Asian Diary - November 2015

Read Nick’s monthly column to get the latest perspectives on what we are seeing on the ground in Asia, with observations from the team’s travels around the region.

Asia ex Japan equity markets slipped backwards in November as a December Fed rate hike became increasingly consensus, and as terrorism and geo-political tensions in Europe weighed on sentiment. The MSCI AC Asia ex Japan index fell -3.38%, underperforming the MSCI AC World index (-0.78%) but outperforming MSCI Emerging Markets index (-3.89%).

Most markets in Asia crowded around the overall regional return. Under-owned Malaysia was the only market to produce a positive return (1.4%) and Indonesia (-0.72%) also outperformed the broader region. Singapore (-5.8%) was the weakest market as the soft export environment and slowing domestic economy, especially the property market, continue to concern investors. India (-4.78%) underperformed with foreign investors selling Indian equities in the wake of another poor earnings season, and following the ruling Bharatiya Janata Party’s (BJP) heavy defeat in the Bihar state election, another indication that the reform path will not be an easy one. China (-3.37%) endured a turbulent month as news flow highlighted investigations into major brokerage houses, another interest rate cut (the 6th in this cycle), and confirmation of RMB inclusion in the Special Drawing Rights at the IMF.

On 30th November 2015, MSCI implemented a change to their index methodology which aims to better include foreign-listed securities within country indices. The change is happening in two equal stages effective 30 November 2015 and 31 May 2016. In Asia, the primary impact of this change is being felt in the MSCI China index, which will now include US-listed ADRs (primarily the ADRs of China’s internet companies, some of which are very large stocks). This resulted in China’s weight within the MSCI AC Asia ex Japan index rising from 28% on 30 November to 30.4% on 1 December (according to Factset). A similar sized move should be expected at the end of May 2016. The broader MSCI Emerging Markets Index has also seen a substantial increase in China’s weight.

It was another busy month for team travel with visits to China, Indonesia and India. Multiple team members made trips to China to attend various conferences and tours focused on the broad economy, banking system, telecommunications and technology sectors. The visits helped reinforce our long held views on China. Policy makers have recently been easing more aggressively through monetary policy and targeted fiscal stimulus, yet growth is likely to continue slowing. Whilst the services and consumption economy remains vibrant, this cannot offset the sharp slowdown in the industrial/manufacturing economy.

Whilst our portfolio managers have a preference towards owning companies exposed to the healthy consumer economy, our visits have also continued to highlight opportunities in state owned enterprises where regulation and reform favour the business, or where valuations have become depressed but we see management driving positive changes at the company.

Our Emerging Markets Equity portfolio managers, Gonzalo Pángaro and Mark Edwards along with Asia Opportunities Equity portfolio manager Eric Moffett paid visits to India later in the month and met many companies across a wide range of industries, as well as government ministers, industry experts etc. After several years of sluggish growth and very slow investment, India is seeing a cyclical economic improvement from quite depressed levels.

However, the rural economy is struggling as the government has reined in populist policies (though this is a positive reform longer term), and the corporate sector in some key industries remains overly indebted. This has meant we have not yet seen the pick-up in private sector investment needed to drive growth to the economy’s full potential. Investors are becoming increasingly nervous about the slow pace of headline-making reforms, and the loss of the election in Bihar. In addition, earnings growth has been disappointing.

Despite these challenges, our visits to India this year have continued to highlight that critical micro-level reform is taking place with the aim of improving efficiency (moving processes online), reducing corruption and enhancing social welfare (for example, according to Prime Minister Modi, 190 million more Indians have basic bank accounts since he came to power nearly 18 months ago).

Our meetings on this visit underscored the hope that Modi will now work more closely with opposition parties in an attempt to get reforms passed, which is why we remain optimistic on the medium to longer term outlook. That being said, India remains fairly expensive in an Asian context (less so compared to developed markets) and it is a consensus overweight – according to Morgan Stanley Research the average Global Emerging Markets Equity manager was 6.4% overweight in India at the end of October. We need to see better earnings delivery come through.

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