The MSCI Asia Pacific ex Japan Index, upon which many funds in the sector are based, comprises ten countries: China, Hong Kong, India, Indonesia, Korea, Malaysia, the Philippines, Singapore, Taiwan and Thailand. Many funds investing in the region additionally look to the developed markets of Australia and New Zealand.
While the recent typhoon put the attention of the world’s news media firmly on the Philippines and, to a lesser extent, Vietnam; the fact it took a natural disaster to eclipse China as the region’s focus indicates how dominant in our thinking the emerging superpower has become.
China spent the past two decades as the standard-bearer for emerging market growth, but it is entering a more difficult stage in its development.
In the short term, the increase in global growth has been positive. GDP numbers published towards the end of 2013 showed a slight increase; and while official figures need to be taken with a pinch of salt, alternative measures such as electricity usage and raw materials consumption suggested an uptick.
This, along with continued spending on infrastructure projects by the state, will likely delay any major slowdown in the country for a while.
This uncertainty is reflected in the performance of Chinese equities. The MSCI China Index only outperformed the MSCI World Index in two of the past six years.
While ten-year performance still looks spectacular – MSCI China made 327.42%, compared with 118.6% for MSCI World – in recent years the nation has lagged substantially.
Over the past three years, MSCI World returned 30.27%, versus a decline of 2.02% in China.
While the possibility of a Chinese slowdown is being hotly discussed, it has been evident in the equity markets for some time.
A paper tiger?
Since 2008, developed markets have been in the ascendency, despite the effects of the great recession. The FTSE 100 and S&P 500 indices both generated returns far superior to those of either the MSCI China or Hang Seng benchmarks.
A €100 investment in the Hang Seng Index on 1 Jan, 2008 would have been worth €110.21 in mid-November, for example, while an investor in the S&P 500 could have walked away with €151.36.
In truth, while the credit crunch may look like the point the Chinese growth story came to an end, movements in the respective equity markets are being driven by the same factors. A reduction in risk appetite saw capital leave China for the relative safety of the developed world, despite the West being the origin of the crisis.
Additionally, the abnormal measures in place at the US Federal Reserve influenced asset values in the region. Low yields and returning risk appetite triggered an increase in emerging market investment, as central banks set about creating liquidity; fears of tapering of the US quantitative easing programme led to record outflows from emerging market funds.
The end of the revolution
The medium- and long-term picture is less rosy, however.
The Chinese industrial revolution has started to slow. The influx of cheap labour from the agricultural heartland to manufacturing centres on the coast, while still in progress, is beginning to have less of an impact on the nation’s competitiveness, as the limits of what can be achieved with low-skilled labour are reached and wage demands increase.
Third-party forecasters see China’s annual GDP growth rate dropping from the double digits witnessed over the past ten years to somewhere in the region of 7% over the coming decade.
While this rate is high by Western standards, in China it represents something of an economic plateau, which will require slow and complex structural reforms to overcome.
While there is still massive potential, there are equally large challenges that will need to be surmounted before it is realised.
Beyond China
It is important to remember, however, that Asia Pacific ex Japan is a broad region with a number of fast-growing economies that are worthy of attention.
While the sheer size of China means it tends to dominate regional affairs – and cannot be ignored as the main economic driver – there are plenty of other opportunities to be explored. Equity markets in Thailand, Malaysia and the Philippines, as measured by their respective MSCI indices, all performed better than the MSCI China benchmark over the past one, three and five years.
The MSCI Philippines Index returned 39.43% for the three years to 30 Sep, 2013, and has been the fastest-growing equity market in the Asia Pacific ex Japan region.
The tragic events following Typhoon Haiyan had an impact on the nation, although early analysis suggested it was unlikely to have a massive effect on GDP in 2013, with some estimates suggesting an initial 1% decrease followed by a boost from reconstruction.
While it might seem heartless to focus on growth prospects for the country, investors should have been paying attention before the Philippines hit the headlines.
In 2012, the MSCI Philippines Index returned 40.01%, making it the fastest-growing market in the region, and one of the best-performing markets in the world.
While 2011 saw a small loss of 0.15%, this was still favourable compared with the MSCI World Index, which declined 6.66% that year.
A game of catch-up
The Philippines has become a centre for outsourcing, with call centres and electronics manufacturing moving to the country, following rising costs in both India and China. Additionally, remittance from overseas workers is fuelling a consumption boom.
Some 10% of the country’s 92 million population is estimated to be working abroad and sending money home. This contributes around 10% of GDP, and provides diversification and stability, as workers migrate to a large number of different countries.
A large, young workforce offers better prospects for long-term growth and development than its larger neighbour. Growth in the Philippines can be expected to outstrip that of China for the foreseeable future, as the nation plays catch-up.
People in China are almost three times better-off according to data from the World Bank, with GDP per capita of $6,188, compared with just $2,587 in the Philippines.
Investing in the nation is not without risk however, and it is an emerging market in the traditional sense, rather than the comparatively gentrified experience of investing in China. Volatility in the MSCI Philippines Index is high, at around 25%, compared with 15% for the S&P 500.
Also, as recently witnessed, the nation is prone to natural disasters. Analysis concentrating on this aspect of the country came thick and fast in the wake of the typhoon, and much of the nation’s manufacturing infrastructure was at risk.
Additionally, thanks to China, emerging Asian equities have become more mainstream and are not considered no-go areas – as was the case following the Asian debt crisis of the ’90s. The positive effect of this for investors has been the additional access to capital for smaller companies in the region, and the chance to gain exposure to this asset class.
While the performance of the MSCI Asia Pacific ex Japan Small Cap Index has not been particularly impressive, this could well be the next area of growth as the asset class matures.
