China: Down but not out
China, which started off 2023 with all the whizz bang of New Year fireworks, has had its powder...
Charles Bond, a fund manager on the Invesco Asian equity team, talks to us about the outlook for Asia in this week’s interview. He tells us which markets are cheap, explains why South Korean pensioners are helping to improve governance, and why some dividends have been growing faster than the market. Charles also discusses the Chinese market, giving us four reasons why Chinese equities have lost their shine, but also reasons as to why the team believes the market is still investable. He goes on to explain the challenges of investing in the Australian market, and wraps up with an in-depth view on emerging Asia, flagging Indonesia as a market full of promise.
Please Note: Below is a transcript of the video, modified for your reading pleasure. Please check the corresponding video before quoting in print, as it may contain small errors.
I’m Sam Slator from FundCalibre, and today I’ve been joined by Charlie Bond, who’s a fund manager on the Invesco Asian equity team. Thanks for joining us this morning, Charlie
Charles Bond (CB):
So, maybe we can start with something that the team said a few months ago, that Asian equity markets are actually trading on their biggest discount to world markets in over a decade. Is that still the case? And if so, which markets are actually better value than others?
[00:28] Yes. Well, the answer to your question is yes, and probably Asian markets are on an even bigger discount today than they were on, about a year ago. So, I suppose that just shows that just because something’s on discount, it doesn’t necessarily mean it’s going to revert back to mean. But I suppose in the long run, we feel that you are better off investing in cheaper assets – in lower-valued assets – and certainly in Asia, you can get those today.
So, the area of the market we’d highlight as being, you know, particularly lowly valued, would be South Korea, where the market trades on a discount to book value, which is pretty rare for a whole market to trade at discount to its book. So, we are overweight South Korea, and we have been for a number of years.
I suppose there are a number of reasons why it’s cheap. First, is that it’s a pretty cyclical market. There’s a lot of heavy industries in the Korean market. Perceptions about governance are that it’s a lower quality place for equity investors. And payout ratios [are] typically a bit lower than the rest of Asia.
But I suppose the things that we feel attracted to are … in a way we quite like the cyclicality, because we feel like cyclicality gives us an opportunity to invest when people are being very pessimistic. And that typically leads to share prices trading meaningfully below their value. And that’s when we like to be investing. So, the cyclicality, we don’t necessarily see the problem, in fact [it’s] potentially an advantage.
And on the sort of structural side, we think there are gradual improvements going on. On governance, we would point to the National Pension Service [National Pension Service of Korea, a public pension fund in South Korea], you know, increasingly owning more and more of the stock market. And that helps because, you know, as a minority, historically, you might have found it very hard to encourage Korean companies to act in your best interests. But when you have pensioners, domestic Korean pensioners on your side as well, the arguments become a lot stronger against anything the company might want to do to dilute you, for example. So that’s a big positive, and that’s improving governance, we think, across the board.
And payout ratios are gradually rising. Samsung Electronics really has been the trailblazer on this and has grown the dividend very strongly over the years. But … and that’s the thing we would focus on, which is dividend growth. So, when you look at the dividend per share of the Korean stock market, it’s actually grown faster than Asia as a whole, over the last 10 years. So, I think it’;s compounded at about 12% over the last 10 years, which is really very impressive. And we think that’s almost more important than the payout ratio because it&’s the dividend per share that you get. And of course, if stocks are on very low multiples, then yields are actually very high too. So, I think the average yield of Korean stocks in the Asian fund is nearly 5% at the moment. So, that’s very supportive to our mind. So yeah, South Korea has been a longstanding overweight of the fund, and we’re sticking with it.
And the biggest market in the region is obviously China, which has had its problems over the last couple of years. We’ve also got the leader who is now staying on for another five years, perhaps longer. As a market, is it investable now or is it actually a value trap?
[04:26] Yeah, it’s kind of amazing to us how perceptions of a market can change so dramatically over pretty short periods of time, frankly. It was only Q1 last year that the Chinese equity market was performing incredibly strongly. People were pointing to new internet companies and technology companies that were trailblazers in their field, that were going to grow for decades to come. And really, people were talking about allocating specifically to China, because they wanted to identify specific growth areas.
And fast forward to today, and really the investor appetites are complete[ly] despair[ing] and people don’t want to really invest in China, frankly, because of a number of different things. So, we have always felt that China is investable. And that view hasn’t changed. We would argue that today, the prospective future returns are much better because valuations have fallen so much. And so, that’s led us to actually significantly close our underweight over the last 12 months in China. So, we feel, in a way, we quite like this term ‘uninvestable’ because it’s giving us an opportunity to buy stocks below intrinsic value. We think that as the market gradually rises, that that term will go away, and people will come back to China.
But, you know, there are clear reasons why Chinese equities [have] done poorly. And we shouldn’t sort of diminish those. You know, we point to four [reasons] – and there are sort of three that we think are transitory, and one that’s sort of a bit more complicated.
The first two are the property market and the internet sector. You know, there’s been a lot of regulation on both of those areas, and we feel like we are coming into the back end now of regulation in those two sectors.
Just recently in internet, we’ve seen, you know, quite warm words from the government about new game approvals, for example. We’ve seen a fine for Ant Financial, AliBaba’s financial subsidiary [Ant Group, formerly known as Ant Financial, an affiliate company of Chinese conglomerate Alibaba Group]. And these are the kinds of things you typically see at the end of a period of regulatory crackdown. So, we feel like we’re through the worst on tech regulation.
On the property market, it feels a bit harder because the sector’s still heavily leveraged and there’s been a long cycle effectively. But just last week we’re starting to see support for the biggest developers in the country, namely through loans from state-owned banks. So, the tight liquidity we’ve seen in the Chinese property market has really been a product of what the government have wanted to do, ie. encourage people to live in houses, not invest in them, and so it’s almost like a self-inflicted tightening of the property market, which we think now the government is slowly reversing on. So, that’s very helpful.
The third one is, you know, zero tolerance on new infections. And we’re starting to see gradual loosening of that. We don’t want to speak too soon, but it looks to us as though the government are gradually loosening restrictions. And by, we’d say at some point next year, we think that the economy will be back to operating in a normal phase. You know, we basically don’t believe the current policy prescription is the right one or remotely sustainable. So, that’s an additional positive to occur.
And the final sort of negative that’s causing this big discount in China is cross rate relations, so, relations with Taiwan. We don’t really think we can add a lot of new analysis on this topic, to be honest. But we basically feel that the status quo is likely to remain in place. We think the status quo serves both sides well. And China’s economy is so deeply embedded in the global economy, that the kinds of sanctions that could be brought upon them, could be completely devastating. And so, I think the Chinese government are more likely to try to find a solution that isn’t military; of course, people will point straight to the Russia example, and there’s no way of us sort of disproving that as a potential outcome. But we feel that it’s different with China. So, we think the status quo can remain in place.
So, we’re not sort of looking for catalysts per se, but we basically think that over the next 12 to 24 months, things will gradually improve, given how much bad news we think is baked into equity prices.
So, when you look at the price to book of the China market, it’s down near one times book, a bit of a premium to book value, which is, … it’s only really traded there before during the GFC [Global Financial Crisis] and in the currency devaluation of 2015. So, these are what we think are probably trough valuation levels for Chinese equities.
And looking at the Invesco Asian fund now, about 10% is invested in Australia. Is that usual for the fund, or are you preferring developed over developing Asia markets at the moment?
[10:35] Yeah, it’s pretty normal to have some of the fund in Australia. So, Australia is in the benchmark for the fund. And we’ve historically been underweight Australia over time. And the reason for that is that it trades at a premium to other Asian markets. There’s a very good reason why it trades at a premium. It’s not just you know, perceptions about better governance perhaps, but it’s to do with tax relief on dividends. So, domestic Australian investors receive dividends gross of tax. Foreign investors like us, receive them net of tax. And so, effectively the yield on an Australian share is higher for an Australian domestic investor than it is for a foreign investor. So, equities are a big part of allocations for domestic Australian institutions, and have been for a long time. It serves them well, but it’s sort of less attractive for the foreign investor. We do like having Australia in the benchmark as a place to invest, you know; the broader, the better, basically is our feeling.
And you can sort of split Australia into three chunks. There’s a big component that’s banks and financials; then there’s a quite a large component that’s commodity-related companies; and then there’s the rest effectively.
When you look at the financials and the rest, they typically trade on premia. But commodity companies is where we’ve typically found our ideas over the years. And that’s partly because of where that some of them sit on the cost curve, so you can get some high quality assets in the Australian market. And again, this thing about cyclicality; I think Australian investors are looking to diversify away from cyclicality. And so, commodity companies tend to be a bit more volatile which, which has given us opportunities over the years. So, at the moment, we own a couple of commodity producers in Australia, an oil company and a gold miner. So, we like the diversification it offers, but we’ve struggled to be overweight Australia for many years.
And what about emerging Asia? What are the longer-term prospects there?
[13:07] Well, it feels very much like countries like India and Indonesia have been…they’ve been places to hide, frankly, for investors in the last 12 months. Investors are, you know, … it’s easy to see a very long growth runway for these countries. So, people have tended to hide in those markets when there’s been volatility.
With India specifically, we’ve struggled to find new ideas because the market now trades on a pretty big premium to historic valuation levels. So, I think it’s two standard deviations above its average valuation for the last 15 years or so. You know, that’s in stark contrast to Korea and China, which are at big discounts. So, we haven’t been adding to India, in fact, we’ve been using it as a funding source of late. But we’re not likely to reduce much more, I would say. And that’s because there’s a lot of high-quality companies [in] India and we don’t want to lose sight of the potential growth opportunities there. So, we still have a few stocks invested in India but we’re not looking to add new names at this point.
The other market I point to is Indonesia, which has been another area of inflow from foreign investors over the last 12 months. And that’s really a beneficiary of high commodity prices. So, we are actually overweight in Indonesia, and we feel that there’s quite a lot of pent-up demand in the economy you know, a lot of economic potential that’s not been realised. So, a good anecdote would be that car sales in Indonesia haven’t grown for 10 years, which is very surprising; in an economy that should be growing at 5-6% per annum, you’d expect car sales to be growing at that rate, or possibly even faster than that. And they haven’t grown in 10 years. So, we think that’s a sign that the economy’s been underperforming you know, under-achieving, and so high commodity prices could be the thing that unlock a bit of potential – a bit of faster growth – in the coming years.
The other thing we like is that there’s a lot of infrastructure spending being planned in Indonesia. They’re hoping to build a new capital city, which is pretty ambitious. But you know, they’re the kinds of things that could get things going. So, we are overweight Indonesia; it’s not a big part of the fund but we’ve been finding new ideas there.
Perhaps you could end with just an example of one of the stocks that you like, please?
[16:02] Yeah. Well, I’ll stick with Indonesia and talk about the cement sector. So again, this isn’t a sexy part of [the] market. Cement companies are very much old economy. Interestingly, in Indonesia, there is a strong perception around brand; people actually think of it as a branded product. But the reason why we’re interested in the cement sector, is that there’s been a kind of classic capital cycle where there has been over-build and now we’re in a period where there’s over-capacity.
And what’s happening is that over-capacity is leading to a reduction in capital spending, and we think that that will lead to pricing power for the companies that remain. So, if you were to rewind five or seven years, there was a lot of new capacity coming in from the Chinese and from other foreign cement companies. And that’s driven utilisations down to somewhere in the sixties – 60% range, which has really hurt pricing power for the incumbents. But there’s now a moratorium on new supply, which means that if you can stay in business at this point, at these price points, then you are likely to reap the rewards later on.
And there are two companies that are listed – two large caps – that are listed in Indonesia that have got between them 70% market share. Both have got good balance sheets and are likely to remain in business, we think. And today you can buy their shares on below replacement costs. In other words, it’s cheaper to buy the shares, than it is to go and build new capacity. So, to us, it’s a complete no-brainer that a company which has got an existing brand, which has got all the licenses, permits, existing infrastructure and good balance sheets, you can buy those companies or a share of them for a discount to build a new capacity. So, that’s a new idea in the fund. And it’s contrarian, because the stocks have done really badly, they were down 70% or so over the last 12 months, pardon me, three years I should say. So, that’s probably the latest new idea in the fund.
That’s really interesting. Thank you very much.
And if you’d like to find out more about the Invesco Asian fund, please go to FundCalibre.com.
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