Why investors need direct exposure to Asia (afr.com)

Australian investors more than any other group appreciate the importance that the rise of the Asian economies has had on our living standards and opportunities yet remain massively under exposed to this growing region in their portfolios.  Individual investors have always feared going direct to the region due to operational difficulties and a lack of trust and understanding of these markets, but that is starting to change as the avenues for access improve.

Over the past 20 years, Asia has become a powerhouse of global growth with favourable demographics and huge investments in digitalisation driving significant economic and business expansion.  The idea that "Asia is the place you fly over on your way to Europe" is well and truly long gone.

In 2000, Asia accounted for just under one-third of global GDP.  This year that number is closer to 50 per cent.  China has clearly played a significant role in the growth of the region.  The Chinese economy has grown fivefold over the past 20 years and now accounts for approximately 20 per cent of total global economic output and a significant share of its annual growth. 

The size of this region is simply too big to ignore in portfolio construction anymore.  Over the past 20 years, as these economies have evolved, the industry mix of the region’s largest firms has shifted.  Manufacturing of capital goods is now a smaller share of the region’s economy, while infrastructure and financial services have grown significantly.  Now, many Asian firms have become global market leaders not only in industrial and automotive sectors but in areas like technology, finance, and logistics. As a region, technology innovation alone has accounted for nearly a third of Asia’s per capita growth and we have seen Chinese internet giants Baidu, Alibaba and Tencent dominating their respective markets.

The composition of growth in the region is changing as well.  Intra-regional trade is increasing as more goods get consumed locally.  The region is becoming less reliant on the importing of intermediate inputs and final goods as the level of sophistication in manufacturing in the region improves.  Services are growing 60 per cent faster than the increasing trade in goods.

Australian companies have been significant beneficiaries to date of this spectacular growth principally through our mineral, education, and tourism exports.  However solely relying on Australian companies to give you your Asian exposure is unlikely to be the optimal way to capture the next generation growth drivers.  Many Australian companies have shelved their Asian growth strategies and it will be critical to invest directly to get exposure to important sectors such as health care, consumer discretionary and financial services.  Combined with our deteriorating diplomatic relationship with China, it is now time to re-think the way we get exposure to this region.

Understanding the seismic shifts underpinning the global technology architecture adds a further dimension to this portfolio allocation necessity.  The technology backbone of the internet is splintering, and it is likely that two quite distinct internets will emerge over the next decade.  One will be led by China and the other will be led by the United States.  The concept has been dubbed the ‘splinternet’, and it refers to a future in which the internet is fragmented, governed by separate regulations, and run by different services.  The Five Eyes dispute over Huawei technology and the pressure applied to many countries to avoid using China based hardware in their 5G networks gave an important glimpse into an aggressive technology war being fought largely behind closed doors.

However what looks to be happening is that superior Chinese 5G technology is gaining rapid acceptance in India, Southeast Asia, South America, Middle East and even in parts of Africa.  United States technology is being adopted by Europe and English-speaking countries like Australia.  So, the trading blocs of the future may be divided down technology lines with a roughly equal number of people split between the two technology worlds.

The implications of this could be quite profound and difficult to judge.  But what is likely is that investors will likely need to own companies in both camps to diversify their risk and maximise their returns to the fastest-growing economies.  Countries in Asia with younger populations and growing middle classes will have consumption tailwinds and offer some of the best growth opportunities.  However, with more volatility expected and an increasing bifurcation at a country, sector and company level, Australian investors will need partners with a deep understanding of the region when building portfolios.