Investing in the rise of Asia’s middle class
McKinsey and HSBC estimate that in the next 10 to 20 years, 19 of the world’s 30 largest economies and two-thirds of global GDP growth will come from growth economies (i.e. emerging and frontier markets). Growth markets consumption will reach US$ 30 trillion, nearly 50% of global consumption, up from US$ 12 trillion in 2010. A growth that dwarfs the one of the 1700s Industrial Revolution, where the US and the UK, with a much smaller population, experienced a tenth of the economic acceleration that India and China alone have experienced in the past 15 years. We explore this investment opportunity (with a focus on Asia frontier markets) with Tony Hann, emerging and frontier markets’ investor. Tony is the head of equities at Blackfriars Asset Management, a long only fund specialized in Emerging and Frontier markets.
You manage a long only equity fund specialized in emerging markets and have just altered your Asia ex Japan fund to include Asian frontier markets. Why have you taken this decision?
We are excited about the long term, structural growth opportunities that these markets afford investors. They remind us of what countries such as Indonesia and Thailand looked like 25 or more years ago when we were first involved with Asia.
Can you give us your definition of what you consider a frontier market?
At Blackfriars we see the distinction between Frontier and Emerging as somewhat arbitrary. They are labels devised by the index business in order to generate fees. The markets in Asia are on a continuous spectrum at various stages of development. We do not want to restrict ourselves by the definitions handed out by MSCI so we will consider investment which gives us exposure to any market in Asia.*
What is the size of Asian frontier markets?
We would estimate the market size to be around 600 million people with very favourable demographics.
Can you give us a historical perspective of their growth? What progress have they made?
It is not very helpful to talk of these markets as a group. They are all at differing stages of development. Some, like Sri Lanka, have had stock markets for a very long time. Others like Cambodia have only recently opened an exchange. Others do not have any listed companies as yet. There are businesses operating in all of them and as a firm with a very focused bottom up approach it is our role to identify what we consider to be the best of these companies rather than to pick a market.
How have they performed through the recent global financial crisis?
If we look at the markets that MSCI call ‘Frontier’ in Asia then the performance through and since the crisis has been varied. The chart below shows the market performance compared to the MSCI Emerging Markets benchmark.
How correlated are these economies between them and with the global economy?
The correlations are low. The table below shows the correlation between the markets on the previous graph plus the S&P 500 (SPX) and the Euro-Stoxx 50 (SX5E)
As you can see the correlations between MSCI EM, S&P 500 and EuroStoxx are high but with the other markets the correlations are low or negative.
One of the main risk of frontier and emerging markets has been a reversal following the initial take off, what economist refer to as the “poverty trap” due to conflicts or a lack of adaptation of their soft infrastructure (e.g. policy frameworks and financial sector regulation) to the new paradigm they find themselves into. How do Asian frontier markets have managed this challenge so far?
Again the answer is not uniform across markets.
Vietnam and Sri Lanka have made good progress here, Pakistan and Bangladesh not as far advanced.
Cambodia is making good strides but has some way to go.
Burma has gone backwards for a prolonged period but we are seeing some changes there now.
Looking ahead – where will their growth be primarily derived from?
Broadly speaking the two key areas are likely to be infrastructure and consumption.
We have seen several hundred million consumers with some kind of discretionary spending power emerge over the last decade.
A large number of these have come from China but going forward, given the poor demographics and slowing growth in the PRC, we expect an increasing proportion to come from south and south-east Asia in both emerging and frontier markets.
Could you tell us about your company and how you position yourself among the options (private equity, ETFs, Debt, Equity etc.) a non local investor has when looking to gain exposure to these emerging and frontier economies?
As a company we invest direct in listed equities. Our fund is open for trading daily so private equity would be problematic. We do not buy ETFs.
Prior to opening your fund to Asia frontier markets, what was your performance?
The fund launched in 2004. Since launch the fund has had a CAGR of 8.4% (U$)
You use a bottom up approach, where you cherry pick companies to invest in. Can you tell us how you source your investment opportunities for your Oriental focused fund?
We source investment ideas in a variety of ways. We do meet the companies, both in the region (the co-manager Henry Thornton is in Asia for the next 2 weeks) and in London. We have a couple of screens that we use to point us in the direction of potentially interesting companies and we read extensively.
Using a bottom up approach we do not focus on specific countries or sectors but our views on the long term underlying macro fundamentals to lead us to believe that there are better growth prospects in the markets of the Indian subcontinent and South East Asia.
Is there a difference in the way you do equity valuations on frontier markets companies ?
We approach valuation on a company by company basis and use our long experience with these markets to decide what is appropriate. For emerging and frontier markets there are sometimes greater risks around corporate governance and the political & regulatory framework so in a DCF type framework we would apply a higher discount rate.
What investment process do you go through when selecting a company?
We are patient, long-term investors. Our aim is to invest in a business (by buying its shares) and then hold it indefinitely. In our view, the best returns are delivered by the power of compounding. With this type of buy and hold approach, making the correct initial purchase decisions is key, so we spend a lot of time researching a company before acting.
The best companies have a robust business model, strong management and exhibit good capital discipline and we study the historical performance of a firm to establish its track record in these areas before looking to the future.
We do this in a quantitative way by analysing a company’s financial statements and also qualitatively – researching the sector, meeting management and investigating competitors.
What is your exit strategy?
Our investment philosophy is such that we want to own indefinitely and compound our returns so we are not actively looking for an exit point.
Our process leads us towards companies that perform steadily but consistently and if the underlying investment thesis remains intact we will remain holders.
However, things do not always go to plan so we operate a soft stop-loss discipline to ensure that positions which are underperforming do not go un-noticed.
*For reference MSCI defines Asian markets as follows:
Developed: Hong Kong, Singapore (Japan)
Emerging: China, India, Indonesia, Malaysia, Philippines, S. Korea, Taiwan, Thailand
Frontier: Bangladesh, Pakistan, Sri Lanka, Vietnam