Early in the new millennium I was in talks with a global bank about becoming an Asia equity strategist. I was between jobs — modern-speak for “recently fired” — so I grabbed every investment book on the region I could find and flew to Chamonix for a month to cram like mad while learning to ski.
A dozen of these tomes are on my shelves to this day. They all have similar titles. Asia’s new century. The rise of Asia. Lots of dragons on covers, roaring with opportunity.
One of the most bullish was Tomorrow’s Gold — Asia’s Age of Discovery. Its author, Marc Faber, had worked in Hong Kong half his life and the book was published by a local stockbroking firm. Naturally, Faber banged the table. But his rosy outlook was commonplace in 2002, especially as western markets were still reeling from the collapse of the dot.com era. Developed nations are screwed, most arguments began, economic growth is heading east, and prices are cheap following the Asia crisis. Buy! Buy! Buy!
As ever, some things occurred as prophesied, others did not. Asia did indeed expand at a breakneck pace during the noughties, helped massively by China’s inclusion in the World Trade Organisation. Stocks soared, though total returns for US and even global share indices are superior over the past 20 years. And therein lies an important lesson for new equity investors. Do not confuse growth and revenues or even profits with returns. What ultimately affects the latter is whether companies care about shareholders. It also helps if politicians and regulators make it easy to do so.
You would have quintupled your money in dollar terms if you’d listened to Faber and purchased an Asia-ex Japan fund two decades ago. But a bog-standard global equity fund performed just as well and you would have made another 90 per cent in the S&P 500. I learned the hard way during my years managing Japanese equity portfolios. Company bosses were obsessed with market share, quality, innovation, culture and hard work. All goals worthy of our respect. But did they sleep at night dreaming about returns on my equity — no they did not, domo arigato.
They barely mentioned them when awake. And it’s the same for most Asian management teams I’ve encountered over the years. This is changing, of course, as modern shareholder-orientated approaches to business spread around the world — though local commercial and political environments matter hugely.
And paying lip service to returns on equity (I once did a fortnight trip to Asia where every company I met had the same 10 per cent target) is different to maximising shareholder returns in practice. Indeed, the major bull case for Asian stocks today remains the hope that managers finally start caring about the owners of their equity.
Which brings us to my holding in the iShares Pacific ex Japan Index. It’s a 12 per cent slice of my savings, as you can see in the table. I moved out of cash into the fund on January 5 last year, mostly based on expectations of corporate change, but maybe too because I had just started working at HSBC and someone in human resources implanted a pro-Asia chip in my head. Whatever the reason, I haven’t lost money thank goodness — if you ignore inflation, performance is flat. But for reference the UK fund I bought on the same date is up more than a fifth.
What to do with the fund now? It is a good time to ask as signs that China is loosening its strict Covid policy have nudged Asia-ex-Japan stocks up a bit recently. It’s also useful that many economists reckon the US interest rate cycle may not be as ugly as feared — though this week’s stronger-than-expected services data are now testing that view. Emerging market shares tend to struggle when Uncle Sam tightens monetary policy hard. Sure, Asia is cheaper than many western stock markets — but this hasn’t helped much in the past. How much of a discount is enough, then?
I’m comfortable with the fact I can buy Asia ex-Japan earnings at least a quarter cheaper than US earnings. Indeed, the top 10 biggest companies in the region are half the price of the 10 biggest US names on an earnings basis. That has been helped by the Asian ex-Japan index becoming less concentrated since 2020 — a healthy development. Also, on both price to book and price to sales ratios, there is a 50 per cent discount in owning the assets of Asia ex-Japan firms versus their US peers, as well as the revenues generated by those assets.
Meanwhile, the dividend yield on both is about the same — not that I care as I won’t be needing an income from my portfolio for a while yet. In fact, the region’s double-digit annual dividend growth during the past dozen years has been superior to everywhere in the world save Latin America. More important from a valuation point of view (high or low dividends do not affect the worth of a company in theory) Sahil Mahtani, a strategist from asset manager Ninety One, notes that Asia-ex Japan stocks now have a higher free cashflow yield than US and European ones.
This is due in part to them having more spending discipline these days — particularly when it comes to capital expenditure. Which harks back to my point earlier about bosses caring about shareholders. Being relatively cheap versus developed markets has never been enough to guarantee Asia ex-Japan will outperform for prolonged periods. I’ve heard that pitch too many times over the decades. But attractive valuations plus a sense that Asian businesses are finally being run for the benefit of those of us who own them?
That’s an attractive combo for me — I’m going to keep my fund a while longer I reckon, dragons or no dragons.