Uncapped Innovation

Portfolio Manager Michael Oh, CFA, says attractively valued companies are growing in Asia unfettered by inflationary headwinds.

How do you view the current state of innovation within Asia?

A lot of the focus from international investors has been on innovative tech stocks in China. It’s not surprising. Since the initial public offering (IPO) of Ant Group was cancelled in 2020, the Chinese government has overhauled regulation of its booming internet and e-commerce sectors. The intervention was aimed at improving oversight, stabilizing exuberant capital flows and safeguarding consumer choice but its execution was heavy handed and poorly communicated which has generated bearish sentiment among foreign investors.

These stocks in China have also been negatively impacted by ongoing geopolitical tensions with the U.S. as well as by China’s zero-COVID policy which has seen large swathes of the country plunged into lockdown. But there are reasons to be positive. We see internet regulation and zero-COVID as temporary headwinds which we expect to unwind over the coming months and while tensions with the U.S. will likely remain, valuations stand out. For many Chinese internet companies, valuations are nearing all-time lows and as the environment becomes more favourable we expect them to positively reprice.

While we see a promising recovery in China, it would be a mistake to focus all our efforts there. Beneath the global inflationary headwinds, Asian economies are resetting after the pandemic and innovation is growing. India, for example is very exciting. There are many interesting, innovative companies including some recent IPOs and while the country is still probably 15 to 20 years behind China when it comes to internet businesses and e-commerce platforms, it's moving in the right direction. There's also Indonesia, which we are excited about, where it is more about consumer-facing innovation. For example, auto dealers are working in partnership with Japanese companies to bring EVs to the Indonesian market. There is also a general uptake in digital services, particularly fintech and eCommerce.

And, of course, South Korea and Taiwan, have thriving innovative and technology-driven companies that warrant attention.

What are the key innovative developments you’re seeing?

For South Korea, the most interesting moves are within electric vehicle (EV) batteries. In the global market, roughly 90% of these batteries are made by Asian companies based in South Korea, Japan and China. There are several South Korean companies that are prospering and even investing in the U.S., so that’s becoming a global story.

The semiconductor industry in South Korea and Taiwan is also very dominant. There are the big names but importantly there are also smaller chip designers which act as more of an enabler to the industry and they are blossoming right now.

Are Asian markets specializing in innovative areas?

Given its scale, the Chinese economy is permeating many areas of innovative activity and in certain industries, such as online gaming, it’s dominating. Other markets have honed narrower strengths. Taiwan, for example, is a global leader in the semiconductor industry.  Growth in fintech and digital financial advisory services is more concentrated in the Association of Southeast Asian Nations (ASEAN) region, in economies like Malaysia, Vietnam, Indonesia and Thailand.

What effect has inflation had on technology and innovation in Asia?

High-growth technology companies have been out of favour for much of 2022, and have derated significantly as investors reappraised their prospects against a global backdrop of rising interest rates and higher inflation.

Inflation, however, has not been a big issue in much of Asia—certainly not to the extent that we are seeing in the U.S. and other developed economies. Asian governments, in general, have been more prudent when it comes to financial stimulus and there are few signs of overheating in Asia. Many economies have yet to return to pre-pandemic levels of economic growth. That's why we are not seeing the same escalation of prices in Asia that we see in the U.S., for example, where more cash was handed out for recovery from the pandemic and the labor market is tight.

We also believe it’s unlikely that we will see large rate hikes in Asia. China, for example, has been able to cut interest rates, lowering the cost of capital for companies. In fact, China is going in the opposite direction to the West. It has the ability, should it wish, to come out with a larger stimulus package simply because it didn’t really spend during COVID.

What is your approach on investing in pre-IPO companies?

The IPO market has been quiet over the past few years but we do keep in touch with a lot of private companies and if there’s something that we’re keen on we’re happy to get involved pre-listing. If we like a company a lot, we may look to go in as a cornerstone investor whereby we receive a greater IPO allocation in exchange for a six-month commitment. But as a general rule, we try to find companies that we can invest in over a three-to-five-year timeframe. Our objective is to find companies that can double their market cap within five years.

What is your outlook for Asian innovation?

The most important market for us is still China. It has had its challenges of late but we feel that valuations are attractive enough to offset those issues, most of which are largely temporary. Geopolitical risks will remain but we think the domestic growth story will be more than enough for us to find great opportunities within China. In the short term, we think China remains the biggest swing factor and probably has the most upside potential.

The EV space is also looking very interesting and even if the global economy falls into recession the penetration of EV cars will continue. Likewise, we anticipate continued investment in both the consumer discretionary and health-care sectors.

We’re still seeing healthy growth in internet companies. It is far from a niche market. Culturally the internet has become a big part of daily life for the Asian consumer and that will grow. There are also specific growth drivers for digital consumer services. Fintech, for example, is really taking off, especially in Southeast Asia and India. In these markets, the physical banking infrastructure is poor and as a result more consumers are fully embracing digital finance.



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