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COLUMBIATHREADNEEDLE.COM
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
3
Asia Quarterly Bulletin – December 2016
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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Asia Quarterly Bulletin – December 2016
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
6
Asia Quarterly Bulletin – December 2016
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.
7
Asia Quarterly Bulletin – December 2016
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)
9
Asia Quarterly Bulletin – December 2016
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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Asia Quarterly Bulletin – December 2016
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.
12
Asia Quarterly Bulletin – December 2016
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%.
13
Asia Quarterly Bulletin – December 2016
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.
14
Asia Quarterly Bulletin – December 2016
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
Asia Quarterly Bulletin – December 2016
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.”
16
Asia Quarterly Bulletin – December 2016
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
Asia Quarterly Bulletin – December 2016
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
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