U.S. institutional investors are on the hunt for new opportunities to diversify their portfolios, and they’ve started looking toward Asia. Spurred by opportunities from the Inflation Reduction Act, CHIPS and Science Act and, oddly, inflation, the opportunity set within Asia is shifting and looks relatively cheap compared to domestic markets.
Asian market performance was somewhat mixed in 2023. The MSCI AC Asia Pacific Index rose 11.9%, driven by gains in Japan, Taiwan, South Korea, India and Vietnam. However, China, Hong Kong and Thailand saw losses, as China continues to struggle to rebound from its lengthy COVID-19 shutdown and lingering trouble in the real estate sector.
Based on the year’s first quarter so far, some trends that started last year appear to be continuing: Japanese equities are on the rise, India continues to grow, and there are pockets of opportunity in countries like Vietnam. Asian strategists for J.P. Morgan Private Bank said in a recent research note that 2024 could prove to be a key transitional year across the region, solidifying new investment trends that could carry into 2025 and beyond.
“Over the longer term, ongoing shifts in global trade flows that diversify out of China can continue to benefit the region’s economy through increased foreign direct investment (FDI) and gains in global export market share, particularly for some Southeast Asian economies like Vietnam and Indonesia,” the note stated.
Japan’s Tech Hopes
After the past two years, it may seem counterintuitive to believe that inflation could be a net benefit anywhere, but it is in Japan, where wage and price hikes are contributing positively to economic growth following a prolonged period of disinflation.
“Inflation is giving the government room to end its yield curve control policies and negative interest rate policy, which is a healthy form of normalization,” says Matt Bank a partner, head of client strategy and deputy CIO at $11 billion Global Endowment Management LP, a company that provides outsourced CIO services. “They’re also working on governance reforms with new regulations on the stock exchanges themselves and putting new rules in place around corporate takeovers and capital discipline. That could potentially shake loose some of the trapped cash and suboptimal capital allocation ownership structures that Japanese corporates have been known for.”
GEM’s outlook for Japan is quick to note that even if the reforms hold, Japan still has an aging population and very limited immigration, which could ultimately dim growth prospects. However, normalizing inflation could change consumer behavior in the country, and there are some corporate tailwinds.
“Entrenched corporate management has recognized that in a lot of cases, it has to yield to opportunities that are good for shareholders,” Bank says. “So what we’ve done is prioritize not just going long Japanese beta, passively, but really trying to find targeted active opportunities—looking for companies that can benefit from corporate reform and maybe agitate a little bit for that reform.”
It does look like those regulations are having some impact. The Nikkei 225 Index hit the 40,000 mark for the first time on March 4—a key psychological number for traders and investors. It may take some time for investors to get comfortable, however; Japan has a history of peaks followed by long, long troughs. The “Koizumi Rally” (named for the country’s prime minister at the time, Junichiro Koizumi) from 2003 to 07 and subsequent fall gave some investors battle scars they are not likely to forget.
The Nikkei’s recent performance has been driven by Japanese semiconductor stocks, and the Nikkei has also announced it plans to launch a market-value-weighted semiconductor stock index later this month, underscoring the importance of these stocks.
Alison Adams, a managing principal and research consultant at Meketa Investment Group, notes that these companies have been working in recent years to improve their technology and may now be poised for some opportunities in the U.S.
“We are seeing more of these re-emerging trade blocs come into play,” she explains. “Specifically, Japan, which is a U.S. ally, has some favorable tech tailwinds, from an investment perspective, that it didn’t have before the Inflation Reduction Act or the CHIPS Act. Rather than having investments based on GDP, Japanese companies are in the sweet spot for investors looking at opportunities in artificial intelligence and other emerging technologies.”
India Seeks More of ‘Global Outsourcing Pie’
India was another standout performer in 2023. The BSE Sensex and the Nifty 50 each closed out 2023 up at least 18%. India’s GDP also finished the year with an increase of 8.4% in the final quarter. India’s 2024 elections are also likely to offer a measure of consistency in the country’s leadership, which investors typically like. Prime Minister Narendra Modi is campaigning on an economic policy called “Viksit Bharat 2047,” intended to make India a fully developed country by 2047, 100 years after its independence.
Peeyush Mittal, a portfolio manager at Matthews Asia who manages the firm’s India strategy and co-manages the emerging markets equity, emerging markets ex-China, Asia growth and Pacific Tiger strategies, notes that the Indian stock market offers investors a fairly diverse opportunity set.
“There are approximately 6,000 companies listed across many sectors and sub-sectors, which is unlike some of the larger emerging markets like Brazil, which is still very commodities heavy, or Russia, which is very energy heavy,” he explains. “So there are a lot of opportunities for investors to explore different themes or strategies within the Indian market.”
Mittal anticipates that GDP growth is likely to continue, which would be supportive to stocks. “India is becoming a bigger part of the global outsourcing pie,” he says. “GDP growth should remain, at the very least, at 6%, which is still a very healthy number. If you’re adding 4% to 5% from inflation, the resulting nominal GDP growth is 10% to 11%.”
Mittal adds that the opportunity set could expand over the long term. “If you look at sectors like autos or aerospace, these are long-gestation orders,” he says. “Once a company decides to do something, from the time it makes the decision to finding a qualifying supplier in India, the lead time is two to four years or longer. What that means is there are active management opportunities, because those transactions are not immediately obvious in the numbers, and once they become obvious, then you’ll see more upside in the stock price over time. We see similar opportunities in manufacturing and renewable energy, where there is a lot of focus from the government.”
Has China Left Door Open for Others?
As China continues to struggle, other countries like Vietnam, South Korea and Taiwan are poised to benefit. All three countries performed well last year. Taiwan’s Taiex, for example, gained more than 24%, the biggest increase on record. Growth in the Taiex was driven by semiconductors and is likely to continue this year. Companies in these countries could also follow Japan by taking advantage of some of the opportunities available through the CHIPS Act.
“China is on the back foot at the moment because the IRA and CHIPS are actually precluding some Chinese companies from competing,” says Meketa’s Adams. “Which is another tailwind for Japan and a reverse of the past two decades.”
The outcomes are already showing up in the data: “China’s own statistics for foreign direct investment were the worst on record in 2023,” Adams says. “So we’re seeing that money being put to work elsewhere in the [Association of Southeast Asian Nations] countries. I think these dynamics will continue to flow through to longer-term asset allocation decisions.”
Adams notes that some allocators could be using this moment to look at other opportunities in Asia, in part because of new pressure coming from regulators and the U.S. government to limit investment in China as a result of security concerns. She is working with clients on understanding where they are already exposed to the country so they can make informed decisions going forward.
“If we look at our client portfolios in aggregate, the total direct exposure is approximately 5%,” Adams says. “So exposure to China is not as big as corporate revenue exposure is to China, for example. There are a lot of things in favor of investing in China: It’s the second largest economy in the world. It’s got first-world, first-rate companies. There’s a lot of technology and know-how and a vibrant consumer class in China, but there are other things that make it a challenge. So rather than having a best thesis around China, we’re actually working with our clients to understand direct, indirect and exposures to China and helping them be comfortable with that, with those risks and those opportunities.”
GEM’s Bank seconds the risk issues for some allocators, but he also notes that China is so unloved by investors right now that equities there are relatively cheap and could provide unique pockets of opportunity.
“We, like everybody, don’t necessarily want to be long China,” he explains. “What China is, for us, is a very good stock picking market. There’s a lot of dispersion there—a lot of liquid, public companies. A lot of variability in outcomes, cross-sectional volatility, however you want to measure it. It’s one of the few markets in the world where active management has added value over time and relatively consistently. GEM likes long/short strategies there but will invest with long-only managers willing to dial up or down net exposures. “We want to play the dispersion in China and, ideally, stay as liquid as we can, because then you have the opportunity to change your mind and move in or out.”
Tags: Alison Adams, Asia, China, Global Endowment Management LP, Hong Kong, India, Indonesia, Japan, Matt Bank, Matthews Asia, Meketa Investment Group, Peeyush Mittal, South Korea, Taiwan, Thailand, Vietnam