I was fortunate to have spent twenty or so years working in Asia. It has been – and continues to be – the highest growth region in the world. Furthermore, equity markets are still on the whole quite inefficient. Thus money making opportunities abound.
"It has not always produced excess returns on capital, to the detriment of minorities"
However, one has to be careful. High economic growth does not necessarily mean high stock market returns. At a company level too, rapid expansion aimed at tapping into the high economic growth can and often does lead to trouble. I thought in this second article for FundsNetwork it might be useful to share one or two of my key experiences and observations of Asia, as they are as relevant today as they were in 1989 when I first worked there. The region remains a great place to invest, and indeed it has been said that the 21st century is Asia’s.
While GDP growth in Asia has been considerably higher than in the US, stock market returns from the region have been poor. From 1988 to 2015, GDP growth in what the World Bank calls East Asia & Pacific has averaged 4.5%, compared with 2.6% for the US. On the stock market front however, the US has been a better place to invest. Since December 1987 when it was incepted, the MSCI Asia Pacific ex Japan index has produced a total US dollar return of 970%. On the other hand, the total return for the MSCI US index over the same period was 1579%. Annualised volatility too has been lower in the US than Asia: 16.9% versus 25.7%.
It is clear that stronger economic growth in Asia has not produced better stock market returns. What this means is that high revenue growth that has gone hand in hand with high economic growth has not filtered down to shareholders in the form of strong EPS growth.
Why is this?
Minority shareholders are just one of a number of stakeholders in any economy. Other major stakeholders include employees, the government, major shareholders, creditors, and suppliers. Along with minority shareholders they all vie for a slice of revenues.
In countries where shareholder rights are well established and protected, minority shareholders can on the whole expect a portion of revenue to accrue to them, commensurate with where they stand in the capital structure and thus the risks they are taking. In Asia however, and indeed in emerging markets generally, this has not been the case. Corporate governance standards have generally been poor, allowing major shareholders at times to benefit at the expense of minorities via related party transactions and the like.
Furthermore, many Asian companies have been keen to expand either into new geographies or new markets. Such investment has almost certainly produced decent tax revenues for governments, and been beneficial for workers, local suppliers and creditors. However, it has not always produced excess returns on capital, to the detriment of minorities.
Asia’s two largest countries, China, and India, provide an interesting contrast. They have both been very high growth economies, and their stock markets both opened to foreigners at the same time in the early 90s. From 1993 to 2015, economic growth in China and India averaged 10.2% and 7.1% respectively. Their stock markets however tell a different story. While the MSCI India index has produced a total real return in US dollars of 601%, the MSCI China has only managed 11%. That’s just 0.4% per annum in country that grew by double digits! Investors who have been lured to China because of its high economic growth may well have ended up disappointed. Although India’s stock market only opened to foreigners in 1992, the country has a much stronger and shareholder culture than China, which may explain the better stock market returns.
But where are the money making opportunities I referred to at the start of this article?
A 2012 paper by US based prof Martijn Cremers entitled Emerging Market Outperformance: Public-traded Affiliates of Multinational Corporations helps explain. He considered the performance of listed affiliates of multinationals, not just in Asia but across the emerging world. He found 92 such companies: 24 in Asia, 15 in Eastern Europe, 22 in the Middle East and 22 in Latin America.
His findings? One dollar invested in the listed affiliates in June 1998 would have grown to $23.03 in June 2011. This compares with a dollar invested in the affiliates’ home stock markets that would have turned into $8.92.
What distinguished these companies in many cases was conservative management and good governance practices, filtered down from the parent. This meant that they only invested where they saw high chance of return on capital exceeding the cost of capital. Furthermore, when they did invest, returns tended to flow down to minorities.
Many of these multinationals had fairly dull businesses such as fast moving consumer goods that in a developed market context would have been considered ex growth. In an Asian or emerging market context however, they made interesting businesses. And with conservative management and good governance, they have made great investments too.
Published in Fidelity Funds Network
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.