How to play the Asian growth story
18 February 2013
By Asia Asset Management
While the long-term economic themes in Asia are well recognised and understood by the investment community, the ways for investors to participate in this structural growth story remain shrouded in mystery and misconceptions. Here King Fuei Lee, head of Asia equities at Schroders, shares his thoughts on how investors can play the Asian growth stories.
Traditionally, investors hoping to participate in a country’s economic growth try to do so by investing in the country’s stockmarket, often through index funds and actively managed relative return funds. After all, conventional wisdom is that the faster an economy grows, the more corporate profits in the country will grow, and hence the higher the stockmarket returns the investors will achieve. This could not be further away from the truth.
Don’t just rely on economic growth
An academic study by Elroy Dimson, Paul Marsh and Mike Staunton, professors from the London Business School (LBS) has found no evidence of a positive relation between a country’s GDP growth and its investment returns. On the contrary, their analysis of the financial data of 83 countries going back to 1990 showed that slower-growing countries actually delivered better investment returns than their faster-growing counterparts.
This is a conclusion that an investor in the Chinese stockmarket will likely concur with as he finds his or her US$1,000 investment in the MSCI China index in 1993 dwindle to $660 in 2011, while the Chinese economy registered an average nominal GDP growth rate of 15.5% per annum over the same period
So why does high economic growth not always translate into superior stockmarket returns, and how can investors wishing to participate in this Asian growth story do so?”
1. Focus on dividends
One of the reasons for the poor relation between economic growth and investment returns stems from the fact that the total return from the stockmarket is really made up of two components, namely capital appreciation and dividend return. Capital appreciation is notoriously susceptible to non-fundamental influences like momentum and sentiment. Fortunately all is not lost. The same LBS study has also found that real dividend per share (DPS) growth is particularly strongly correlated to real GDP per capita growth. Because dividends can only be paid out of corporate earnings which are in turn directly driven by the state of the economy, dividend returns tend to be highly linked to economic growth. Investors seeking exposure to the multi-decade Asian growth story should pay close heed to the dividends that they are capturing from their equity investments.”
2. Ignore the stockmarket index and look further down the market cap spectrum
Another explanation for the poor relation is because the stockmarket index does not precisely represent the country’s economy. This can be very problematic for investors targeting the Asian market index as more than half of the index is in fact made up of ‘global cyclicals’ or companies which are more exposed to the vagaries of the global economy than to domestic Asian influences. Investors looking to play the Asian growth story should therefore ignore the benchmark when investing in the region and focus on companies that genuinely benefit from favourable domestic dynamics. This is particularly important for investors willing to look further down the market capitalisation spectrum as small- and mid-cap companies in Asia typically earn a greater proportion of their revenues domestically. With these smaller stocks generally also suffering from poorer analyst coverage, the greater inefficiency in their share prices should represent opportunities for making multi-bagger returns.
3. Buy good stocks, not markets
An often-cited reason for the inability for high economic growth to manifest in strong returns is that the growth is being siphoned off by insiders – executives and managers – at the expense of shareholders. Despite the hype about the tremendous economic growth in Asia over the next few decades, it is crucial for investors to realise that ultimately it is stocks that make up their portfolios, not markets or countries. The key for investors to participate is simply to ensure that they only invest in good companies. These are essentially companies which are able to channel the growth back to shareholders in the form of high-quality earnings, and delivered within a system of strong corporate governance and sound business practices. Performing in-depth bottom-up research on companies and understanding their business models and earnings drivers will go a long way in helping investors crystallise the Asian growth story in profitable equity investments.
4. Remember that valuation is important
Just as with investing in growth stocks, the returns from investing in growth markets can be pretty meagre if the future growth is already reflected in the prices. With the region currently trading at 1.7x price-to-book and 13.9x price-to-earnings, valuations are thankfully reasonable compared to longer-term averages.
For long-term investors looking to participate in the Asian growth story now is as good a time to start accumulating.
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