decreased their reliance on manufacturing for the West, and pivoted to the increasingly resilient and sophisticated domestic and regional markets.
Important strides were also made in technology and in the digital economy. For instance, since 2014, Indonesia and India have been well ahead of the rest of the world in digital adoption rates, with the number of internet subscribers in India almost doubling by 2019 and mobile data consumption growing by over 150% annually, more than twice the rate of the US. Also, with Asia accounting for over half of the world’s total internet users, e-commerce has exploded, and so has the inflow of venture capital in the region’s start-ups, as can be seen in the graph below.
Another major long-term trend is the steady decline in global poverty rates. This has played a particularly crucial role in Asia, as it transformed national and intraregional consumption patterns. Wage growth and a rapidly expanding middle class have fueled local demand and according to McKinsey projections, the region will account for more than half of global consumption growth by 2030.
By 2018, Asia already accounted for nearly half of global investment in start-ups
Source: Preqin, McKinsey Global Institute analysis
There’s also a strong argument to be made based on the region’s fundamentals. Coming into this crisis, the finances of many Asian countries were significantly healthier than most of their Western peers. There are of course exceptions, like Japan, but a lot of Asian nations tended to carry less debt and exercise stricter budget discipline. According to the UN’s Economic and Social Commission for Asia and the Pacific (ESCAP), public debt was at sustainable levels before the onset of the crisis, “with a regional median at about 40% of GDP”. This meant that the region was overall better positioned to sustain the impact of the Covid crisis, but also to handle the costs of the fiscal support measures that were deployed to combat the effects of the pandemic.
This tendency toward more financial prudence is also present in the region’s companies that, in general, also tend to have stronger balance sheets, something that was highlighted in recent reports by PineBridge Investments and UBS as an advantage for Asian equities going into 2021. There are advantages on the monetary front as well, with interest rates being relatively higher in many Asian countries than in most advanced economies, which gives them more room for monetary stimulus, but also makes them more attractive for investors. In fact, we saw this interest pick up significantly over the past decade and even more so over the past year, with Asian bonds being among the fastest-growing segments in the global bond market.
Last, but certainly not least, there’s the impact of the US dollar and shifts in the region’s dependence on it. The USD has long been the dominant currency not only in international trade and intraregional transactions, but also as a reserve currency and as a reference in domestic policy making. Historically, this reliance on the USD, although a practical necessity, has rendered Asian economies particularly vulnerable, as highlighted during past crises. Thus, a wider “de-dollarization” drive, originally led by China, has been gaining traction over the last decade. In recent years, we saw some meaningful developments on that front emerging from Sino-Russian deals, with the two nations agreeing to reduce their dependence on the dollar. According to the Financial Times, in the first quarter of 2020, the dollar’s share of bilateral trade fell below 50% for the first time on record.
China has also been inking similar deals with Asian partners to promote the use of local currencies, like it did with Indonesia last September. The use of the Chinese yuan has seen a significant boost in recent years in trade, but also as a reserve currency. This is a trend that Morgan Stanley analysts expect to continue, predicting that the currency will account for 5% to 10% of global foreign exchange reserve assets by 2030, making it the third largest reserve currency in the world, after the US dollar and the euro. Meanwhile, other local currencies have also been enjoying wider use, as domestic consumption and inter-Asian trade continue to strengthen.
Accelerators and triggers
Apart from slower-moving shifts such as the ones outlined above, there were also some key events that served as triggers and further boosted the regions’ prospects. Chief among them was the Covid pandemic. Although in some cases the measures taken did not fit the western understanding of personal freedom and self-determination, the way that it was handled by many Asian nations proved to be very effective.
Asian experience with previous outbreaks arguably played an important role in this. The quick government response, efficient testing campaigns, swift border closures, all contributed to a faster containment and to an earlier resumption of economic activity. This provided a valuable head start to the recovery and a clear advantage going into the new year, with the IMF predicting a strong growth rebound to 6,6% in 2021.
The US-China trade war was another interesting accelerator, as it was smaller Asian economies that arguably reaped the spoils. For example, US imports from Vietnam kept growing throughout the trade crisis. By 2019, they were up nearly 40% year on year, while those from China had sunk by more than 20% and in the summer of 2020, the US trade deficit with Vietnam surged to an all-time 7 high. Overall, according to UBS analysts, the Vietnamese economy now presents “one of the brightest outlooks in Asia”, with growth set to rebound to 6,8% in 2021. Supporting this positive view is the EU-Vietnam free trade agreement, signed in 2020, that scrapped almost 99% of customs duties and is expected to spur foreign direct investment.
Of course, when it comes to Asian trade deals, we couldn’t fail to take into account the largest and most consequential of them all, namely the Regional Comprehensive Economic Partnership (RCEP). Signed in November 2020, after 8 years of negotiations, it created the largest trading bloc in the world. Consisting of 10 Southeast Asian countries, as well as China, Japan, South Korea, Australia and New Zealand, members of the RCEP make up nearly a third of the world’s population and account for almost 30% of global GDP. The RCEP aims to eliminate tariffs within 20 years, but also includes provisions that help streamline trade rules and supply chains. This deal is expected to provide a remarkable boost for the region and to strengthen its economic and geopolitical position on a global scale.
RCEP: The world’s largest trade bloc
Source: Bloomberg, Statista
At BFI Infinity, we see Asia’s bright outlook as a great investment opportunity. Overall, Asian markets have now matured and are quickly catching up with the West. They no longer present merely speculative attractions but are now ripe for sound investments and can offer both value and growth, often at very attractive price levels. We can see this in equity markets, where Asian stocks appear cheaper compared to the current valuations in the US and Europe, and in the debt market too, where Asian high yield and investment grade bonds both offer better yields than their developed market counterparts. The currency diversification which comes with these investments might positively add to the performance as well.
Of course, Asia shouldn’t be seen as a homogenous block and there are still structural, political, geopolitical and economic issues that vary from market to market and that need to be taken into consideration. Nevertheless, with a careful and diligent selection process, investors can find excellent opportunities in the year ahead, especially given Asia’s head start in the recovery stage after the Covid crisis.