Navigating Risk and Exposure in Asia
HONG KONG, April 19, 2023 /PRNewswire/ -- The Asian market is finally consolidating after a strong rally. A major turnaround in Asia's market performance has triggered renewed interest from global investors to increase their allocation to Asia. From peak to trough, the MSCI China index rebounded an astonishing +59% from a -62% drawdown.
With 17 years of experience on the ground in Asia, Silverhorn's Chief Investment Officer, Marco Klaus, addresses how global allocators should consider the risks and exposure before committing capital to Asia.
China and Asia are an important part of the investment universe. How much exposure should a global allocator consider in their portfolio?
Marco Klaus: This question is a great starting point for allocators. Certainly, one end of the extreme is to look at Asia's share to global GDP, which stands at ~45% today and is expected to pick up to 50% by 2030. Similarly, if we look at the rising middle class in the region, consumption is expected to contribute 50% or more to global consumption by 2030, illustrating its power in a global context.
On the other end, if you look at MSCI All Country World Index, the allocation to Asia is meaningfully lower. It stands at ~10% today. In our view, the sweet spot for Asia exposure today is 20% to 30%.
20-30% is rather on the high end for a global allocator outside of Asia. How can exposure be allocated through different asset classes?
Marco Klaus: Size isn't necessarily an issue. Asia operates such a vast opportunity set across public equities as well as public fixed income markets. Allocators may consider a multi-asset approach. Also, they may choose to diversify across public and private markets to tap different growth drivers. Today, exposure to the vibrant startup ecosystem in China, India, and Southeast Asia provides immense diversification benefits to a global portfolio.
What is preventing global investors from expanding more in Asia?
Marco Klaus: The reasons are manifold, particularly lack of familiarity, high perceived risk, and home bias. Asia isn't easy to understand, and I can say that even after 17 years on the ground, I still need to follow closely and check in with partners regularly to have a complete picture of the landscape. The region consists of multiple countries, cultures, and market idiosyncrasies, so it requires being close to the market and understanding a complex system.
Making a commitment to the region ties up resources; it requires a dedicated team to keep up with the fast-changing nature of the market and, if there is not already a team in place, it requires travelling on a frequent basis to understand what is really happening on the ground. This was not possible or practical over the past few years. However, there are trustworthy local partners that can also play a critical role in capturing the diversification opportunities which exist.
Another concern on the minds of global allocators is policy risk. The crackdown on the education sector has wiped out billions of dollars overnight. How do we deal with this?
Marco Klaus: Policy risk is real and tends to move on a pendulum. Over the past couple of years, it was clearly on the higher end of the spectrum and affecting many sectors. We now seem to be entering a phase of lower policy risk. Excesses and unwanted business practices have been addressed with the focus clearly shifting back to growth. Chinese authorities tend to let things run freely up to a point where the dynamics either raise concerns about systemic risks (e.g. real estate) or run contrary to the Party's long-term goals (e.g. the burden of after-school tutoring costs on household expenditures).
Understandably, such incidents leave scars. The crackdown on the after-school tutoring industry was a painful experience for foreign investors. That said, it accounted for less than 1% of China's market capitalisation (Silverhorn China Briefing "Schooled by education's new rules", August 2021) and hence would have had a limited impact on a diversified portfolio. Therefore, my piece of advice is simple: diversify, align with policy direction, and watch for signals. The latter is the most difficult part and requires more access to expertise than some global allocators likely have available without a partner.
How can portfolio construction mitigate these risks?
Marco Klaus: Portfolio construction is crucial in mitigating risks inherent in Asian markets, be it policy risk, corporate governance risk, or FX risk to name a few. It's the same logic that applies elsewhere.
First, it's important to have an investment policy framework in place. Once you know how much you want to allocate to Asia, you have to think about the various risks. So the investment policy framework would entail that you start thinking top-down from a macro or policy risk perspective. For instance, how much directional market risk would you want to take in your portfolio at a given point in time?
Second, think about how you want to invest across different asset classes and the corresponding risk-return profiles and how they correlate with one another to construct a robust portfolio. The great thing is, today, this region offers a bigger opportunity set than ever before. So not only can you go long on the market, but also you can extract returns from various strategies that apply shorting or hedging techniques.
And through the private markets, investors can capture growth opportunities not available in public markets. Perhaps in a few years' time, once these companies mature and float, then you can participate. Until then, much of the value creation is happening on the private side.
What do you see are the near-term opportunities?
Marco Klaus: Last year showed the challenge of staying invested through a very difficult environment when things seemed to get from bad to worse.
But where we are today, there are plenty of great opportunities. How quickly these will pay off is a separate story. On the fixed income side, many credits have yet to recover fully from China's property meltdown and spillover effects. On the equity side, valuations are still attractive while business fundamentals remain solid. For instance, we continue to be attracted to the dividend value theme. Also, we see compelling opportunities to extract value from heightened volatility and return dispersion (e.g. relative value strategies).
On the private market side, valuations have come off (albeit with a lag to public markets). We view this as a healthy adjustment as it has taken some froth out of the market. We remain particularly focused on the venture space.
Key Takeaways
- Asia is an increasingly important part of the global investment universe. Allocators should consider a meaningful exposure with the sweet spot between 20-30%.
- Investing in Asia is a daunting task. Policy risk is real, especially, but not only, in China. Having an investment policy framework in place and diversifying exposure across countries, sectors, and asset classes are key to constructing robust portfolios.
- Allocators need to assess whether they have sufficient resources and capabilities to implement and monitor their portfolio, or whether it's wise to partner with local experts who have teams dedicated to building conviction in the region.
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