What is the most important event over the past decade? Many would say that the rise of China completely changed the global economic, political, and social landscape. Since China’s entry into the World Trade Organization in 2001, China’s GDP has grown 4.5 times larger, making its economy a growth engine of the world.
In doing so, China has helped reshape the private sector in not only emerging economies but also the developed world. In the past decade, China Exim Bank has extended $12.5 billion more in loans to sub-Saharan Africa than the World Bank. China National Offshore Oil Corporation spent $18 billion to buy Nexen in Canada, while the Chinese sovereign wealth fund China Investment Corporation bought 8.68% of Thames Water, the UK utility group — examples of recent Chinese transactions in strategic industries.
China’s story has been central in discussions about the “Asian Century.” But alongside the growth of Chinese economic and political clout, the rest of Asia has advanced too, playing an integral part in the global economy.
At every turn, we are seeing significant Asian presence in the global economy once dominated by U.S. and European multinationals. South Korea’s Samsung (GM:SSNLF) is the world’s largest mobile phone device manufacturer, a crown once held by the Finnish giant Nokia (NOK). Indian conglomerate Tata Group now owns Jaguar, the iconic British car manufacturer. China’s Lenovo Group (OTC:LNVGY) is the world’s second largest personal computer [PC] maker after its acquisition of IBM’s PC business. Its share price has increased 450% since 2009, while U.S. icons like HP and Dell struggle to maintain growth and market valuation.
In the financial services sector, the Asian financial centers of Hong Kong and Singapore have gained prominence and stature as U.S. and European banks continue to shed employees and deleverage their balance sheets. Post-global financial crisis regulations such as Basel III are likely to lead to a greater pullback of lending in Asia by European banks, giving Asian banks, financial institutions, and investment funds an opportunity to step up to meet the needs of Asian corporations. Standard Chartered estimates a US$340 billion shortfall in European lending over the next five years. Meanwhile, Asian banks have been fortifying their balance sheets and are adopting Basel III this year ahead of many Western banks.
Indeed, Asia has gone beyond being a leveraged play on developed market GDP growth via cheap manufacturing.
Challenges for investors
However, investors face numerous challenges in this disparate and diverse region. With over 2,000 different languages spoken on the continent, a savvy investor will need to be well versed with local culture and customs to be successful.
Every country has its own set of rules and ways of doing business. Requirements for foreign securities trading, for example, vary. India requires a foreign institutional investor license to invest in equities and fixed income. China has quotas for Qualified Foreign Institutional Investors that limit participation in the domestic equity markets.
Apart from the jurisdictional risks, one must also understand the different governance dynamics at play in Asia. The first example of different governance expectations and practices involves family ownership. Unlike typical corporations in the U.S. and Europe that have transitioned to institutional ownership, many prominent businesses in Asia are still family owned and run. This is a tribute to the founding entrepreneurs as they have built businesses that span the globe in just one generation.
But for the investor, a keen understanding of the relationships between the various families is not only useful, but essential for investment success. Family ownership is not necessarily a negative, and in many cases it gets around the “principal-agent” conflict that has often bedeviled investors in “professionally managed” publicly listed companies in the developed world. As a guide to investors, CFA Institute published Related-Party Transactions: Cautionary Tales for Investors in Asia (PDF), a detailed look into the prevalence of related transactions in Asia and how they affect the interests of minority shareholders.
State ownership is another example of a common ownership structure for publicly traded companies in Asia, which poses its own set of governance risks. At the same time, state ownership can also be a source of strength and provide stability to the financial markets. Many recent Asian privatizations have been remarkably successful for investors who bought them on issue — companies that all of a sudden had an incentive to improve performance. Countries themselves have benefited from more efficient state-owned corporations. Many large Chinese privatizations fall into this category.
However, the alignment of interests between a strategic investor and a public shareholder is never complete, let alone when the investor is the state. These dynamics need to be monitored by investors in the region. With many of the largest listed companies in the region having large government shareholders, this is a dynamic that is difficult for investors to avoid in the region.
Another common challenge in many markets in Asia is the insufficient financing for businesses, especially small and medium enterprises. Outside of bank financing or an equity listing, there is very little middle ground for most corporations looking to raise capital in China, Taiwan, and most ASEAN countries. (Debt capital markets represent less than 30% of capital markets in Asia, versus 65% in the U.S.) This has given rise to a large and growing offshore U.S. dollar bond market. A confluence of factors, including low global yield, ageing population, good historical performance, good economic fundamentals, stable politics, strong corporate balance sheets, and low default rates should ensure that Asia’s fixed income markets continue to grow strongly over the next several years.
However, there are some downsides to lending offshore, as enforcement can be challenging due to the different laws in various jurisdictions in Asia, along with the priority that onshore lenders get over their offshore counterparts.
This has given rise to a type of investment fund unique to Asia — a special situations credit fund that is able to capture mid to high teens return on investments with senior type security. A special situations fund can provide alternative source of financing to smaller companies unable to access capital markets that favor strong assets and balance sheets. Private equity and hedge fund players are starting to take advantage of these opportunities, mostly based out of Singapore and Hong Kong. Distressed/special situation funds raised US$2.4 billion in 2012 — the highest level in 6 years.
Moreover, Asia in general and Singapore in particular provide a test bed for innovation in the arena of social enterprise. While there is growing acceptance that a range of development outcomes aimed at the base of the pyramid can be attained via sustainable enterprise, the sum total of funds aimed at financing this space remains a negligible proportion of investable assets. Driven by the demographic and socioeconomic backdrop in most Asian countries, it is reasonable to expect significant growth in the range of activities variously categorized as “responsible investment,” “impact investment” or “social business.” By extending the established models of microfinance and borrowing from the traditional models of investment banking, innovation in the funding of these initiatives will be an aspect of the future of finance in Asia.
How should investors prepare for future opportunities? What will the future of finance in Asia look like?
Asia ex-Japan now accounts for 21% of global GDP, according to the International Monetary Fund (IMF). Even with recovery in the U.S., IMF is projecting that Asia ex-Japan will account for 41% of global GDP growth over the next five years. Asia’s combination of strong underlying GDP growth and evolving governance standards against a backdrop of fragmented and developing capital markets creates great opportunities for agile investors.
The 66th CFA Institute Annual Conference, which will be held for the first time in Asia on 19-22 May 2013, in Singapore, will be a perfect platform to network and learn more about investment opportunities and challenges. Speakers will include investment professionals, academics, government officials, and representatives of regulatory bodies from various markets. Learn what the future holds for Asia and position yourself well in the “Asian Century.”