Sector Watch: Asia-Pacific funds enjoy solid growth

China, India and other Asian countries are experiencing superior growth rates relative to Western economies as the former group of economies continue to mature. Their rising middle classes are spurring domestic consumption and reducing dependence on exports, giving rise to sophisticated, high-quality companies with business models far beyond the production of low-end products and basic commodities that led Asia’s initial transformation from agrarian economies.

Governments are benefiting from improving tax revenue and investing in badly needed infrastructure, such as roads, bridges, power grids and ports that lubricate business. India’s government, for example, is in the midst of a multi-year project to spend US$1 trillion on infrastructure, particularly on railway networks and airports.

India has been one of the world’s fastest-growing economies in recent years, with annual gross domestic product (GDP) forecast to be more than US$2.9 trillion in 2018, far surpassing Canada’s GDP forecast of US$1.8 trillion, according to Spain-based Focus Economics. Future growth potential is huge, with India’s population of 1.3 billion people almost 40 times greater than that of Canada, and with India’s demographics skewing significantly younger.

Focus Economics estimates China’s 2018 GDP will be US$13.1 trillion, compared with the U.S.’s estimated US$20.2 trillion. China is the world’s second-largest economy, but is gaining fast on the U.S. The focus in China is turning toward the development of the high-technology sector, which is viewed by the country’s leadership as a driving force behind economic development and social transformation.

President Xi Jinping has publicly articulated China’s goal of encouraging more significant applications for the Internet, big data and artificial intelligence (AI) within the economy to spur consumption and encourage efficiencies. If China manages to sustain balanced economic growth in the range of 6%, the country is on target to become the world’s largest economy by 2030.

With China as the kingpin, interregional trade barriers in Asia are falling, creating freer flows of goods, services and labour. Global initiatives, such as the Trans-Pacific Partnership trade agreement, encourage the manufacture of goods, such as textiles and electronics, to move to lower-cost countries such as Vietnam and Malaysia, thereby encouraging the rise of more middle-class consumers across Asia.

“Initially, Asia was a story of capital markets opening up, cheap labour and opportunities in real estate, banking and low-cost manufacturing,” says Ben Zhan, portfolio manager with 1832 Asset Management LP in Toronto, who oversees Dynamic Asia Pacific Equity Fund together with Dana Love, vice president and portfolio manager. “Now, it’s totally different,” Zhan adds. “We’re seeing explosive growth in consumption, along with global leadership in technology. China is stepping onto the world stage. In coming years, the new safe haven for investors will be China as a region of political and economic stability.”

China is by far the dominant country weighting in the Dynamic fund, accounting for 43% of geographical exposure, followed by Japan (13%), Hong Kong (10%) and South Korea (8%). Zhan says China-based tech companies are playing a vital and expanding role in connecting young, digitally savvy consumers to products.

The preference among the Chinese for making electronic payments through mobile smartphone apps rather than using credit cards has resulted in a torrent of easy transactions that facilitate commerce.

The biggest holdings in the Dynamic fund are China’s two e-commerce platform developers: Ali Baba Group Holding Ltd., which specializes in shopping search engines, electronic payment and cloud computing, and is considered the Amazon.com Inc. of China; and Baidu Inc., which operates a popular search engine that’s considered an equivalent to Google. Baidu also is dedicating significant resources to AI.

Zhan says China-based tech companies are at the forefront of developing facial recognition applications, and retail transactions using instant facial recognition via camera already are happening at some outlets, including restaurants. Culturally, China’s population is more accustomed than North America’s to impositions on social freedoms and a high level of surveillance in public places.

“Society’s tolerance for some invasion of individual privacy gives China an advantage in technology,” Zhan says. “The next generation of development is slowly and decidedly shifting to China from Silicon Valley.”

With China’s growing domestic demand and expansion of trade with a variety of partners, Zhan isn’t overly concerned about threats of a China/U.S. trade war. U.S. tariffs threatened on steel and aluminum and possibly other goods produced in China would affect a tiny percentage of the latter country’s giant and increasingly diversified economy, he says. And if U.S. President Donald Trump moves to impede U.S. trade with other countries, his protectionist stance may push these countries to do more business with China, Zhan adds.

“China is opening up to trade while the U.S. is shutting down,” Zhan says. “Any trade war with the U.S. would be insignificant for China in terms of magnitude or implication. China is on the rise, and the U.S. is helping. Every stock market sell-off creates opportunities to buy [shares in] companies that will benefit.”

Upwardly mobile Chinese middle-class consumers are a powerful group within their country’s population of 1.4 billion, and they increasingly support domestic brands, Zhan says. Key holdings in the Dynamic fund include Li-Ning Co. Ltd. and Anta Sports Products Ltd., both of which produce athletic shoes and sporting goods and compete with global brands such as U.S.-based Nike Inc. and Germany-based Adidas AG.

Another top holding is Tsingtao Brewery Co. Ltd., a beneficiary of expanding lifestyles and growing support for Chinese brands, which has about 15% of domestic market share.

Outside China, another favorite of Zhan’s is South Korea-based Amorepacific Corp., a beauty industry behemoth that manufactures cosmetic and personal-care products. The company’s popular products focus on natural ingredients and are sold in stores around the world.

“South Korea is the land of plastic surgery and skin care,” Zhan says, “and the company holds a prominent space in the Asian consumer story.”

Although Japan lacks the rapid growth potential of India and China, Zhan says, economic stimulation measures implemented by the government have energized the country. Among the Dynamic fund’s Japan-based holdings are consumer electronics and entertainment giant Sony Corp. and Square Enix Holdings Co., producer of video games sold globally, with a big market in China.

Eileen Dibb, portfolio manager with Smithfield, R.I.-based Fidelity Institutional Asset Management, a unit of Boston-based FMR LLC (a.k.a. Fidelity Investments), oversees Fidelity AsiaStar Fund. She also is keen on Asia-based technology firms.

Technology is the largest industry weighting in the Fidelity fund, at 22%, followed by financial services (20%) and consumer discretionary firms (19%). The top holding in the fund is China-based Tencent Holdings Ltd., which specializes in Internet-related services and products, entertainment and AI; and Taiwan Semiconductor Manufacturing Co. Ltd., a giant microelectronics maker.

“Tencent can monetize its software services across hundreds of millions of users in an expanding base – mostly in China – but there are opportunities for digital uptake in other parts of Asia,” Dibb says.

Financial services are a logical beneficiary of a growing middle class in Asia, Dibb adds. Another key holding in the Fidelity fund is HDFC Bank Ltd., which is the largest private bank in India and is taking share away from state-owned banks. “[HDFC] has the lowest-cost, highest-quality assets in the market and is experiencing strong loan growth,” she says. “It’s on a good growth runway in a good industry.”

Dibb also likes REA Group Ltd., an online real estate advertising company in Australia; and Challenger Ltd., an insurance and investment company in Australia that benefits from a trend among clients toward diversifying their portfolios into income products such as annuities.

On a geographical basis, Dibb favours more mature markets. The Fidelity fund has a 37% weighting in Japan, 16% in Hong Kong, 12% in China and 11% in Australia.

Holdings in Japan include Orix Corp., a diversified financial services conglomerate, as well as other companies that Dibb considers “stable growers.” Top holdings in that category include Itochu Corp., a global trading conglomerate; SoftBank Group Corp., a diversified telecommunications giant; and Marui Co. Ltd., a department-store chain with strong merchandising skills in women’s fashion and a growing credit card business.