ASIA QUARTERLY BULLETIN - Columbia Threadneedle...Indonesia, the world s largest Muslim country. Annual economic growth is consistently above 6%, and a rapidly growing, affluent middle

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ASIA QUARTERLY BULLETINDECEMBER 2016

Keep faith in Asia

Proiting from Asia’s inancial growth

Time to diversify into international equity income

Asia’s moderation is good news for stock pickers

From the Financial Times – China seeking to revive the Silk Road

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Asia Quarterly Bulletin – December 2016

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Keep faith in AsiaInvestors should focus on Asia’s bigger picture rather than transitory setbacks.

Asia’s star seems to have dulled.

Political scandals and instability,

territorial disputes in the South China

Sea, stalled structural reforms, the

accumulation of private sector debt

and, most of all, China’s economic

slowdown have turned some

supporters into doomsayers.

However, any shift from euphoria to

despair is irrational; a bipolar mood

swing that emphasizes transitory

problems and disregards the

substance beneath the dazzle of

Asia’s renaissance.

The bigger pictureDuring several years of double-

digit GDP growth, China became

the second-largest economy in the

world, asserted a dominant role in

global trade, finance and investment,

generated conquering multi-national

companies and catapulted millions of

its people out of rural poverty.

Now, as wages rise, China’s industry

is moving up the value chain,

applying the latest technologies and

management practices, and focusing

on new economy sectors such

as healthcare, the internet, digital

technology, the consumer and

green industries.

Economic growth is still impressive at

6.6%1 this year, as the country moves

from an investment- and export-led

model to one based on domestic

consumption, and as the government’s

anti-corruption drive contains the

economy’s earlier excesses.

Meanwhile, President Xi Jinping’s

One Belt, One Road strategy

promises to extend China’s global

investment reach even further and

boost economic activity along its

maritime and terrestrial routes. The

renminbi has quickly become a major

global trade settlement currency and

further internationalisation will likely

make it a reserve currency too.

Developments in Asia’s second

most populous country, India,

are equally striking. This year the

IMF projects a GDP growth rate of

7.4%2, similar to the previous two

years, as Prime Minister Narendra

Modi’s administration implements

radical reforms to open commerce

to competition, improve corporate

and public sector governance and

transparency, and cut through the

state’s rigid bureaucracy.

Similar reforms are underway in

Indonesia, the world’s largest Muslim

country. Annual economic growth

is consistently above 6%, and a

rapidly growing, affluent middle class

of about 150 million is shifting the

sprawling archipelago away from a

reliance on commodities to a vibrant

consumer society.

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In East Asia, South Korea and Taiwan

remain world-beating manufacturers

of industrial and electrical goods and

computer technologies. They boast

instantly recognizable brands such

as Samsung, LG and Hyundai, and

Asus, HTC and Acer.

The region’s financial and

commercial hubs, Hong Kong and

Singapore, continue to attract

multinational companies and

financial institutions to trade and

intermediate with China and the

newly-formed ASEAN Economic

Community.

Both territories are centres for an

expanding wealth management

industry, that is fuelled by the riches

earned by billionaire entrepreneurs

and passed on to their cosmopolitan

children. They are also incubators of

disruptive fintech startups and offer

a platform for all types of commercial

innovation and enterprise.

Indeed, in September a well-

respected U.S. think-tank3 declared

Hong Kong to be the world’s freest

economy, closely followed by

Singapore in second in a survey of

159 countries. It ranked countries

according to a series of criteria,

including personal freedom, access

to markets, respect for private

property and the rule of law.

The U.S. was listed in 16th place.

Problems in perspectiveOf course, there are problems that

cannot be ignored and dismissed.

Some commentators have warned

about asset price bubbles in China

and forecast an implosion of the

official and shadow banking systems.

Many people in Hong Kong are

concerned and angry about the

mainland’s encroachment on its

internal affairs and civic liberties,

as reflected in the recent legislative

elections that saw victories for

prominent leaders of 2014’s

Occupy movement.

There are still restrictions on

political activities and press freedom

in Singapore, and the country’s

economy is particularly vulnerable to

any slowdown in international trade.

Elsewhere in Southeast Asia,

Malaysia is still mired in the 1MDB

corruption scandal, while Thailand

is into its third year of military

government with little sign of

democracy returning soon.

However, all countries and regions

face challenges and encounter

problems: there are no parts of the

world free of domestic turbulence or

geopolitical uncertainty.

Asia’s distinctive qualities and

its appeal to investors lie in

its economic growth, energetic

populations, largely youthful

demographics and forward-

looking vision.

Capital markets are liberalising

and opening up, financial market

and banking sector supervision

have tightened, and region-wide

passport schemes will soon allow

greater cross-border sales of fund

management products.

Investors have both reason and

opportunity to maintain their

confidence in Asia.

Notes:

1. IMF World Economic Outlook Update (July 2016)

2. See above

3. Fraser Institute, Economic Freedom of the World:

2016 Annual Report

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6


Proiting from Asia’s inancial growthFavourable demographics and reform are fuelling Asia’s burgeoning inancial services sector, offering opportunities for investors.

Asia’s banking and financial sector

has matured and reformed since the

regional financial crisis in the late

1990s. It is also adapting rapidly

to meet distinctive demographic

needs, enthusiastically introducing

new technologies, and contains

several world-class institutions that

are extending their footprint beyond

domestic markets.

Illustrating the pace of growth,

a 2013 report found that Asia’s

financial sector accounted for almost

40% of the world's banking and

insurance market capitalization, more

than double a decade before1.

For investors, there is an opportunity

to profit from the sector’s growth.

Broadly speaking, the region’s

banks have increasing earnings,

with defensive qualities and stable

dividend payouts. At the same time,

Asia’s multiplying wealth is leading

to greater opportunity across the

financial sector, including wealth

management and life insurance. Over

time, higher earnings and dividends

should drive stock price gains.

In Singapore, for instance, DBS,

OCBC and UOB are prudent, well-

managed banks with strong balance

sheets that withstood the 2008

global financial crisis better than

most of their international peers.

DBS, in particular, is expanding

its retail and corporate operations

throughout Southeast Asia and,

along with OCBC’s Bank of Singapore

private bank, is attracting a growing

volume of the region’s wealth

management business.

This last trend is significant. Last

year, Asia-Pacific recorded high net

worth individual (HNWI) population

and wealth growth rates of 9.4%

and 9.9%, respectively. These were

the biggest gains across the world,

according to the Capgemini and RBC

Wealth Report, 2016.

Asia-Pacific has edged past North

America to become the region with

the biggest pot of HNWI (people with

investable assets of at least US$1

million) wealth: US$17.4 trillion with

a HNWI population of 5.1 million.

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Low banking and life insurance penetrationThe rise in the number of rich

individuals and families and the

value of their assets, largely fuelled

by the extraordinary economic growth

and entrepreneurialism of China, is

only part of process underway

in Asia.

Many countries are underbanked,

leaving considerable room for

growth. Personal bank account

penetration varies from just 20% in

youthful Indonesia to 99% in greying

Australia2. The Philippines is also

underbanked and Indian lenders

are applying leapfrog technologies

to reach remote rural communities.

In contrast, Singapore and Hong

Kong banks have to compete

with international rivals to offer

sophisticated products and services

to almost fully banked individuals

and businesses.

In Indonesia, Bank Central Asia,

Bank Mandiri and others provide

a comprehensive platform of

financial products and services

to the country’s rapidly expanding

consumer class, as does BDO

Unibank in the Philippines and ICICI

and HDFC in India.

Similarly, there is significant room

for life insurance companies to grow

in parts of Asia. For instance, life

insurance coverage is a mere 2-3%

in Southeast Asia compared with 7%

in South Korea. Not surprisingly, the

Asian insurance sector is expanding,

with gross written premium achieving

a 6% compound annual growth rate

between 2010 and 2014. Two of

the region’s leading life insurance

companies, AIA and Prudential (UK),

have grown revenues at 15% or more

in recent years3.

A promising futureIn future, the Asian insurance sector

is expected to grow steadily from a

low base, due to rising levels of GDP,

increasing individual wealth, a large

regional population and youthful

demographics in the least

penetrated markets.

Of course, Asian financial institutions

face similar challenges to those

elsewhere in the world. They

are confronted with the costs of

implementing stricter regulatory

and compliance regimes, earnings

pressures from low interest rates

and the threat of disintermediation

from fintech disruption.

However, these challenges are

mitigated by over a decade of more

prudent controls, an expanding

and wealthier customer base,

and a flexibility that allows many

of the region’s financial firms to

adopt and even innovate disruptive

technologies. Against such a

promising macro-economic backdrop,

this appears to be a promising

sector for investors to profit from.

Notes:

1. Oliver Wyman, Fung Global Institute (2013).

2. World Bank (2014)

3. EY (2016)

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9


Time to diversify into international equity incomeWith equities volatile and interest rates low, Asian and Australian investors can gain from diversifying into international portfolios of high-dividend stocks.

The recent past has underscored

the danger of Asian and Australian

investors relying on local asset

classes to achieve their long-term

investment goals. Not only have

equities in markets such as

China proved exceptionally volatile,

some local currencies have also

fallen and interest rates have

touched historic lows.

In the 12 months to the end of

June 2016, for example, the MSCI

China Index fell 23.20%. Meanwhile,

interest rates and government bond

yields have fallen to lows that have

not been seen before.

It’s time for local investors to learn

the benefits of diversifying through

a portfolio of either pan-Asian or

global high-dividend stocks. The

benefits of a diversified global

portfolio are well-supported, both

by rigorous theoretical study and

empirical evidence. Investors gain

exposure to a variety of companies,

sectors and countries with different

economic and structural profiles,

as well as access to undervalued

markets and currencies.

The best dividend stocksWhether seeking income yield or

capital gains, there are advantages

for investors. By widening their

investment net to the whole of Asia,

or even the globe, they access the

best high-dividend companies, which

tend to combine a high yield, earnings

growth and robust balance sheets.

When reinvested dividends compound

over time, they make a powerful

contribution to capital growth.

Dividends are an under-appreciated

sign of investment quality. There are

a number of reasons why companies

paying consistent dividends are

appealing. Businesses which

prioritize paying a steady stream of

income to their shareholders are

typically well managed, with a strong

degree of cashflow certainty. They

are usually established, profitable

companies.

The year-to-date decline in the 10-

year local government bond yields

in several Asian territories has

made high-dividend stocks in these

markets compelling. Australia (4.7%),

Hong Kong (4%), Singapore (4%) and

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Taiwan (4.8%) stocks currently trade

with average forward 2017 dividend

yields of at least 4%, according to

brokerage CLSA.

European stocks offer yields of about

3.5% and U.S. stocks on average pay

around 2% – although their earnings

are supported by a more buoyant

economy and the relatively low figure

doesn’t include the contribution of

share buy-backs which are common

in the U.S. market.

Income with a growth tiltIt is possible to split the universe

of high-dividend stocks into several

groups. The greatest opportunities

lie within the group of companies

that delivers a steady flow of

dividends but is looking to grow its

earnings. That ideal combination

of income with a growth tilt, when

correctly identified, generates steady

dividends which will grow over time.

Specific examples of stocks which

fall into this category include:

Coca-Cola, derivatives exchange

operator CME Group, and theme

park company Six Flags.

Stocks with increasing dividends

are most likely to cope with a rising

U.S. interest rate environment by

increasing their payouts concurrently

with higher rates. They are also

usually well managed companies

with clear strategies.

Asian dividend payouts growTurning to Asia, there has been a

shift towards companies paying

higher dividends over the past

decade, including several Taiwanese

companies and some in South

Korea. For example, Samsung, the

electronics conglomerate, is now

committed to pay out 50% of its

operating cash flow.

Taiwan’s semiconductor sector offers

attractive yields supported by long-

term business models, profitability

and consistent cash flows. In

addition, infrastructure companies,

such as Indian power generators,

have taken advantage of their

high operating margins to reward

shareholders with high dividend

payouts.

Active management through mutual

funds is preferable to passive

exposure via ETFs (exchange traded

funds), given the dynamic nature of

the underlying dividend yielding stock

universe. Individual stock selection

is critical to pick 'dividend gems' and

avoid 'value traps', as companies

with weak balance sheets and

decelerating cash flows run the risk

of potential dividend cuts.

Quite simply, investors need a more

dynamic, diversified approach to avoid

the pitfalls of local equity volatility and

low interest rates. They can achieve

this through investing in actively

managed equity income funds, on

either a global or pan-Asian basis.

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12


Asia’s moderation is good news for stock pickersMore sustainable policies are reducing economic volatility, fostering the rise of well-managed companies dedicated to delivering high returns to investors.

China’s renminbi joined the

IMF’s list of official reserve

currencies on October 1, 2016,

testament to the progress of reform

over the years. Throughout Asia,

governments are emphasizing

sustainable economic development,

and companies are becoming more

cost-efficient and profitable.

It’s true that growth is slowing from

previous highs, but this more robust

economic environment is likely to

prove more durable. Furthermore, the

region’s growth remains the fastest

in the world.

A new moderation mindset is taking

hold in Asia. This means that a

higher-growth environment is making

way for slower but better quality

growth, and the pool of well-run

companies is expanding. Economic

growth has fallen from its highest

levels to a far steadier rate – China

has slowed from 10.6% GDP growth

in 2010 to about 7% this year. But

this makes for a more predictable

environment for business, which

is good news for active managers

picking stocks.

In particular, companies in the

developed markets of Hong Kong,

Singapore and Australia are well

suited to this changing economic

world. They are generating more

cash flow and have started to pay

out more dividends. Reflecting

the evolving environment, steadily

investing for dividend income will

become more important as a source

of return.

A misunderstood transitionAsia continues to be misunderstood

as it goes through a process of

economic transition. China remains

the region’s most important

economy, both due to its size and

because a lot of Asian countries

have exposure to it. Meanwhile, India

is also an economic powerhouse, but

it is more insular.

Although the region’s economies

have been slowing, their growth

remains fairly strong, providing a

stable backdrop for investing in

Asia Ex-Japan (the IMF forecasts

that Emerging and Developing Asia

will grow at 6.4% in 2016 and 6.3%

in 2017)1.

The slowdown of the Chinese

economy has caused anxiety, with

questions over whether it will suffer

a sharp deceleration. However, the

near-term outlook has improved due

to interest rate cuts, fiscal expansion

and infrastructure spending. Recent

economic data suggests that China

will achieve a soft landing and the

government will meet its full-year

GDP growth target of 6.5-7%.

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Fast-growing sectorsIn economies changing this quickly,

it is important to look beyond GDP

benchmark figures to find the

sectors that are growing faster

than the overall economy. In Asia,

the rapid expansion of the middle

classes is leading to the rise of

services such as insurance, the

growth of ecommerce and an

increase in consumption. Ping An

Insurance, AIA Group, Baidu and

Alibaba are examples of interesting

companies in these areas.

One sector doing well in developing

and emerging Asian economies is

healthcare. There are some strong

healthcare and pharmaceutical

names in Australia (Healthscope,

Ramsay Health Care, CSL) and China

(China Biologic Products). They are

tapping into the requirements of an

ageing population across Asia, as

well as the broadly rising demand

for healthcare.

Infrastructure spending continues to

grow steadily and the region remains

a manufacturing powerhouse.

For example, it leads the world in

making smartphones and personal

computers. There are a number of

Asian companies at the forefront of

technological innovation, including

selective chip makers and electronic

components manufacturers in

Taiwan and South Korea.

High-quality companiesThe quality of companies in Asia is

improving and it boasts an increasing

number of globally competitive

superstars such as Samsung.

Through focusing on competitive

advantages, sustainable profitability

and corporate governance, these

companies deliver more resilient

earnings and dividend streams.

It is, therefore, important that

investors do not concentrate too

much on the region’s slowing growth.

For sure, China’s 2015 stock market

crash and the mini-devaluation of

the renminbi led to increased market

volatility. But they did not alter

the fact that Asia’s moderation is

fostering a more resilient economic

environment and the rise of well-

managed companies with strong

competitive advantages.

All of this is promising for investors

seeking a combination of capital

growth and income.

Notes: 1. IMF World Economic Outlook Update. July 2016.

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From the Financial Times – China seeking to revive the Silk Road

The ancient trade in silk, spices and

slaves between China and Europe

turned central Asian oases into

wealthy business hubs. Now, with

China seeking to rebuild the Silk

Road as its signature foreign policy

initiative, countries across post-

Soviet Central Asia, the Caucasus

and beyond are hoping China’s

westward expansion will once again

bring them riches.

The investments “will revitalise

economic activity and trade in this

part of the world”, says Erlan Idrissov,

foreign minister of Kazakhstan.

They are much needed. With falling

commodity prices and recession in

Russia, growth in Central Asia and

the Caucasus is set to fall to a two-

decade low this year, according to

the International Monetary Fund.

“This set of shocks is likely to

persist,” says Masood Ahmed, IMF

director for the Middle East and

Central Asia. “The [new Silk Road]

initiative can bring substantial

advantages and gains.”

The effects of Beijing’s new 'One

Belt, One Road' policy, unveiled in

2013, however, remain unclear. Two

decades of hefty investments since

the break-up of the Soviet Union have

already made China the pre-eminent

economic power in Central Asia.

China’s trade with the region rose

from US$1.8bn in 2000 to a high

of US$50bn in 2013, says the IMF.

Chinese companies own close to a

quarter of Kazakhstan’s oil production

and account for well over half of

Turkmenistan’s gas exports. China’s

state Eximbank is the largest single

creditor to impoverished Tajikistan

and Kyrgyzstan, respectively

holding 49% and 36% of their

government debt.

Officials have seen a rush

from Chinese bureaucrats and

businessmen eager to brand projects

as part of the new Silk Road.

Initial discussions have focused

on infrastructure and exporting

overcapacity in China’s industrial

sector – sometimes by literally moving

unneeded factories and equipment.

©AFP

15


Gulmira Issayeva, Kazakhstan’s

deputy agriculture minister,

says Chinese companies are in

negotiations to invest US$1.9bn into

Kazakh agriculture – including one

project that would see the relocation

of tomato processing plants from

China to the Kazakh Steppe.

First freight trains from China

arrive in TehranThe overland route takes just

14 days compared with around

45 by sea. New trade routes are

opening, with rail commerce between

China and Europe more than doubling

last year. While Beijing insists its Silk

Road plans are not a geopolitical

gambit, some parties are wary

of China expanding its economic

presence. The creation of financial

architecture to fund 'One Belt, One

Road' – including the US$40bn

Silk Road Fund and the US$100bn

Asian Infrastructure Investment

Bank (AIIB) – met resistance from

Washington and Tokyo. From

Russia, which is promoting its own

integration project, the Eurasian

Economic Union, China’s plans

received a cold reception and were

“perceived as ‘they’re trying to

steal Central Asia from us,’” says

Alexander Gabuev at the Carnegie

Moscow Centre think-tank.

A combination of careful Chinese

diplomacy and Moscow’s economic

woes led to an agreement in

May 2015 to 'co-ordinate' the

projects. The AIIB will work with the

Washington-led World Bank and

Tokyo-led Asian Development Bank

on many investments.

How the Silk Road projects

will be inanced

Foreign investors are joining Chinese

policy banks in providing funds.

"Two years ago people were saying

this is an imperialistic move,"

says Agris Preimanis, Central Asia

Economist at the European Bank for

Reconstruction and Development.

“Now, partly thanks to the way

the Chinese have played it, partly

because of the economic situation,

it is shaping up.”

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Some concerns remain as China’s

influence grows. In a recent outburst,

leaked online, China’s ambassador

to Astana, Zhang Hanhui, upbraided

Kazakhstan over visa difficulties faced

by diplomats’ families. “[China] is the

second largest economy in the world,”

he said. “Like it or not, favourable

conditions should be created.”

Local people are suspicious of

China’s motives. Protests broke

out in several provincial towns in

Kazakhstan in April over a new land

code and fears that the government

could sell off land to China.

Others worry that the new Silk Road

is simply a subsidy for Chinese

companies and that local people will

see little benefit. Corruption is rife in

the region and Chinese projects have

been no exception. In April, a scandal

over the allocation of a road-building

contract to a Chinese company led

to the resignation of the Kyrgyz

prime minister.

“Chinese money will definitely boost

us,” says one Kazakh executive.

“It is beautiful. But who will get the

benefit? The man in the street or

someone in power?”

Selected infrastructure

projects

Moscow-Kazan high-speed

railway A China-led consortium

last year won a US$375m

contract to build a 770km

high-speed railway line between

Moscow and Kazan. Total

investment in the project – set

to cut journey time between the

cities from 12 hours to 3.5 hours

– is some US$16.7bn.

Khorgos-Aktau railway In May

last year, Kazakhstan’s President

Nursultan Nazarbayev announced

a plan to build – with China –

a railway from Khorgos on the

Chinese border to the Caspian

Sea port of Aktau. The scheme

dovetails with a US$2.7bn

Kazakh project to modernize

its locomotives, freight and

passenger cars, and repair

450 miles of rail.

Central Asia-China gas pipeline

The 3,666km Central Asia-China

gas pipeline predated the new

Silk Road but forms the backbone

of infrastructure connections

between Turkmenistan and China.

Chinese-built, it runs from the

Turkmenistan/Uzbekistan border

to Jingbian in China and cost

US$7.3bn.

Selected infrastructure projects

2

3

1

17


Central Asia-China gas pipeline,

line D China signed agreements

with Uzbekistan, Tajikistan and

Kyrgyzstan to build a fourth line

of the Central Asia-China gas

pipeline in September 2013.

Line D is expected to raise

Turkmenistan’s gas export

capacity to China from 55bn cu m

per year to 85bn cu m.

China-Kyrgyzstan-Uzbekistan

railway Kyrgyzstan’s prime

minister, Temir Sariev, said in

December that the construction

of the delayed Kyrgyz leg of the

China-Kyrgyzstan-Uzbekistan

railway would start this year.

In September, Uzbekistan said

it had finished 104km of the

129km Uzbek stretch of the

railway.

Khorgos Gateway A dry port on

the China-Kazakh border that

is seen as a key cargo hub on

the new Silk Road, the gateway

began operations in August.

China’s Jiangsu province has

agreed to invest more than

US$600m over five years to

build logistics and industrial

zones around Khorgos.

Selected infrastructure projects

4

5

6

18

19

Important information: This material in this publication is for information only and does not constitute an offer or solicitation of an order to buy or sell any securities or other inancial instruments to anyone in any jurisdiction in which such offer is not authorised, or to provide investment advice or services. Past performance is not a guide to future performance. The value of investments and any income is not guaranteed and can go down as well as up and may be affected by exchange rate luctuations. This means that an investor may not get back the amount invested. The research and analysis included in this publication have been produced by Columbia Threadneedle Investments for its own investment management activities, may have been acted upon prior to publication and is made available here incidentally. Any opinions expressed are made as at the date of publication but are subject to change without notice and should not be seen as investment advice. Information obtained from external sources is believed to be reliable but its accuracy or completeness cannot be guaranteed. The mention of any speciic shares or bonds should not be taken as a recommendation to deal. This document includes forward looking statements, including projections of future economic and inancial conditions. None of Columbia Threadneedle Investments, its directors, oficers or employees make any representation, warranty, guarantee, or other assurance that any of these forward looking statements will prove to be accurate. This document may not be reproduced in any form or passed on to any third party without the express written permission of Columbia Threadneedle Investments. This document is not investment, legal, tax, or accounting advice. Investors should consult with their own professional advisors for advice on any investment, legal, tax, or accounting issues relating an investment with Columbia Threadneedle Investments. Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058. Issued by Threadneedle Asset Management Malaysia Sdn Bhd, Unit 14-1 Level 14, Wisma UOA Damansara II, No 6 Changkat Semantan, Damansara Heights 50490 Kuala Lumpur, Malaysia regulated in Malaysia under the Capital Markets and Services Act 2007. Registration number: 1041082-W. Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies. Issued 12.16 | Valid to 03.17 | J25899

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ASIA QUARTERLY BULLETIN - Columbia Threadneedle...Indonesia, the world s largest Muslim country. Annual economic growth is consistently above 6%, and a rapidly growing, affluent middle