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October 27, 2021

4 Things companies get wrong when embarking on the digital transformation journey

Marietjie Geldenhuys, Senior Analyst at Stonehage Fleming Investment Management South Africa

With its resilient economies, growing middle class and technological innovation, Asia is continuing its leadership in driving global growth.[1] A recent study by Credit Suisse indicates that although there are over one billion people in Asia who live in poverty, these individuals are already spending over US$2 trillion annually on basic goods and services[2]. In the coming decade, the geographic patterns of consumption and the income levels in Asia are expected to change rapidly.

In 2000, Asia represented just under one-third of global GDP (in terms of purchasing power parity), and is on track to exceed 50% by 2040.[3] It emerged from the pandemic ahead of the west and is showing buoyant earnings growth as well as equity valuations that appear reasonable. The region’s fixed income market also offers differentiated return characteristics.

For investors with a long term investment horizon, seeking access to structural growth opportunities and diversification, we believe a dedicated allocation to Asia will deliver robust performance. 

The continent is still underrepresented in both global equity and bond benchmarks, despite the region’s strong economic and demographic trends[4]. Emerging Asia’s share of the world economy is approximately 24% today, but makes up only 10% of global equity market index and 3% of the bond counterpart[5]. Many investors use these indices as benchmarks, and as a result have significantly lower exposure than a simple analysis of the region’s share of the global economy would suggest. Active managers who are not constrained by a specific benchmark can capture these opportunities by allocating capital to the distinct structural growth drivers in Asia. 

Interestingly, the Asian bond market has rapidly expanded in recent years. It offers many opportunities for investors to increase yields and diversify existing holdings. For example, the Chinese onshore bond market is now the second largest bond market in the world (behind the US) and continues to grow at a strong pace. The China 10-year yield is currently 2.9%, compared to 1.6%in the US and negative in many European countries. 

For foreign investors, the opportunity is clear. In addition to lower interest rate sensitivity and correlation to global equities, China government bonds offer higher yields compared to traditional counterparts.  In recent years, global companies and governments have become more comfortable using the renminbi (RMB) to conduct international transactions. This rising demand for the Chinese currency may also help RMB-denominated bonds to appreciate in value for foreign investors.

A longer term theme coming to the forefront in Asia is the transformation to a more green economy, powered by China’s carbon-neutral pledge. Producing more than 70% of all photovoltaic panels, half of the world’s electric vehicles, and a third of its wind power, Asia is already a global leader in renewable energy.[6] The sector will be boosted by the government’s intention to reach carbon neutrality by 2060.

With equity valuations elevated in some countries, especially the US, investors need to look further afield for investment opportunities. At Stonehage Fleming, a main rotation we are currently implementing for clients is from large cap US equities to Asian equities. 

The Asian opportunity is a long term theme, linked to compelling growth areas – the digitisation of the economy (a theme accelerated by the pandemic), sustainability (accelerated by net-zero carbon emission targets) and the evolving consumer market in Asia. We believe that the rotation to Asia should be a key element of an investor’s equity strategy.

Over the past few months we have witnessed a series of regulatory changes from the Chinese government. These regulations are mainly aimed at addressing social inequality, false advertising, unfair competition, data protection, and the disorderly expansion of capital. 

Regulations and reforms have always been part of the growth path in China, with Xi Jinping emphasising common prosperity, deleveraging, and supply-side reforms aimed at reducing economic and financial risks.  Chinese shares have sold down significantly as the markets discount the potential negative impact of these changes as well as the nation’s lower growth expectations. As such, current valuations might provide a good opportunity to increase exposure, especially for investors who are meaningfully underweight Chinese equities. 

Ultimately, we believe that it is the Chinese Communist Party’s continued intention to grow the economy, protect the interests of international investors and to nurture the functioning of the private sector[7].

Our expectation is that over time, the Asian investment universe will become an ever deeper pool of rich alpha opportunities, full of quality companies that focus on sustainable returns that compound over time. 

As the current business cycle progresses from the ‘relief rally’ of the past year into a more typical ‘mid-cycle’ phase, it raises the likelihood of shorter term volatility and increasing divergence of the winners and losers at a country, sector and company level. We therefore believe that a regional specialist manager with an established active investment approach, will perform best in this region.

Sources

[1] The unprecedented expansion of the global middle class – The Brookings Institution, January 2020. 

2 https://www.credit-suisse.com/sg/en/private-banking/invest-with-impact/solutions-for-your-goals/unlocking-the-untapped-opportunity-in-asia-through-impact-invest.html

3 https://www.mckinsey.com/featured-insights/asia-pacific/asias-future-is-now

4 https://digital.citywire.co.uk/why-invest-in-asia/p/1?utm_source=campaignpage_en&utm_medium=affiliate&utm_campaign=asia2021&utm_content=infographicpageEN

5 https://am.pictet/en/why-invest-in-asia?Languages=/en/why-invest-in-asia

6 https://www.ft.com/content/a37d0ddf-8fb1-4b47-9fba-7ebde29fc510

7 https://www.wsj.com/articles/china-moves-to-reassure-global-banks-and-investors-after-market-rout-11627528509?mod=e2tw

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