How the investment landscape is changing in Asia

‘China was one of the few countries in the world to achieve GDP growth last year … without expanding their balance sheet’ – Charlie Dutton – portfolio manager, Ninety One.

RYK VAN NIEKERK: Charlie Dutton joins me now – he is the portfolio manager of the Ninety One Asia Pacific Franchise Fund. We’re going to talk about how the investment landscape is changing in Asia. Charlie, thank you so much for joining me. Asia has been a significant success story for many years, especially pertaining to economic growth. The Chinese economy has been a juggernaut and it has shown double-digit economic growth for many years. And even in 2021, in a post-2020 Covid year which has been absolutely disastrous for many markets, it may grow by more than 8%, which is phenomenal. So the region really has become a critical investment geography, which should be on the radar of investors.

CHARLIE DUTTON: Ryk, thanks for having me on the programme. Yes, it’s pretty phenomenal what has been achieved over the last decade in particular. I do think when you look at how the Covid crisis in particular was managed in 2020, China was one of the few countries in the world to achieve GDP growth last year (2.3%). And what’s particularly astounding with that, I think, is that they managed it without expanding their balance sheet. When you look at everywhere else in the world, typically Europe and the US, they’ve significantly expanded their balance sheets – whereas China has done it without doing that. So the economic policies they’re putting in place have been very impressive.

RYK VAN NIEKERK: How do those economic policies they put in place affect investment decisions?

CHARLIE DUTTON: I think, again, this is an interesting aspect when you’re looking at not just China but Asia as a whole. If you go back 10 years and you’re looking to invest in Asia, it was an asset allocation around your view on the world, in the sense that Asia was like beta on economic growth around the world. If you thought the world was going through a strong period of growth, you’d buy some Asia because Asia is the manufacturing centre of the world. It has been quite cyclical in nature, in terms of the resource problems, the businesses out there and also financial systems. It was really quite leveraged to economic growth – whereas, if you roll forward since then, what you’ve seen happen is quite a structural growth in areas such as healthcare, consumer IT, which actually are starting to grow independent of the economic cycle. So it offers a very different asset allocation decision now.

RYK VAN NIEKERK: It seems as if the economic growth was fuelled in the past by aggressive infrastructure development. But it’s now starting to bear fruit and we see a rapid rise in the Asian middle class. And the consumer-driven economy offers a lot more investment options because you’ll see companies emerge with this massive potential.

CHARLIE DUTTON: Completely. If you look at where the middle classes are really going to grow on a global basis over the next three, five, 10 years, it is very much driven from Asia. And it’s not just the China story; you’re looking at the rest of Asia as well and India in particular. There’s a fantastic stat that I was reading the other day – that Asia effectively is creating the equivalent of the population of France in the consuming middle class every three to four years, and the duration of that is going to continue for many years to come.

Now, a key point there is when you get to $10 000 per capita, because when you get to that point in terms of economics you move from being consumer-staple-driven to [being] consumer-discretionary-driven, and that’s a movement towards luxury spend.

It could be towards housing, it could be towards autos, it could be towards electrical goods, [and that] really drives that growth going forward. As you say, that becomes much more structural in nature rather than cyclical.

What we’ve seen happen, certainly over the last decade, is a real rise in local brands in Asia. There’s a company called Kweichow Moutai, for instance, which many people haven’t heard of, which is the largest alcohol company by market cap in the world, larger than AB InBev or Diageo or Heineken…. And there are a whole spate of businesses like that in Asia: local brands, which are now incredibly successful riding along this consumption wave.

RYK VAN NIEKERK: In the past many fund managers looked at Johnson & Johnson, Procter & Gamble and Visa to profit from the emergence of the middle class in the area. It’s good to see the local brands coming through. I would assume it’s quite a wide offering. How do you look at those local brands, and does your investment analysis differ from what you use for the bigger, established companies in the portfolio?

CHARLIE DUTTON: Absolutely. I mean, there are a number of crossovers that we apply on a global basis, but also on a local basis.

But one of the key areas we’re looking at is premiumisation – making sure that we’re in those brands which are very much regarded as the premium brands, the ones which have got significant market share, but also apply to local tastes.

We spend a lot of time visiting the markets and we have local analysts who go out and look at these individual positions as well, just to make sure that we are getting those niche products.

Having said that, if you’re looking at multi-generational luxury products which have been established in Asia for many, many years, we’re not looking at what is regarded as the new fad coming through. We’re looking at these established brands. So the equivalent in the West would be looking at Hermes or Louis Vuitton and looking at those luxury brands again in Asia.

RYK VAN NIEKERK: Another interesting trend, which you referred to in a recent presentation, was the significant increase in spend on research and development. In the past Asian countries were known for producing cheap products, and now it seems like many of these markets also compete on quality; that’s also a significant shift.

CHARLIE DUTTON: Ryk, you bring up something very interesting there. As I say, when you are used to investigation – I’ve been doing this for over 20 years – certainly when I started looking at investing in Asia, it was around manufacturing. It was around looking at who could produce the lowest-cost application, and those tended to be the most successful companies.

If you roll forward to today, one of the stats you are referring to there is that on a cumulative basis in 2020, China’s R&D actually matched the amount of R&D spent in the US. What this means is that not only are you getting significant improvements in terms of information technology and applications within that sector, but it’s also happening within healthcare and a whole product of suites. What that results in is that the manufacturing which is coming out of Asia as a whole is moving up the value chain, and therefore the financial characteristics of these businesses are improving. They’re increasingly coming up with niche products, which means that they are globally competitive.

One of the sectors you could really focus on here is Korea and Taiwan, looking at the semi-conductor industry.

Samsung and TSMC, Taiwan Semi-Conductor Manufacturing, are the largest semi-conductor companies in the world, and they absolutely dominate their particular aspects of chip manufacturing. And if you believe that the world is going to need more computing power going forward, these are the businesses which are going to benefit from that.

RYK VAN NIEKERK: Many people think of Asia as being China. There are many other markets that offer exciting opportunities – the Indian market has been on the radar of many fund managers. You just referred to Taiwan. Is there a difference in dynamics between these different markets? Should you evaluate them differently?

CHARLIE DUTTON: That’s a very interesting point. I do think China is more isolated in nature. And, as we know, from a political perspective but also from an economic perspective it has a closed capital account. It also has barriers in place with regard to various industries that are there. There’s a particular reason why there are no really large internet companies in Europe – because Google, Facebook and Amazon came in and dominated. The Chinese, I think, took a look at this and went, “No, thanks, we want to create our own national champions” in the likes of Alibaba, Tencent, Baidu, which have come to the fore.

Interestingly, in the rest of the region those barriers haven’t been put in place. So you don’t really get the same internet giants in India, for instance, or Korea or Taiwan. But in those other countries you do have particularly interesting businesses. India is very much a consumer-led investment story for us. There are some amazing consumer stories there. But there aren’t that many healthcare stocks or IT stocks there. And elsewhere in the region it’s the same; if you look at careers in Taiwan, it’s more about the IT opportunity set there. So you’re absolutely right, there is a fascinating diverse opportunity set around the region in these different sectors in these different countries.

RYK VAN NIEKERK: So, if you are an investor in South Africa or in any geography in the world, in the past you would have looked to invest in the US. It’s a growing economy, maybe some diversification into Europe; and then maybe let’s put 10% into Asian markets. It wasn’t actually a priority, but this seems like that perception should change because Asia is really going to become a dominant force in the world economy. The big question is, will the equity markets mirror that change in dynamics?

CHARLIE DUTTON: Ryk, you bring up a very interesting point there, because at the moment the x-markets don’t mirror the economic size or opportunity set that Asia is within a global context. And part of the reason for that is that the Chinese market in particular is underrepresented within NSEI indexes [benchmark representing the weighted average of 50 of the largest listed companies in India]. So, as you say, at the moment it’s more of a kind of sideshow. Going forward, though, the economic development you’re going to see across the region means that you’re able to actually allocate capital, I think, on a more permanent basis to Asia.

I think if you’re looking at the structural growth that you can get exposure to in Asia, putting money into Asia doesn’t mean you’re replicating a gem exposure by being invested in South African stocks or Latin American stocks or other gem markets, because it does offer a very different return profile.

RYK VAN NIEKERK: Charlie, let’s talk about the fund you manage, the Ninety One Asia Pacific Franchise Fund. It has performed really well over the past year. It grew by more than 40% but it came of course from a low base due to the crash in March last year. But over the past few years and since inception it’s grown by more than 9%. What is your investment philosophy and strategy for this fund?

CHARLIE DUTTON: Asia Pacific Franchise is a Ninety One fund. I sit within a capability there which also includes a global franchise, which I think is quite well recognised in South Africa. What we do is we’re really looking at businesses which we want to invest in on a long-term basis. When we’re looking at the portfolio as a whole, there are only 27 stocks in the portfolio, so it’s very focused. We have low turnover each year, which means that we’re really looking at these businesses on a four- or five-year-plus basis.

What that means is the research process that we have to go through in order for these stocks to enter the fund is extremely diligent, and we’re really looking at the sustainability of these bases on a long-term basis.

The Asia Pacific Franchise Fund is almost predominantly invested in just the healthcare sector, IT sector and consumer sector – those areas which we believe have long-term structural growth.

So, what I don’t want to have to do, Ryk, at the end of the year is turn to my investors and say, sorry, we’ve done badly because we thought the oil price was going to be at $60 but it’s at $40, or Chinese GDP growth was 4% and we thought it was going to be 6%. We’re trying to take that economic uncertainty out and invest on a structural basis without that cyclical risk.

RYK VAN NIEKERK: I like the financial sector. I think it’s one of the most exciting sectors in the world. Apparently on your radar the exposure to the financial sector is only 9.2%. Is there a specific reason why you would not favour the financial sector, because usually that sector mirrors the economic performance of a country quite closely?

CHARLIE DUTTON: Ryk, I think you’ve hit it on the head there. We don’t want to mirror the economic performance. We rather want to take ourselves outside of that. If you look at the financial sector in Asia as a whole, the banks in Asia tend to be quasi-national banks. So, all the banking in China tends to be quasi-national banks of China, the same in Australia, (the) same predominantly in India, Hong Kong, Singapore. So, we try and extract ourselves away from that. Our financial exposure is just through two businesses. One is called HDFC Bank, which is in India, which is an incredible business but very fintech orientated. And the other one is AIA, the insurance company which actually has a tie-up with Vitality and Discovery in South Africa.

But again, we’re looking at the structural growth of the middle classes requiring improved insurance policies going forward, rather than looking at the cyclical nature that the financial sector normally has.

RYK VAN NIEKERK: Charlie, thank you so much for your insights today. I think many people don’t appreciate the economic shift that is happening in the world. Maybe there is a lag, but the investment shift and the investment priority Asian markets present is also increasing. Maybe it’s a good time to get in there now. If you’re an investor now, how much of a portfolio do you think you should allocate to Asian markets?

CHARLIE DUTTON: Ryk, I think that’s definitely outside of my expertise. I’m not a wealth manager. But, as I say, if you’re looking at the world as a whole, and you’re looking at where the economic growth is going to come from on a kind of multi-year structural basis, a lot of that is going to be from Asia. So therefore, I think you do need to have at least some allocation to Asia. But obviously that’s down to individual decision.

RYK VAN NIEKERK: Charlie, thanks for your time today. That was Charlie Dutton. He is the fund manager of the Ninety One Asia Pacific Franchise Fund.

Brought to you by Ninety One.

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