After a reset, has Asean found its mojo?

In 2022, The Edge Singapore examined Asean’s decade of “healthy reset”, underscoring the factors that would support the region in the short, medium and long term. However, Asean equities continued to be under-allocated among global investors last year.

But the tide may be turning. On Sept 19, the Fed announced a “bold” half-point rate cut aimed at bolstering the US labour market. Even before the announcement, attention was already turning towards Asean, as evidenced by record-breaking foreign direct investments (FDI), a key barometer of economic confidence.

In its Sept 10 report, Maybank Investment Banking Group analyst Anand Pathmakanthan noted that Asean has been a “magnet for investment”, recording an increase in inward FDI flows for three consecutive years. In 2023, Asean attracted US$229.8 billion ($297.51) worth of FDIs, a slight increase of 0.3% from US$229 billion in 2022.

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Singapore attracted the lion’s share of the FDI flows into Asean at almost 70%. Indonesia and Vietnam were also big winners, attracting US$21.6 billion and US$18.5 billion each. In 2022, Singapore attracted more than half of the total FDI flows at US$141 billion, followed by Indonesia, Vietnam (7.9%) and Malaysia (7.6%).

Amid the challenges posed by the Covid-19 pandemic, Asean’s swift recovery and economic resilience appear to have successfully maintained investor confidence, says Pathmakanthan.

The US, intra-Asean, Japan, the European Union (EU) and China were the top five sources of FDI in the region in 2022. FDI from the US and intra-Asean primarily went to financial, insurance and manufacturing activities, while FDI from China was significant in manufacturing and real estate activities. The EU concentrated on wholesale and retail trade and manufacturing activities. FDI from Japan invested strongly in transportation and storage activities.

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Against a backdrop of growing US-China rivalry, one of the biggest growth drivers of the FDI flows into the region is the supply chain relocation and tariff arbitrage.

Known widely as the “China Plus One” (China+1) strategy, which first emerged in the mid-2000s, this involves Chinese companies establishing production hubs outside the mainland to lower-cost Asean countries to reduce expenditure. It is also a well-known tactic to protect supply chains and export markets against the potential fallout of US-China trade tensions.

Asean’s proximity to China and its ties with the US make it a favoured destination, with notable investments in Malaysia’s chip industry, Indonesia’s electric vehicle (EV) supply chain and Vietnam’s electronics production.

No way to play Asean

Will the strong FDI inflows going into Asean eventually lead to higher allocation into Asean equities? In August, EMs ex-China sustained the second straight month of net outflows, mostly reflecting a switch from technology to Asean and Brazil. In their Sept 3 report, Macquarie Research analysts Viktor Shvets and Kyle Liu say the switch makes sense in the context of expectations of Fed rate cuts and, hence, lower pressure on local currencies.

Global funds were found to be snapping up assets in the region. Bloomberg reported that money managers had boosted their positions in sovereign bonds in Thailand, Indonesia and Malaysia in recent months, in addition to being net buyers of Indonesia, Malaysia and Philippine equities.

Pundits expect the region’s central banks to begin their monetary easing cycle as soon as the Fed makes its first move. Ahead of the Sept 19 rate cut, the Central Bank of the Philippines had already unexpectedly cut its benchmark interest rate by 25 basis points (bps) to 6.25% during its August policy meeting. Indonesia followed suit, trimming its benchmark interest rate by 25 bps on Sept 18, its first rate cut in more than three years.  

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Eastspring Investments portfolio manager Daniel Lau points out that those who invest based on the MSCI ACWI index have “negligible” exposure to the Asean markets at less than 1% of the benchmark. Between 2013 and 2023, China equities’ weight in the MSCI ACWI index grew by 40 bps to 2.4% while India equities grew by 130 bps to 2%. At the same time, Asean equities fell by about 70 bps collectively to 0.94%.

Going forward, Lau expects Asean equities weightage to increase in the MSCI ACWI index, given superior GDP growth in markets such as Indonesia, the Philippines and Vietnam. Meanwhile, more mature countries such as Malaysia appear to be given a “second wind” amid political stability and rising FDI across various sectors.

According to data compiled by the Hong Kong Trade Development Council (HKDTC), Asean averaged an annual GDP growth rate of 4.2% between 2013 and 2022. Meanwhile, a report by DBS, Bain & Company and Angsana Council forecasts that Asean’s annual GDP growth rate will be 6% yearly from 2024 to 2034. With a combined population of 672 million, Asean’s GDP stood at about US$3.6 trillion in 2022.

However, it is important to note that as a region, Asean is highly fragmented, with significant differences across markets regarding political, economic and social systems. Income levels also vary widely. Although the bloc had an average GDP per capita of US$5,395 in 2022, those of Asean member states range from a low of about US$1,130 in Myanmar to US$82,795 in Singapore, HKDTC finds.

Returns of Asean equities are also still trailing behind broad EM equities. This is evident in the performance of the MSCI Asean Index, which includes large and mid-cap equities across Singapore, Indonesia, Malaysia, the Philippines, Thailand and Vietnam, covering approximately 85% of the free float-adjusted market capitalisation in each country. As at Aug 30, the index, which has provided returns of 11.6%, 1.41%, 0.49% and 0.37% over the one-, three-, five- and 10-year periods, has underperformed the MSCI EM index, which has provided returns of 15.07%, –3.06%, 4.79% and 2.56% for the respective periods.

But Lau argues that Asean equities still present viable prospects for investors. He notes that Asean equities tend to exhibit lower volatility compared to other asset classes as they are under-owned by global investors and hence act as a good countercyclical exposure.

As the region was also overlooked for an extended period of time, Asean equity markets tend to be less efficient than their global counterparts. Therefore, it offers ample bottom-up opportunities for investors familiar with the region, Lau stresses. “Consequently, we believe that a well-constructed portfolio should also offer attractive returns for global investors,” he adds.

Within Asean, Eastspring prefers rate-cut beneficiaries with large domestic markets, ranking the Philippines and Indonesia highly. A large domestic consumption base should help to provide a safety cushion in the event of a hard landing in the US, which will have repercussions across the region.

On the other hand, the Macquarie analysts say they are “not prepared” to “overweight” the region, despite reducing its “underweight” call, as they believe that any cyclical boost to terms of trade-oriented EMs is likely to be moderate. Unlike India, Asean markets lack a wide waterfront of investable assets at the current stage, even as underlying economies are starting to change, he notes.

“Instead, investment choices are restricted to select few proxies, mostly banks and some utilities,” they write. “This keeps us bullish on long-term prospects of India and tech themes in Northeast Asia, and we continue to treat Asean as mostly trading opportunities. However, as economies change and the investable universe expands, it is possible that some Asean economies might emerge as meaningful competitors to India, Korea and Taiwan.

“A paradigm economic and geopolitical pivot by China could also meaningfully alter the investment calculus, although this seems unlikely, at least in the short-to-medium term,” they add.

The rise of new players

Traditionally, Asean’s investable universe is dominated by banks, telecommunications and industrial conglomerates. As at Aug 30, financials is still the largest sector in the MSCI Asean index at 42.96%, followed by communication services at 12.13%, industrials at 10.11%, consumer staples at 7.27% and real estate at 6.44%.

Likewise, top sector holdings for Eastspring Singapore Asean Equity fund, JP Morgan Asean fund and United Asean fund are the banking and financial sector at 40%, 47.3% and 34%, respectively, followed by telcos, industrials and real estate. The dominance of these sectors is underpinned by ongoing robust economic growth, rising middle class and digital transformation, which spurs the demand for such products and services.

However, Asean has seen a rise in companies in emerging industries, propelled by changes in consumer behaviour that accelerated during the pandemic and other disruptive technologies. In a Sept 17 report, Morningstar analyst Hunter Beaudoin highlights that companies operating in industries such as e-commerce, digital entertainment and online ride-hailing have emerged as fresh investment prospects in Asean.

Singapore’s Sea and Grab, listed on the New York Stock Exchange and Nasdaq in 2017 and 2021, respectively, saw an intense rally at the beginning of the pandemic. Sea even overtook banking giant DBS Group Holdings as the largest listed Asean company from May 2020 through February 2022.

Domestically listed “new economy” names like GoTo are also formidable players in the regional landscape. Still, Asean equity fund managers have remained cautious about these stocks amid recent plummeting share prices.

Some managers, who were previously bullish on these stocks before their index inclusions, are now increasingly cautious. JP Morgan Asean Equity fund was an early embracer of Sea, initiating an off-benchmark investment in March 2020 based on Garena Free Fire’s success and improvement in Shopee Indonesia.

Since 2022, though, there have been increasing concerns over Shopee’s aggressive cash burn and the intense competitive landscape that it faced, Free Fire reaching maturity and weak company disclosures resulting in relatively flat exposure against the benchmark from 2Q2022 through June this year.

Similarly, Fidelity Indonesia acquired shares in e-commerce player Bukalapak during its August 2021 IPO and made a private investment in GoTo before its IPO. Although fund manager James Trafford did not consider Bukapalak one of the high-quality companies which his portfolio had focused on at the time, he viewed it as a potential yield opportunity due to its healthy balance sheet, supported by a strong net cash position and the prospect of it turning cash flow positive.

The risks of these new economy players cannot be overlooked, Beaudoin asserts. These companies have yet to turn profitable, with unproven business models in a highly competitive environment and vulnerable to business cycles. He further points out that some traditional Asean stocks exposed to the new economy are also subject to dramatic swings in volatility.

Beaudoin says: “A prime example is Thailand’s Delta Electronics, an electronic components manufacturer that expanded into the electric vehicle supply chain and renewable energy. Its share price soared over 1,000% over the four years ended June 2024, at one point becoming the largest Thailand-listed company and surpassing the market capitalisation of its Taiwan-listed parent.”

“However, the stock’s low free float relative to its market capitalisation poses hazards. Low-float stocks tend to have lower trading volume and wider bid/ask spreads, which can make it difficult for investors to trade at a fair price, an issue that may be exacerbated in the event of a sharp market correction,” he adds.

Delta Thailand’s erratic performance caused the Stock Exchange of Thailand to intervene at multiple points to warn investors to exercise caution when trading the stock and implement several market surveillance measures. This includes requirements to pay cash upfront for trading orders and excluding it as collateral when calculating credit limits.

Beaudoin believes there is potential for a more diversified investment opportunity set within the Asean region over the long-term. He notes that Asean governments are actively pursuing policies that foster the growth of new economy companies through tax incentives and investments in digital infrastructure, such as Thailand 4.0 and Vietnam’s Digital Transformation plan.

“Asean’s young population of digital natives is a structural driver of the new economy. The region’s strong fundamentals and continued support of local governments and institutions will ultimately pave the way for a more diverse investment landscape in the future,” he concludes.

UOB Asset Management (UOBAM) Malaysia’s CEO Lim Suet Ling is “positive” about the Asean markets over the next 12 to 24 months.

This is as several factors are aligning for a favourable environment for growth, on the back of the the Fed rate cut which could lead to US dollar index softening, Lim writes.

“Historically, a weaker USD has been supportive of equities in EMs, and this trend is especially favourable for Asean markets. We expect this trend to continue,” she adds.

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