We’re always hearing Australian investors should look to Asia for growth opportunities that can’t be found elsewhere in the world. But in reality investors remain cautious, with the majority seeing the region as too adventurous and outside the mainstream investment consideration set.
Evan Erlanson is the chief investment officer of Seres Asset Management, a thematic long-short manager based in Hong Kong that focuses on small and mid-sized companies in Asia (including Japan), and Douglas Loh is the head of Asia at Acorn Capital, a well-known microcap manager that launched an Asian small cap fund in 2012 using a research process honed over a 14-year period investing in Australian microcaps. Both Seres and Acorn Capital are joint venture partners of Australian Unity. Here these two expert fund managers give their perspective on current and future investment opportunities in the region, and why Asia should be part of every investor’s portfolio.
1. In 25 words or less, why should Australian investors have a specific allocation to Asia in their portfolios?
Evan: Asia represents a larger demand pool than all other emerging markets combined, allowing it to support more sustainable growth and innovation over the long term.
Douglas: Asia is characterised by market inefficiencies, a large investment universe, and higher economic growth rates driven by a rapidly expanding middle class.
Buy good houses in bad neighbourhoods - they have tremendous scarcity value
2. What are the key things investors need to know about China?
Douglas: Until recently, China’s economic growth has been driven by exports. However, the next stage of its growth will see a growing consumer class purchase goods and services associated with a higher standard of living. A wide array of industries including food, household goods, education, travel and health care spending for personal wellbeing will benefit from this growth. Recent research has shown that by 2022, more than 75 percent of China’s urban consumers will earn between RMB 60,000 and 229,000 a year (approximately AUD $10,300 and $40,000), compared to four percent in 2000. In purchasing-power-parity terms, this range is between the average income of Brazil and Italy. This demand is not only positive for Chinese companies, but for the region as a whole.
Evan: China is in the early stages of financial reform that will eventually result in higher real rates, lower asset prices, and the more rational allocation of capital. This process will hopefully help resolve some of the excesses of the past 14 years and give investors more opportunities to make rewarding long-term investments in Chinese equities.
3. Can you share your investment war stories and how they changed the way you invest?
Douglas: War stories do come with the turf, and we have plenty of them. In Asia, as in Australia, we place considerable emphasis on understanding the people behind the companies. In some parts of the market, corporate decision-making is largely dictated by the objectives of the owners and their family as well as related parties. This isn’t necessarily a bad thing, but we want to understand the dynamics as best as we can. For example, a warning bell for us is turnover in company executives which, in our view, is an earlier indicator of potentially greater problems than a change in the company’s auditor.
Evan: Fifteen years ago, what we refer to today as ‘small caps’ would have been considered mainstream investments by Asian equity managers. Thinking back on my investment career, there have been very few horror stories that were purely attributable to the size of the stock. On the other hand, there have been many instances in which large, liquid stocks (household names among them) inflict massive losses on investors in a matter of hours. Thus, while some consider small caps to be riskier due to their relative illiquidity, we consider this to be a short-term consideration that can be mitigated by investing in uncorrelated markets and themes. In the end, consistent growth overwhelms volatility.
4. What is one of the more interesting companies in your portfolio at the moment?
Evan: One of our most unique positions is Mega Lifesciences, a Thai-headquartered pharmaceutical distribution company that realises 80 percent of its revenue from the fast-growing markets of Laos, Vietnam, Myanmar, and Cambodia. Mega is also growing its own-brand vitamin/ nutraceutical business (with all production located in Australia, incidentally), which enjoys top share in the Thai market. Over the past 30 years, the company has developed thousands of touch points with drug wholesalers and retailers across the region, making it the partner of choice for multinational drug companies seeking to sell into these frontier markets.
Douglas: Overseas Education caters to K-12 students (children aged between three and 18 years) and is the third largest international school in Singapore, with approximately 10 percent market share. The stock offers excellent growth prospects, given the company is in the midst of constructing a new and larger campus to cater for the burgeoning demand for quality education. The company is characterised by its pricing power, strong margins and cash flow generation, and is the only pure school play listed in the public market in Asia. A key positive is Overseas Education’s professional management experience—it has a 22-year track record. The company is listed in Singapore.
5. What is a universal investment truth, regardless of the region you are investing in?
Douglas: Successful investment relies on sound investment research. Stocks represent ownership of businesses that exist and compete in the real world. You need to understand how they operate and compete, and have a view of the strengths and weaknesses of the underlying franchise as well as the industry dynamics in which they operate. We take it one step further by identifying and investing in companies that are ‘best of breed’—understanding the sector and its strengths, opportunities and inherent risks.
Evan: Ignore headlines, but read the fine print. It is difficult to create alpha when your information comes from mainstream sources. On the other hand, digging into the details often leads to counterintuitive conclusions, which can help you get ahead of the information curve.
War stories do come with the turf, and we have plenty of them
6. What is your advice for investors interested in building exposure to Asia?
Evan: Avoid companies with a high degree of government control or ownership, or those in a position to perform ‘national service’. Definitely buy good houses in bad neighbourhoods—they have tremendous scarcity value. Try not to think of Asian markets in their current form. Instead, imagine how they are likely to develop structurally over the next decade and choose the companies that are most likely to rise to the top. Such a strategy will deliver the benefits of Asian growth even if the broad market does not perform well.
Douglas: Determine your risk appetite, including your time horizon (i.e. how long you can commit to the investment), the proportion of assets you are prepared to commit to the investment, and your level of comfort with volatility. By their nature small caps in any country are more volatile than large caps, so your time horizon should be long enough for the investment to pay off (five years plus) and small cap investments should not make up the largest proportion of your assets.
7. What are the two or three things on your mind for the rest of 2014?
Evan: The unexpected strength of the US Treasury market has taken many investors by surprise, contributing to robust Asian currencies and fixed income markets. In the short term this is positive, but we will be on the lookout for the formation of USD (or Yen) funded carry trades around the region, as these could lead to dangerous asset price inflation.
We will also be keeping a close eye on soft commodity prices, which are particularly relevant for countries such as Indonesia and India that are still recovering from the brief period of capital flight that shocked emerging markets after former Chairman Bernanke’s ‘Taper’ comments. Crop conditions have been poor globally while disease and drought have reduced herd sizes, with potential implications for trade balances and inflation in vulnerable Asian markets.
Chinese import statistics are less easily manipulated than export statistics, and are a better indicator of the true state of industrial demand in China. This number matters a great deal for the economies of Korea, Taiwan, and Germany (less so for most other countries). Chinese imports have been stagnant for the better part of two years, but an inflection point (positive or negative) that lasts for more than three months could indicate the beginning of a trend.
Douglas: The Asia ex Japan small cap space is an ideal hunting ground; there are approximately 5000 companies in the universe across 10 countries and 12 industries. A huge proportion of these companies are not on the radar of investors and professional analysts, meaning the opportunity to discover well-managed small companies generating attractive returns for investors is high.
Many of the countries we invest in are immature democracies or undemocratic. Rapid modernisation across the region, changing demographics, explosive urbanisation and other factors combine to make the region subject to potentially substantial shifts of power. Thailand and Indonesia have national elections within the next few months and we have to keep an eye on the political developments and how this may impact our investment strategy. We keep a very close watch on what is said and what is popular to ensure changes in government policy don’t have an adverse effect on the companies we own. The opposite is also true—change may bring opportunity, and we have to be aware and ready for that too.
1. Mapping China’s middle class, Dominic Barton, Yougang Chen, and Amy Jin – McKinsey & Company, June 2013
The information in this article is general information only and does not take into account the financial objectives, situation or needs of any particular investor. This article is not a recommendation to buy or dispose of any of the stocks noted. Any examples or information provided in this article are for illustrative and discussion purposes only and do not represent a recommendation or Acorn Capital or Seres Asset Management’s view on future events, and in no way bind Acorn Capital or Seres Asset Management.
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