First Sentier Investors

2023 has not been for the faint-hearted. The euphoric mood from China’s post-Covid reopening that highlighted the start of 2023 revealed its alter ego as the year progressed with a series of turbulent events, such as the regional banking crisis and Israel Hamas war. Adding to that, markets were dealt a challenging hand — the persistent increase in US rates, a struggling Chinese property sector as well as China’s economic slowdown.
 

Asia’s long-term outlook

China’s policies have been turning highly accommodative. By allowing budget deficit to widen to above 3%, it is a very strong indication of China’s commitment to prop up growth. However, despite the political commitment to stabilise growth in China, the multilayered problems causing China’s slowdown means that it is unlikely we will see a quick recovery. The property sector and weak consumer sentiment remains to be addressed. The actual gross domestic product (GDP) numbers and pre-sales in the property sector will need to pick up on a sustained basis before market confidence can be restored. That said, First Sentier Investors’ Asian Fixed Income team (“the team”) believes that the Chinese economy will emerge much stronger from this consolidation process and maintains a positive long-term outlook for the economy.

Asian economies have been resilient thus far, but effects from China’s slowdown cannot be ignored. The growth outlook in Asia is showing signs of weakness especially for exports-oriented countries including Singapore, South Korea and Taiwan. Caused not only by China’s slowdown, but it is also a reflection of the lackluster demand from developed economies. Within the Asian region, countries with a stronger domestic story, such as India and Indonesia would likely fare better. Against this weakening external backdrop, most Asian central banks have paused rate hikes as inflation moderated and shifted attention to supporting growth. The team remains constructive on the region’s longer-term growth prospects as Asian economies continue to move up the value chain in the global economy.

Are we at the end of the rate hike cycle?

Entering 2024, the First Sentier Investors’ (FSI) Asian Fixed Income team expects global growth, in aggregate, to be slower compared to 2023. As savings run dry, jobless claims on the rise and retail sales weaken, the team is beginning to see the sobering reality of an economy under strain due to the prolonged high interest rate and high inflationary environment. The Federal Reserve (Fed) will most likely adopt a wait-and-see approach over the next few months before deciding on their next move. Barring a reacceleration of inflation in 2024, the team believes we should be at the end of the current rate hike cycle.

Positioning with a long-duration strategy

With the end of the rate hike cycle looming on the horizon, investors could consider a long-duration fixed income strategy. This strategy could be particularly attractive in a low interest rate or rate-cutting environment, as longer duration bonds may offer higher yields than shorter duration bonds.

What is fixed income and the relationship to interest rates? 

Fixed income or bonds are a type of debt security that represents a loan made by an investor to a borrower, typically a corporation or government entity. In other words, a bond is a loan issued by the borrower (issuer) and purchased by the lender (investor). In return, the borrower promises to pay regular interest payments at an agreed rate (also known as the coupon rate) and to repay the capital at the maturity of the loan.

Bonds are priced to reflect the value of its income or coupon payments in relative to the prevailing interest rates. When interest rates are falling, bonds that offer a higher yield would become more valuable and fetch a premium on the secondary market. Generally, fixed income has an inverse relationship with interest rates. When interest rates go down, bond prices will go up, and when interest rates down up, bond prices will do down. 

Why a long-duration strategy? 

In simple terms, duration measures a bond’s sensitivity to changes in interest rates. The longer a bond’s duration, the more its value will fall as interest rate rise. In other words, a long-duration strategy is an investment strategy where investors buy bonds with a high duration value, and a long runway before reaching maturity. This would provide greater exposure to interest rate risks and potentially a higher yield. The strategy could work well as we anticipate interest rates to fall in the near term. 

Investment-grade (IG) VS high yield (HY) bonds 

Besides interest risk, investors should be aware of credit risk too. Not all bonds are the same as not all issuers are the same. Credit risk for a bond is the risk of the issuer defaulting on its debt obligation.

IG bonds are bonds issued by companies or governments that have good credit ratings. In other words, they are considered a to have a minimal to moderate chance of defaulting. HY bonds on the other hand, are by issuers that are considered to have a substantial to high chance of defaulting.

These credit ratings are assigned by external credit rating agencies and the most significant firms in the market are Standard & Poor’s (S&P), Moody’s and Fitch. They will screen the bond universe and carry out detailed research to decide which are IG or HY bonds. To qualify as an IG bond, the credit rating must have a rating of BBB- and above. Anything below that will be considered a HY bond.

IG bonds are considered to be less risky than HY bonds but usually deliver lower returns. HY bonds typically deliver higher returns but with more risk. Also, some of the HY bond issuers would offer to play higher coupons to compensate for the credit risk associated with their debt. 

With the recent headlines on Chinese property developers defaulting, it serves as a sobering reminder on the importance of the credit rating and quality of the issuers. It may be a good idea for investors to err on the side of caution and consider IG bonds over HY bonds depending on their risk appetite. 

Navigating the uncertainty with quality 

Investing in Asia’s dynamic market comes with an evolving set of challenges and opportunities. Despite all the recent headwinds, FSSA Investment Managers, FSI’s Asian equities specialist team, sees an attractive opportunity set in the unique market. They have been impressed with the improving quality of companies and management over the years.

FSSA has a strong focus on quality as they believe only quality companies that are backed by strong management teams will emerge stronger after crises. This has been tested time and time again through the team’s experience of more than 30 years investing in Asia. 

Asian equities: 2024 investment themes

FSSA believes that the structural growth drivers for Asia are still intact despite the pessimism in the market. With an emerging middle-class, and improving corporate governance, below are some of the long-term investment themes. 

• Dominant consumer franchises

With favourable demographics and populations that are still growing – particularly in Southeast Asia and India – FSSA believes dominant consumer franchises can offer good growth potential over the long term. These dominant franchises will keep gaining market share as the markets formalise and premiumise over time. 

• Rise in healthcare spending

Many Asian countries are under-invested in healthcare compared to the global average. As these economies become richer and population increase, FSSA expects healthcare and health-related spending to rise. 

• High quality financials

FSSA believes banks and high-quality financials should benefit from similar drivers as consumer businesses: demographics, rising incomes and urbanisation. Well-managed banks should continue to benefit from greater penetration of financial services across the region. 

• A more connected and automated world

As the world embraces a digital future, FSSA believes Asian technology firms should benefit from strong end demand and a growing market. At the same time, lower-cost robots will allow manufacturers to automate their processes.

Spotlight: India’s resurgence

India recently overtook Hong Kong to become the fourth largest stock market in the world. However, unbeknownst to most, established in 1875, India’s Bombay Stock Exchange is the oldest stock market in Asia. The culture of entrepreneurship, and the ability to deal with the opportunities and challenges that come with being a public listed company, has been in place for many decades. As a result, there is an abundance of family-owned business that are listed. It is not uncommon for a public company in India to have more than 50 years of listed history and is now being managed by the third or fourth generation of family members. 

The sheer scale of India’s population (1.4 billion people)¹ and the still nascent stage of several industries in the country means that the market leaders are quite small in comparison to regional and global peers. For example, per the International Energy Agency (IEA), it is estimated that China has 860 million air conditioners installed versus around 80 million in India (2023 figures). ² The top three listed air conditioner manufacturers in China have a combined market capitalisation of USD 105bn (as at January 2024), whereas the top listed companies in India are tiny in comparison –for example, a leading player with 13% industry market share, has a market cap of just USD 2.6bn. 

As bottom-up investors, this presents an attractive opportunity to discover hidden gems who could be long-term winners early and enjoy the growth potential they have to offer. Coupled with an improving corporate governance and shareholder protection, the Indian subcontinent remains a key investment destination for FSSA. 

_{Source: Company data retrieved from company annual reports or other such investor reports. Financial metrics and valuations are from FactSet and Bloomberg. As at December 2023 or otherwise noted.
¹Source: World Bank Databank, as at 2022 https://data.worldbank.org/indicator/SP.POP.TOTL?locations=IN
²Source: IEA, Global air conditioner stock, 1990-2050, IEA, Paris https://www.iea.org/data-and-statistics/charts/global-air-conditioner-stock-1990-2050 , IEA. Licence: CC BY 4.0}

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