Asia’s track record for exceptional growth in the modern era spans from the 1950s to the present. This research explores North American institutional investors’ plans, priorities, and strategies for investment in Asia, as the pressure to pursue performance builds—and demographic forces, political and governance reforms, and the prospect of new multinational trade agreements refocus attention on the region.
Asia is undeniably the world’s fastest-growing, most dynamic economic region. Asia’s modern track record as a growth powerhouse began in the 1950s and 1960s, when Japan emerged as one of the world’s largest economies in the course of its postwar revival.
From the 1960s through the 1980s, Hong Kong, Singapore, South Korea, and Taiwan—the Four Asian Tigers—carried the region’s growth story forward. All four Asian Tigers enjoyed extraordinarily high, sustained rates of growth as they first industrialized rapidly, then successfully transformed themselves from low-cost manufacturers to advanced economies with large populations of highly skilled, high-income workers. Hong Kong and Singapore today are leading global financial centers and key hubs for international trade. South Korea and Taiwan have become leaders in complex manufacturing.
The region’s economic momentum continued to build over the course of the 1990s, as China and its neighbors in southeast Asia enjoyed manufacturing-export fueled growth rates that far outpaced their counterparts in the West. Meanwhile, India built on its labor-cost advantage to become a global leader in information and business services.
Although growth in Asia has slowed in recent years due to a weak global recovery, a slowdown in global trade, and the effects of China’s economic transition, Asia remains an engine of global economic expansion. According to the IMF, Asia now accounts for nearly two-thirds of global growth. A robust labor market, rising disposable incomes, a growing middle class, the prospect of new regional and multilateral trade agreements, and increasing momentum toward political, economic, and governance reforms are among the many factors that are refocusing institutional investors’ attention on Asia.
To explore North American investors’ priorities, plans, and strategies for investment in Asia, Institutional Investor Research, in collaboration with Matthews Asia, surveyed 116 institutional investors based in the United States and Canada. We supplemented survey results with a series of in-depth, one-on-one interviews with senior decision makers at large pensions, foundations, and endowments. The following is a report on our findings.
Challenged by a low-yield environment and faced with increasing volatility and uncertainty in the West, institutional investors recognize the growing appeal of investment in Asia. As a result, investors expect to focus greater investment-management effort, attention, and resources on Asia in coming years.
The institutional investors who responded to our survey recognize that Asia represents opportunity: a majority of respondents agree that Asian markets are likely to offer higher risk-adjusted returns than markets in North America (65% agree), Latin America (70% agree), and Europe (74% agree), respectively.
These growth prospects gain additional appeal when placed in context with growing uncertainty and volatility around the world—including the developed markets of the West. Eighty-two percent of all respondents agree that geopolitical uncertainty and market volatility have made meeting performance targets more challenging in general. As geopolitical uncertainty in the West—including the Brexit vote and potential turmoil in the European Union, threats of violence, and the prospect of a new administration in the United States, among other factors—takes on a new and unsettling cast, a majority of respondents (63%) say that geopolitical uncertainty in Europe and North America is likely to increase the appeal of investment in Asia among North American investors. In light of all these forces, it can hardly be a surprise that a vast majority of institutional investors—89%—agree that potential growth in Asia’s markets is too great for North American investors to ignore over the next five years.
Interview sources confirm that Asian investment is becoming increasingly attractive as the search for yield becomes increasingly urgent. Central banks continue to dominate markets. As a result, the value of negative-yielding bonds worldwide topped US$13.4 trillion in August 2016, as this research was being conducted. Negative interest rates now feature in about one-quarter of the global economy. Exploring investment in Asia’s relatively fast-growing emerging markets—particularly those benefiting from a rapidly expanding consumer class—is, sources say, an essential path to performance amid seemingly unprecedented yield scarcity.
Although few investors disagree about Asia’s potential, many respondents say their funds’ allocation to Asia today is relatively small. Nearly half of all respondents (47%) say their allocation to Asia’s emerging markets is less than 5%; approximately the same proportion (41%) say their allocation to developed Asia is less than 5%. (See Figure 1.) Only about one in five (21%) report their allocation to emerging markets in Asia is greater than 10%; even fewer (17%) say the same for developed Asia. Those figures are, however, poised to change: a solid majority of respondents (66%) anticipate that their fund’s allocation to emerging markets in Asia is likely to increase over the next five years. Nearly half (49%) expect their allocation to developed markets in Asia will increase over that time frame.
Allocation size is, of course, only one dimension of the effort, attention, and resources that investors plan to place on Asia in coming years; their approach to that allocation is also important to consider. Survey results reveal a marked trend among investors toward a long-term, strategic approach to Asia. The number of respondents, for example, who predict that their investment objectives in Asia will become increasingly strategic over the next five years (26% of all respondents) outnumber those who say their objectives will become increasingly tactical (7% of all respondents) by a factor of more than three to one. Respondents who anticipate that their approach to Asia will become increasingly active over the next five years (26% of all respondents) outnumber those who expect their approach will become increasingly passive (11% of all respondents) by a margin of more than two to one.
This anticipated shift in approach is underlined by indications of a shift in asset allocations. Across the population, respondents anticipate more emphasis on management-intensive private equity and direct real estate, infrastructure, and other alternatives—and less emphasis on public equities—over the next five years (see Table 1).
In one-on-one interviews, sources point out that these alternative investments can often benefit from institutional-quality management attention and expertise. Becoming more closely involved in longer-term investments like these, investors say, can also support information sharing, transparency, and improved insight into the company’s performance and prospects.
Across the survey population, investors currently dedicate a larger proportion of their portfolio allocations to developed markets in Asia, compared with Asia’s emerging markets. Fifty-nine percent of respondents allocate 5% or more of their total portfolio to developed Asia, compared with only 53% of respondents who say the same for emerging-markets Asia (see Figure 1).
But survey results also suggest that this trend is set to change: Two-thirds of respondents expect their allocation to Asia’s emerging markets is likely to increase over the next five years. In contrast, only 49% of respondents predict their allocation to developed Asia will increase over the same time frame.
The investors we interviewed for this study confirm this orientation to Asia’s emerging markets, characterizing the trend as simply following the opportunity. “Especially in this yield-challenged environment, we’re committed to following the opportunity, wherever that might take us,” one investor said. This research shows that North American investors expect their quest for returns will lead them to emerging markets in Asia.
Even as prospects for growth and potential for yield increase Asia’s appeal to investors, uneven governance, risk, and compliance (GRC) standards and market shortcomings call for careful attention and deliberate, well-informed action.
Given the intense pressure to meet performance targets in a low- to no-yield environment, what barriers stand in the way of pursuing the Asia opportunity? Survey results confirm persistent caution regarding Asia investment among institutional investors, tied to uneven governance, risk and compliance (GRC) standards, political interference, and other market shortcomings. Seventy percent of all respondents agree that “North American institutions should be wary of investing in Asia due to political and regulatory risk.” The top barrier cited by respondents to approaching Asia’s emerging markets as a strategic investment (as opposed to merely a tactical investment) are uneven GRC standards (cited by 56% of respondents), followed by political interference/lack of political will to enforce free trade (42%). (See Figure 2.)
When queried on a broad array of potential geopolitical and economic events that might influence investment decisions, the developments that would be most likely to strongly encourage investment in Asia, according to respondents, center on market and GRC improvements: “Emerging-market Asian countries take major steps to increase market transparency and improve corporate governance” (50%) and “Developed-market Asian countries take major steps to increase market transparency and improve corporate governance” (39%).
But these perceptions, too, seem to be on the verge of change as momentum toward structural economic and political reform builds in Asia. Survey results suggest that, in general, investors will move their attention to Asia over a longer, three-year time horizon, as regulatory and structural improvements take shape. Over the shorter time frame of 12 months, only 39% of respondents say they’re likely to increase their allocation to Asia; more than half (61%) say they are not likely to increase their allocation to Asia. These figures reverse when the time frame extends to three years. Over that longer time period, 71% of respondents anticipate increasing their allocation to Asia; only about 29% do not.
“You do have to be careful in Asia,” one interview source says, articulating a sense of caution that was universally ratified by his fellow interview-program participants. Several sources recount first-hand observations in Asia of poor-quality company reporting, substandard management practices, and confused priorities, ultimately leading to value destruction and investment losses. But investors participating in the interview program also agree that governance and management practices in Asia are heading in the right direction (even if they disagree to some extent on the pace of progress). “There’s a new generation of managers in Asia who are very focused on creating value and generating returns,” one source says, citing a trend toward more sophisticated, professional management among enterprises in Asia’s emerging markets. “I’d like to see better quality reporting and greater transparency in Asia,” says another. “We’re not there yet, but overall things are heading in the right direction.”
Several sources explain that information, governance, and management shortfalls call for investors to engage much more deeply in Asia, by taking an active approach to investment; developing close relationships with asset-management resources specializing in the region; and spending time with local Asian corporate-management teams. Adopting a longer-term, more strategic view on investment, they say, improves the odds of finding sustained success in Asia, as opposed to relying on incomplete public reporting and less than fully informed markets to seek short-term gains.
The expansion of the consumer class, growing momentum toward political and regulatory reform, and improved access to markets are each key components of an evolving Asian investment landscape. Investors see bright prospects not only for Asia’s existing financial centers, but also for countries with favorable demographic profiles and demonstrable progress toward political, regulatory, and market reform.
One of the best illustrations of the Asian growth phenomenon is the towering stature of Hong Kong and Singapore as two of the world’s leading financial centers. When asked about their outlook for investment for various Asian markets, respondents across the population acknowledge the position and growth potential of Asia’s major financial centers. Forty-four percent of respondents, for example, hold a positive outlook for Singapore, offset by only two percent who hold a negative outlook. Similarly, 40% of respondents have a positive outlook for Hong Kong, while only five percent of respondents hold a negative outlook for Hong Kong (see Table 2).
But investors also see robust prospects—perhaps the most robust prospects—outside of Asia’s established financial and manufacturing centers, particularly in Asia’s emerging markets. These emerging markets stand to benefit most from powerful, underlying demographic forces and growing momentum toward reform. Across the population, survey respondents hold positive expectations across emerging Asia, including well-established manufacturing powerhouses Korea (41% hold a positive outlook, compared with only 4% with a negative outlook) and Taiwan (33% hold a positive outlook; only 5% hold a negative outlook). Among Frontier Asia markets, they are notably upbeat on Vietnam: 42% of respondents hold a positive outlook for Vietnam, compared with only 10% who hold a negative outlook.
Among many bright prospects in Asia, India stands out in particular. Nearly two-thirds of all respondents (63%) hold a positive outlook for India; only 7% say their outlook for India is negative. China also amassed a substantial number of respondents holding a positive view on its prospects (42%), although a meaningful number of respondents—17%—also hold a negative outlook for China.
Participants in the interview program affirm a positive outlook on India in particular, based in part on recent, sweeping tax reforms that will help to create a more predictable and transparent investment landscape across the country. Interview sources also identify China as an especially appealing investment destination, especially over a longer, three- to five-year time horizon, as the country works through its transition to an economy fueled in large part by domestic consumption.
The inclusion of China A-shares in global benchmarks would represent a major milestone on the road toward market transparency and access in Asia. The prospect of such a move promises to expand the invest-able universe substantially. As China makes strides toward opening the A-share market to investors around the globe—in particular, through the inclusion of A-shares in key global benchmarks—anticipation regarding the A-shares opportunity is building. A majority of respondents to our survey (61%) predict that adding China A-shares to the MSCI benchmark would encourage investment in Asia.
But respondents seem to be less than fully confident in their overall level of preparation with respect to China A-shares. Only 20% of respondents say their own teams are “very well prepared to understand the risks and opportunities presented by A-shares.” Even fewer (14%) say their external consultants are very well prepared in this respect. On a brighter note, respondents seem to be more confident in their external asset managers’ ability to take full advantage of the A-shares opportunity—47% of respondents report that their current asset managers are very well prepared with respect to A-shares. Taken together, survey results suggest that investors have yet to fully digest the potential impact of A-shares on their approach to Asia.
When considering the appeal of greater access to China A-shares, the investors we interviewed as a group hold mixed views. Those who had invested in China’s public equities market prior to the stock market crash of 2015 were especially apt to voice skepticism, as they expressed concern that more access to A-shares could stimulate the formation of another market bubble. Other investors, however, see the evolution of the A-share market as a buoy for transparency and investment quality, through at least two mechanisms: additional oversight applied to A-shares through index fund providers’ standards for inclusion; and the incorporation of the observations, information, analysis, and assessment of an influx of many new market participants. With Chinese regulators continuing to make progress in meeting the remaining hurdles toward full inclusion of A-shares in global benchmarks—recently declaring A-shares’ eventual inclusion “purely a matter of time”—interest and attention among investors in the A-shares opportunity will continue to grow.
Survey results suggest that investors are relying on external asset managers to help them understand the opportunities and risks associated with key developments in Asia, such as the prospect of increased access to China A-shares. What do investors consider most important in asset managers focused on Asia? The attributes that investors most often say they value are tied to experience in Asia and Asian investment talent. Having portfolio managers and analysts based in Asia is the most valued trait across the respondent population (59%), followed closely by a long track record of investing in Asia (54%) and by Asian cultural and language competency (41%). Having a “singular focus on Asia” follows other factors (20%). (See Figure 3.)
In individual interviews, investors echo the perceptions expressed through survey results, citing local talent in Asia and a long record of successful investment in the region as key qualities in external managers for several reasons. First, the unfamiliar regulatory and business landscape demands local insight, sources say. Second, a long track record in Asia provides rich and varied experience, and shows that the manager has had time to develop the kinds of deep relationships that can help to transcend deficiencies in formal reporting. Finally, sources emphasize the importance of working with Asia-focused managers that hold values consistent with their institution’s approach to investment—pursuing investment in Asia to attain performance goals by promoting and facilitating the creation of economic value, while avoiding short-term speculation.
The balance of risk and opportunity that has recently favored the developed markets of the West is shifting. Europe and North America have been increasingly buffeted by major developments that are likely to have profound consequences on regional growth and stability. In Latin America, reduced demand for commodities, volatility in financial conditions, and persistent domestic imbalances, among other factors, continue to generate drag on the region’s growth prospects. The outlook in Africa has also been weakened by falling oil and commodities prices and pervasive political uncertainty. In this changing global landscape, Asia—with its powerful growth engine in the form of a rising consumer class—will compare increasingly favorably.
The universe of available investment opportunities in Asia is expanding—a trend exemplified by increasing access to China A-shares and the near-term prospect of their inclusion in global benchmarks. This survey confirms that institutional investors are placing Asia closer to the center of their investment plans and priorities. Their ability to identify, assess, and optimize the risks and opportunities presented by Asia may make the difference between achieving performance goals, or falling short of them.
Asia currently represents one-third of global GDP and more than half of global growth. Despite its size and global impact, accessing both developed Asia and the region’s emerging markets poses challenges to institutional investors in the West. Asian equities today represent a relatively small part of both developed and emerging-market indices. At the same time, the investors who participated in this research make clear that deep engagement in Asia is a path to strong, sustainable returns. Uneven GRC standards, a lack of market transparency and information, and a lack of familiarity with the Asian business landscape are all factors that have stood in the way of that level of engagement in the past. But the results of this study show that change is in the offing, as investors look beyond no- and low-yield markets in the West to focus their attention on the Asia opportunity.
This research reveals several important trends: First, investors affirm Asia’s growth potential compared with other major regional markets, fueled by highly favorable demographic forces that are creating a powerful new consumer class. Investors also recognize that the risk/reward balance is shifting again in favor of Asia, as they factor growing economic and geopolitical uncertainty—most recently exemplified by the Brexit vote—into investment prospects in the West. It comes as little surprise, then, that allocations to Asia are poised to increase, particularly to high-growth emerging markets in the region. This growing interest in Asia is supported by recent reforms that signal positive, if gradual, transformation in the region’s regulatory and market landscape. Market access in Asia is also improving—a trend perhaps most clearly demonstrated by the near-term prospect of including China A-shares in global benchmarks.
As these various forces—the pressure to seek growth and returns; increasing uncertainty in the West; growth prospects in Asia; and regulatory and market improvements—come together, many institutional investors are now considering how, as a practical matter, they can take advantage of the Asia opportunity. As this research demonstrates, their answer lies with deeper, longer-term, more committed engagement in Asia. Rather than approaching Asian investment as a source of short-term, tactical investment of limited scope, investors plan to take an increasingly strategic, long-term approach to the region. Doing so will require time, resources and—as the investors participating in this program point out—the right partners.
Local talent, a long track record of success in Asia, and deep familiarity with Asia’s unique opportunities and risks are all critical attributes of a strong partner in Asia, according to investors. At the same time, investors are seeking partners who share their institutional values and pursue investment approaches that fundamentally support the long-term strength and viability of their organizations.
Uncovering opportunities while navigating risk effectively is challenging work, especially in unfamiliar business and investment environments. This research shows that North American investors are increasingly embracing this challenge in Asia. As investors themselves recognize, those who succeed will do so by devoting the time, effort, and resources that yield deeper insight into the Asian investment landscape and, ultimately, a more robust and fruitful understanding of the Asia opportunity. We at Matthews Asia look forward to partnering with you to make the most of that opportunity.
Head of North American Institutional Business
At Matthews Asia, we believe in Asia’s profound potential for long-term growth, concentrating our efforts and expertise within the region since our founding in 1991. As an independent, privately owned firm, Matthews is the largest dedicated Asia investment specialist in the United States. Throughout our 25-year history, we have applied our high degree of conviction and our bottom-up, fundamental investment philosophy with a focus on long-term investment performance. Our track record of success extends through a variety of market environments. Today, we offer a range of carefully selected strategies that provide exposure to the equity and bond markets of one of the world’s fastest-growing regions. Together, we partner with our clients to craft investment solutions best suited to their unique goals and tolerances, investing in the future of Asia.
In August 2016, Institutional Investor Research (II Research), in collaboration with Matthews Asia, launched a research study based on a survey and interview program among North American institutional investors.
To explore North American investors’ priorities, plans, and strategies for investment in Asia, II Research surveyed 116 institutional investors based in the United States and Canada. II Research also conducted a series of interviews with Chief Investment Officers and other senior investment executives at leading institutions across North America to gather additional insight into the survey findings.
Survey respondents hold the following titles:
Chief investment officer: 26%
Managing director: 19%
Portfolio manager: 18%
Equity analyst: 18%
Director of research: 5%
Chief operating officer: 4%
Respondents work for the following institutional types:
Foundation or endowment: 24%
Public pension: 19%
Family office: 16%
Private pension: 14%
Institutional consultant: 13%
Insurance company: 7%
Assets under management for participating institutions are as follows:
US$50 billion or more: 11%
US$10 billion to US$50 billion: 19%
US$5 billion to US$10 billion: 15%
US$1 billion to US$5 billion: 26%
US$500 million to US$1 billion: 27%
Less than US$500 million: 2%
FOR INSTITUTIONAL USE ONLY – NOT FOR RETAIL DISTRIBUTION
The views and information discussed in this report are as of the date of publication, are subject to change and may not reflect current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. Investment involves risk. Past performance is no guarantee of future results. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. The information contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation, but no representation or warranty (express or implied) is made as to the accuracy or completeness of any of this information. Matthews International Capital Management, LLC (“Matthews Asia”) does not accept any liability for losses either direct or consequential caused by the use of this information. This report is for informational purposes and is not a solicitation, offer or recommendation of any security, investment management service or advisory service.