Healthy reset

The Google mobility index on retail and recreation activity, for instance, suggests a sharp recovery of economic activities after the Omicron wave, thanks to a sharp pick-up in vaccination rate. In fact, despite concerns on food inflation, spending on consumer goods such as high-margin (60%-70%) bubble tea is still on the rise with the market seeing a US$3.66 billion ($5.1 billion) turnover in 2021, according to venture builder Momentum Works and fintech firm Qlub.

Would this recovery of economic activities translate to compelling long-term investment opportunities in Asean? The economic bloc was “quite a darling” after the Asian Financial Crisis (AFC) in 1997 through 2013, when the taper tantrum, which caused emerging markets to suffer sharp capital outflows and currency depreciation, took place, says Fidelity International Southeast Asia portfolio strategist Christopher Wong.

Once the dust settled, the narrative turned to favouring growth stocks over value cyclical stocks — the latter of which Asean has a bigger weight on. In fact, almost 40% of the MSCI AC Asean Index consists of the financial sector, followed by communication services (13.8%) and industrials (8.82%), as at end-July. Due to this, Asean lost its spotlight to markets such as China and India which have larger pools of well-run, fast-growing companies that include new-economy players, says Wong.

Eastspring Investments client portfolio manager Dalphin Hou shares a similar view. China and India are the two most populous countries in the world, boasting large domestic markets and huge talent pools, and such large markets tend to have inefficiencies in the system. Coupled with loose monetary policies of the past years, these economies provided a good breeding ground for growth stocks, particularly tech start-ups.

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“Asean did not catch on the digital wave like China and India, partly due to the lack of a large domestic market,” says Hou, noting that all Asean countries except Indonesia (270 million) and the Philippines (110 million) have populations of less than 100 million people. “The small and fragmented markets make it difficult for any big Asean tech plays to gain scale on a regional basis. There is also insufficient talent pool in these markets. As a result, Asean has always been seen as an old-economy value play, which underperformed growth during the era of cheap money,” says Hou.

Now, after undergoing a decade of “healthy reset”, the regional grouping of 10 nations (Singapore, Indonesia, Malaysia, the Philippines, Thailand, Brunei, Laos, Cambodia, Viet-nam and Myanmar) has seen rapid growth, underpinned by foreign direct investments (FDIs), infrastructure investment and structural reforms, says JP Morgan Asset Management’s Stacey Neo, co-fund manager of the JPMorgan ASEAN Fund.

“Given the fact that we are seeing the global geopolitical tensions, macroeconomic uncertainties, China’s ongoing zero-Covid policy and supply chain disruption, the interest in Asean has certainly been heightened. I believe it continues to be a very effective source of portfolio diversification,” says Neo.

See also: After a reset, has Asean found its mojo?

Photo: JP Morgan Asset Management's co-fund manager of the JPMorgan ASEAN Fund Stacey Neo.

Short, medium and long-term catalysts

The Asean region is relatively insulated from geopolitical tensions in Europe and North Asia, seeing less direct impact from the geo-political events on its economy and assets. Case in point is the fighting between Russia and Ukraine, which has caused much economic worries. However, these two countries, while grabbing headlines worldwide, account for less than 1% of Asean exports, Neo points out.

In addition, higher commodity prices have been a net positive for commodity exporters in the region such as Indonesia and Malaysia. From a stock market perspective, the commodity price rally has also benefitted markets with more energy-related stocks such as Thailand.

Aside from that, there are several short, medium and long-term catalysts that are making Asean attractive from an equity perspective. One immediate catalyst or driver of growth is the proper economic reopening throughout the region, says Wong. Over recent months, there is a concerted effort to reopen the region to tourists and business travellers, allowing the countries to benefit from the post- Covid-19 recovery.

In early August, for example, Thailand’s Prime Minister Prayuth Chan-Ocha said a faster-than-expected rebound in international visitors to Thailand would help the country’s economy to return to pre-pandemic growth at 4.2% in 2023.

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The region is also starting to see FDIs coming back, says Neo. The FDI inflows into Asean reached their highest ever level in 2019 at US$182 billion, making Asean the largest recipient of FDIs in the developing world. The following year, it declined to US$127 billion due to the impact of the pandemic, but still performed slightly better compared to the decline of global FDI level as its share of global FDIs rose from 11.9% in 2019 to 13.7% in 2020, according to the Asean investment report 2020-2021.

The report adds that the outlook for FDIs in Asean is promising, on the back of improving national and global economic growth, as well as strong efforts by the member states to attract investments.

On this, Neo shares the anecdote of toy brickmaker Lego Group, which announced late last year that it is investing more than US$1 billion to build its first carbon neutral-run factory in Vietnam. This is the privately-held company’s second manufacturing site in Asia after China.

Electronics giant Samsung Electronics is also a big investor in Vietnam. It has announced an additional US$3.3 billion of investments to start producing semiconductor components in the country by July 2023 — on top of its existing manufacturing sites. “Samsung is already a significant player in Vietnam, accounting about 20% of the total export value,” says Neo.

Other countries in the region such as Malaysia have also seen significant FDI inflows, says Neo. German semiconductor manufacturer Infineon, for instance, is investing over EUR2 billion ($2.8 billion) to build a third module at its site in Kulim, Kedah — a northern state in Malaysia known for its vast paddy fields. Construction will begin in June and the fab will be ready for equipment in the summer of 2024, the company notes.

“With the continued focus on the emerging Asean economies including the frontier markets within the region, it goes to show that Asean is no longer seen as the world’s sweatshop,” says Neo.

In terms of funds flow, since the announcement of the taper tantrum in 2014 to 2021, the Asean region saw cumulative net outflows of around US$50 billion, says Neo. Of this, US$30 billion happened in 2018-2020. Year-to-date as at early August, however, the Asean region is seeing foreign inflows of US$9 billion.

“While this is still a fraction of the outflows, we can clearly see that there is a growth momentum picking up with economic reopening in Asean amid uncertainties in the region. We are positive that we will continue to see inflows coming back to Asean,” Neo adds.

The region’s long-term catalysts include its ample young and productive population; growing tourism; e-commerce and financial services penetration; development of electric vehicles (EVs); as well as the reshuffling of the global supply chains. “Given the US-China tensions, coupled with the strict lockdown in the latter’s major cities, corporates are recognising the need to diversify their supply chains. We expect some of this to come through from China to our part of the world,” says Wong.

Photo: Fidelity International Southeast Asia portfolio strategist Christopher Wong.

From risky assets to balanced diet

Asean equities used to be associated with risky assets. Plenty of companies did indeed fit that mould — especially when they took on copious amounts of US-dollar debt to fund growth — only to run into deep trouble when their local currencies plunged versus the dollar during the AFC of 1997 to 1998. Eastpring’s Hou explains that poor balance sheet management and government policies pre-financial crisis had led to a multi-year restructuring and gradual recovery of Asean economies since.

“Asean corporations previously had corporate governance issues that were inherent in many family-run listed businesses across the region, and the heavy reliance on foreign funding had caused huge volatility on the back of global flows. All these issues had led to declining weights in the MSCI index,” says Hou.

Meanwhile, the rise of China and India resulted in waning investor interest in the region over time. The lack of understanding of Asean markets further cemented the view that this region was “risky”, she adds.

“However, things are very different today. We see sound government policies, stable politics in most countries, improving corporate governance, lower reliance on foreign funding — these factors should reduce volatility in Asean equities’ returns,” says Hou.

Neo further points out that Asean has been able to evolve over time, and growth is more sustainable now compared to decades ago. “If I were to put it into context, Asean has gone through three phases. One is the ‘binge eating’ phase, which happened from 2008 to 2013. Thereafter the second phase started — the detox phase which involved tax reforms and recognising bad loans in the banking system from 2013 to 2017,” she says.

Neo adds: “Today, we are on a balanced diet, by virtue of the fact that we have gone through tough times and the building blocks are in place for Asean to deliver more sustainable growth.”

Fidelity’s Wong acknowledges that Asean markets are slightly more volatile in the short term compared to the broader Asian markets, and it has a smaller number of companies with large market caps compared to China and South Korea. However, from an investment perspective, the firm does not see it as risky, as it is viewing the individual equities based on their fundamentals.

“From that perspective, we’re finding quite good companies and stewards of capital in the region. If I extend it to an environment, social and governance perspective as well, Asean stands out, but there is definitely a lot of room for improvement. That’s where we’re also kind of sifting through, working with companies to improve their profiles as well,” says Wong.

As at end-July, the MSCI AC Asean Index is providing returns of –3.67%, –8.64%, –5.23%, –1.23% and 0.5% over the one-year, ytd, three-year, five-year and 10-year periods. As a comparison, the MSCI Emerging Markets is providing returns of –19.77%, 17.61%, 1.25%, 1.32% and 3.21% over the one-year, ytd, three-year, five-year and 10- year periods.

Photo: Eastspring Investments client portfolio manager Dalphin Hou

Financials still the preferred sector

Within Asean, Eastspring’s Hou prefers markets with large domestic economies like Indonesia and the Philippines, which should ride out the global demand downturn better than export-oriented Singapore, Thailand and Malaysia.

Fidelity’s Wong likes Indonesia for several reasons: good fundamentals, undemanding valuations and ongoing structural growth trends. Its rich commodities base gives it good growth exposure too. Nickel, for one, is seeing strong demand growth from EV makers. Indonesia produces one million metric tons per annum or 37% of the worldwide nickel production.

Singapore has not a single drop of oil or an ounce of precious metal that can be dug out from under its soil, but Wong likes Singapore too, given its cyclical inclination as undemanding valuations of a big part of the Singapore index. “Generally, the market pays quite a nice level of dividends as well,” says Wong.

JP Morgan’s Neo says the firm is more “constructive” towards structural growth markets such as Indonesia and Vietnam. Aside from its structural growth drivers, Indonesia also has low financial penetration, with three out of four in the population either unbanked or underbanked. “The Indonesian economy has transformed and [its President Joko Widodo] has done a very good job in that regard. From the infrastructure development since he first came on board, the country is now embarking on another plan which is to monetise its downstream,” she says.

“It is rich in natural resources but also building up the clean energy space which is in the EV supply chain segment — attracting the likes of Contemporary Amperex Technology Co and an LG Energy-led consortium which have announced a cumulative US$15 billion worth of investment to build the downstream economy,” Neo says. “Higher commodity prices have also led Indonesia to a current account surplus, something we have not seen over the past decade.”

On the other hand, the firm is more cautious towards markets like the Philippines as it is a twin-deficit country and an importer of major commodities, making it fiscally vulnerable to rising inflation. Malaysia is the other country the firm has structural underweight position on, due to its lack of compelling valuation opportunities, although there are pockets of strength, adds Neo.

JP Morgan continues to favour the Asean financial sector. In fact, 43% of the JP Morgan Asean Equity fund is allocated to the financial sector, followed by communication services (10.6%), industrials (8.9%) and real estate (8.3%). The fund’s top five holdings are DBS Group Holdings at 7.5%, Bank Central Asia (BCA) at 6.8%, Oversea-Chinese Banking Corp (OCBC) at 5.2%, Bank Rakyat Indonesia (BRI) at 4.1% and Sea at 4%.

Neo says that digital banking efforts are a key catalyst for banks in the region. For instance, BCA has leveraged technology as an enabler throughout the pandemic period — it came out with a super-app which has helped it to expand its customer base by nearly 40% over the past two years, while its Internet banking transaction value has exceeded the branch banking’s value.

“About 60% of the new customers are acquired digitally, with insignificant incremental costs. This helped the bank to improve the cost efficiency ratio, in turn lifting the return on equity improvement profile,” says Neo.

From their peak of around US$370 last October, Sea’s New York-quoted shares have lost around 80% of their value. Nevertheless, the way Neo sees it, the company, which owns the Shopee online shopping app and the Garena gaming platform, is a new-economy play in Asean which benefitted from the gaming boom during the pandemic. “Alongside the correction in the growth and technology names, the stock has corrected amid a reset of expectations to a more realistic level,” says Neo.

She points out that China’s digital economy already accounts for about 40% of its GDP, while in Asean, the digital economy’s share is still trending at less than 10%. E-commerce, on the other hand, accounts for 25% of China’s digital economy, while it is still single digit in Asean. JP Morgan continues to expect more long-term growth of Asean’s digital economy, says Neo.

Similarly, Fidelity’s Asean funds also have financial counters as its top five allocations — DBS (7.3%), BCA (5.2%), Sea (5%), United Overseas Bank or UOB (4.4%), and BRI (3.7%). However, the fund is currently favouring opportunities in consumer staples and healthcare sectors, where it holds key conviction positions.

One such holding is the Thai consumer value store (CVS) operator CP All, which operates the well-known 7-Eleven convenience store chain in Thailand and has about 80% market share in this segment — a substantial competitive moat for the business. Notwithstanding the pandemic-driven drop in tourism, the company has maintained a consistent pace of new store expansion since 2018 of over 700 stores per year and has indicated a similar path for 2022.

Its results for 1QFY2022 ended March reflects that the recovery in tourist footfall in Thailand has aided a same store sales growth of over 13% over this period. Fidelity believes that CP All has a long-duration growth profile as the CVS format remains supported by several factors, including rising urbanisation and increasing basket size with likely growth in private labels.

Eastspring prefers banks and remains selective on consumer staples. Its top holdings are UOB (8.1%), DBS (8%), Singapore Telecommunications (5.2%), OCBC (4.2%) and Keppel Corp (4%).

Photo: Bloomberg

Further outlook

Moving forward, JP Morgan believes that inflation in Asean would remain much lower compared to Western economies. Inflation risks continue to vary across Asean economies, with large net energy importers such as the Philippines being more exposed to energy inflation, while Vietnam and Thailand are more insulated from global food shocks due to high food self-sufficiency.

“The rise in inflation that we see in the West is essentially driven by labour wages, which is tight on top of the supply chain disruption and food inflation. In Asean, wheat is less of an issue compared to rice — in fact, 35% to 50% of our calorie intake is actually rice. Rice prices have not gone as high as wheat prices, keeping food inflation at a manageable level,” says Neo.

In terms of wage inflation, Neo highlights that some countries in Asean have already hiked its minimum wage. Malaysia, for instance, has increased the minimum wage by 25% to RM1,500 ($467) from RM1,200 previously. Similar measures have been seen in countries like the Philippines, while discussions on this issue are taking place in Thailand. “Certainly, the policymakers are aware of the need for wages to catch up with inflation, and they are putting measures in place for wage increase to ease the burden of inflationary pressure,” says Neo.

Hou says that Eastspring remains positive on the long-term outlook for the Asean economies, given the region’s healthy macroeconomic fundamentals. She points out that most Asean countries are likely to see stronger GDP growth in 2022 — with the exception of Singapore — driven by the reopening boost.

“However, we expect continued volatility in the short term due to rising inflation, interest rates and slowing global growth. Notwithstanding this, banks in this region are generally expected to benefit from the rise in interest rates,” she says.

Hou adds: “We remain mindful of market volatility during periods of risk aversion and will continue to monitor the macro situation while maintaining our bottom-up, valuation-driven investment approach. We view any sharp market correction as an opportunity to accumulate fundamentally strong companies at more attractive valuations.”