The trade dispute between the USA and China; the risk of interest rate hikes; structural changes – Asian equities have become much more volatile. Elina Fung, lead portfolio manager of HSBC’s Small Cap Asia (excluding Japan) equity strategy, talks about recent developments in Asian equities and how she reacts to them in her portfolio.
AsiaFundManagers: Mrs Fung, how do you assess recent market developments, particularly US interest rate hikes and increasing trading tensions?
Elina Fung: The succession of interest rate hikes in the USA has long been anticipated by the market, and has been accompanied by the recovery of the global economy. As long as we do not see any significant change in the expectation of interest rate hikes, we are not concerned about the interest rate cycle. Indeed, carefully planned rate hikes can be good for the economy and suggest that economic growth is on track. However, there has been some capital outflow from the equity markets as a result of the interest rate cycle. This has increased market volatility.
Asian equities: in the current environment, selection is crucial
Trade tensions between the US and China have intensified since the beginning of the year. The US had announced a provisional list of Chinese imported products that would be subject to additional tariffs, to which China responded by announcing tariffs of a similar scale on US imported goods. Trade talks are taking place, but their outcome is uncertain. What is clear, however, is that China is making efforts to improve relations with the US. This is shown, for example, by recent announcements of the further opening-up of the automotive and financial services sector.
AFM: Asian equities were impacted by profit increases in 2017. How will 2018 develop?
Elina Fung: The results of the second half of 2017 surprised the market in terms of margins. Despite the good sales growth, some companies recorded a decline in margins due to rising production costs. This underlines the increased importance of selective stock selection. In this market environment, it is crucial to select companies that can pass on rising costs to customers.
Equity returns – Asia – by international investors
Profit growth slowed in the first quarter of 2018. However, three factors should be highlighted that influenced this market: Despite a moderate slowdown, a decent profit growth in Asia, excluding Japan, is still expected for 2018. Consensus estimates predict an increase of 14%. Foreign investors have been the net sellers of Asian equities this year.
This is only the fifth time since 1997, which usually signals a certain capitulation of the markets. If history repeats itself, we could see a significant recovery in the markets from here. Interestingly, many Asian Small Cap companies have been active in buying back shares. In our Hong Kong/China Small Cap equity strategy, around a quarter of our shareholdings had been bought back towards the end of the first quarter, which is very encouraging.
AFM: What investment opportunities do you see in view of the increased market volatility?
Elina Fung: We are now actively looking for opportunities in the healthcare sector. The ageing world population is an encouraging demographic trend for the healthcare system. In Asia, apart from Japan, per capita health spending is still very low. We believe this sector will experience strong multi-year growth. We used to be underweight due to valuation issues, but after the recent market correction we identified some companies in the Hong Kong region with attractive valuations relative to their growth and earnings profile.
AFM: What other investments do you find attractive?
Elina Fung: We still like the industrial and consumer goods sectors. In consumer goods, we particularly appreciate luxury retailing, where we are seeing strong sales growth and margin improvement. Two years ago, we established a position in a luxury retailer that developed well. Thanks to a good turnaround, the company recorded high sales growth in recent months.
Luxury goods, gambling and hotels profit from tourism figures
We have also observed a sharp rise in tourism figures in recent months. This is benefiting luxury retailers, gambling and hotels, for example. We also like to invest in gaming stocks, not only in Macau, but also in the Philippines. We are also optimistic about China-related hotel companies. Chinese hotels are seeing an end to oversupply and many are seeing an improvement in occupancy rates and room prices.
AFM: How does the tense trading situation affect your strategy? What has changed for your investments?
Elina Fung: As a result of the trade tensions, some companies in our Asian strategy are affected. However, this is due to deteriorating sentiment and not to a change in fundamentals. For example, the US sanctions list includes PCBs, so some Asian PCB companies have been affected even though they export very limited amounts to the US. In this situation investors react to the market noise. We believe that in the midst of this situation there are potential buying opportunities for building positions in interesting companies at attractive entry points.
Setbacks open up buying opportunities for Asian equities
Against the backdrop of trade protectionism, we remain vigilant in our stock selection and avoid global commodities. Instead, we are sticking to regional commodities such as cement, which is also one way of exploiting Chinese supply reforms. We have also reduced positions in Taiwanese and Chinese equities that are dependent on US exports. The recent volatility also opens up buying opportunities in areas not affected by trade tensions. These include both companies with labour-intensive manufacturing in Asia and companies benefiting from the recovery in domestic consumption.
AFM: What are the arguments for investing in Asia, excluding Japanese equities, and how does your strategy differ from the market?
Elina Fung: The Small Cap market in Asia, excluding Japan, is much more diversified than the Large Cap market. While the financial sector accounts for 24% of the Large Cap index, it accounts for only 9% of the Small Cap index. The Small Cap market is therefore more dominated by “New Asian” sectors, including consumer goods, industry, real estate and healthcare. Accordingly, Small Caps allow investors to take advantage of structural opportunities. In addition, brokerage firms often focus on Large Cap versus Small Cap research. The lack of coverage is particularly pronounced in Asia, leading to both inefficiencies and opportunities.
We are bottom-up investors looking for stocks that are attractively valued due to their sustainable profitability. We use a disciplined and consistent approach to generate long-term alpha results. For Small Cap investments, fundamental research by experienced analysts is critical. The aim is to identify and invest in attractive companies at an early stage. We do this successfully in our Asian Small Cap equities strategy. In the Morningstar ranking, our strategy has ranked in the first quartile over 2, 3, 4 and 5 years. This underscores our consistency in various market situations.
AFM: Mrs. Fung, thank you very much for the interview.