Asia Long-Term Unconstrained 2018 Outlook
After the strong run for Asian equities in 2017, backed by an earnings recovery, Andrew Graham and Paul Danes look ahead to what we can expect for the coming year.
11 January 2018
What were the key drivers of markets last year?
One of the key factors for investors in Asian equities over the past 12 months was the expectation of the strongest earnings recovery in seven years (based on consensus forecasts), with the prospect of this being sustained into 2018.* Meanwhile, in terms of global investment, the weak US dollar supported strong inflows into emerging market debt and equities, compounding the positive flows generated through improving company fundamentals.
Importantly though, the strong performance in Asian markets last year came from a narrow selection of companies. As of December, only 36% of stocks in MSCI Asia ex Japan had outperformed the index for 2017. In fact, a further probe into that data reveals just how the narrow the breadth of the market has been; just 15 stocks accounted for nearly 40% of the index return† and over half of this came from just five technology stocks. In country terms, China and Korea were the clear outperformers.**
Did your strategy perform as you would have expected in 2017?
In absolute terms, the ALTU strategy performed strongly in 2017.†† Although there were fluctuations over the course of the year, the strategy generally performed as we would have anticipated, given market conditions. Contributions over the year came from a broad base, with strong performances from technology, financials, consumer discretionary and real estate. In particular, the portfolio’s Korean and Taiwan-based holdings fared well.
Since inception, the ALTU strategy has achieved approximately 80% upside participation, but only 60% of downside participation relative to the performance of MSCI AC Asia ex Japan. On this basis, comparing 2017, with the historic average, the strategy has performed slightly better than our expectations, participating in around 90% of the upside. Considering the concentrated nature of the portfolio, and given the narrow breadth of the market in 2017, this upside capture has been particularly significant.¶
What do you think will be the key drivers for your markets in 2018?
As we have already mentioned, performance in Asian markets has been strong in 2017, but from a narrow base. As we enter 2018, regional employment levels remain high, incomes are growing and the consumption environment is either stable or improving, depending on the individual country. All of these factors should be supportive of continued market strength, but of a broader nature than in 2017, which would of course be welcome.
One of the key factors driving markets should be the positive impact of reform-minded administrations in control of Asia’s leading economies. In particular, the two largest economies are now beginning to emerge from the transition effects of regulatory change: India as it comes through the short-term effects of demonetisation and the introduction of a goods-and-service tax; and China from anti-corruption measures, as well as the impacts of capital controls, state-owned-enterprise reform and policy tightening in certain sectors.
One of the key factors driving markets should be the positive impact of reform-minded administrations in control of Asia’s leading economies.
Companies also have cash to spend – Asian non-financial corporates are sitting on approximately US$1.8 trillion of cash & equivalents (around 35% of market capitalisation). These are the highest levels we have ever seen.§
Finally, we are only one year into the recovery of revenues per share, post-global financial crisis. If this trend continues and feeds through to earnings growth, it should be supportive of continued share-price growth, assuming valuation multiples are at least maintained.#
How are earnings revisions and valuations looking relative to historic averages and other markets?
As referenced, earnings revisions continue to be positive. Naturally, with higher 2018 growth already anticipated, the pace of positive revisions has eased. However, these earnings revisions are not yet broad based. Korea, technology and real estate have seen substantial upgrades, while India, Indonesia and the Philippines have all seen downgrades.
In terms of valuations, MSCI AC Asia ex-Japan multiples do look elevated relative to the past five years, with 2018 price-to-earnings (p/e) at 12.6x and price-to-book at 1.5x. However, the further back you go, the closer those valuation multiples look to the historic averages.** Furthermore, it is worth putting those increased valuations into context, with 2017 also having seen improvements in the Asia ex-Japan return on equity for the first time since 2009.||
Not to forget, despite the strong performance in 2017, Asian equities continue to trade at a significant discount to global, European and especially US equities – with MSCI Asia ex Japan trading at a 31% discount on 2018 (p/e) multiples versus the MSCI USA index.†
What are the biggest risks to your markets in 2018?
Given the extensive liquidity from global quantitative-easing programmes in recent years, both the pace and scale of subsequent tightening will be crucial determinants of the broader impact on both Asian and global equity markets. A well-managed, gradual unwinding should result in more fundamental factors driving the performance of Asian (and global) equities. Liquidity being withdrawn too fast and/or rates rising too quickly would also represent risks. That said, both the tone and actions from central banks thus far suggests they are well aware of this.
Of course, there’s also the geopolitical backdrop, which has continued to create unwelcome distractions. However, the performance of Asian markets in 2017 suggests investors are capable of seeing through the noise, at least while there have been other positive factors driving the market. On top of the global and regional geopolitical environment, a busy election calendar in Southeast Asia represents localised risks for the relevant economies over the course of 2018.
Meanwhile, in China, the risk of a continued property-led slowdown has repercussions both for domestic growth and on regional trade.
What sustainability themes do you see yourself engaging with companies on most in 2018?
The ALTU strategy is typically focused on companies with stronger balance sheets, better free cash flow yields and higher return profiles, relative to the broader MSCI AC Asia ex Japan market (but at reasonable valuations). With a typical investment holding period of at least five years, it is fundamental to our process that we have confidence in the future sustainability of those positive financial characteristics.
As a consequence of that investment philosophy, underpinned by our detailed accounting diagnostic work, the overwhelming majority of our sustainability-related engagement with companies revolves around the operational, strategic and accounting decisions responsible for delivering those historic returns. This enables us to be confident in the ability of the company to maintain or improve on these returns in future periods. This practice will continue in 2018.
Another theme featuring in our engagement will be corporate culture. This will include executive/staff remuneration policies, the quality and extent of financial and operational disclosures and a company's attitude to (and treatment of) minority investors. All of these can give us good insight into the factors that have helped deliver superior returns and, in turn, their sustainability.
*Source: Martin Currie and FactSet as at 4 January 2018.
†Source: Martin Currie and FactSet as at 7 December.
**Source: FactSet as at 7 December.
††Source: Martin Currie over 12 months to 31 December 2017 in US$. Representative Martin Currie Asia Long-Term Unconstrained account shown. Net data is presented net of investment advisory fees, broker commissions, and all other expenses borne by investors. An annual fee rate of 0.75% has been applied for the net data. The figures provided includes the re-investment of dividends.
¶Source: Martin Currie as at 30 November 2017, Martin Currie Asia Long-Term Unconstrained US$ composite shown. Net data is presented net of investment advisory fees, broker commissions, and all other expenses borne by investors. Composite start date 31 July 2008. This strategy is not constrained by a benchmark but we show it versus the MSCI AC Asia ex Japan for illustrative purposes.
§Source: Martin Currie and FactSet as at 31 August 2017. MSCI AC Asia ex Japan in US$.
#Source: Martin Currie as at 31 August 2017. MSCI AC Asia ex Japan calculated in US$ shown.
||Source: Martin Currie and Bloomberg LP as 27 November 2017.
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