Emerging Asian equities have suffered in the short term because of China’s slowing growth and trade tension with the US but Fidelity’s Dhananjay Phadnis believes there are long-term reasons for confidence in the region. 
Last year, the MSCI Emerging Markets Asia index dropped 10.2 per cent (in sterling total return terms) compared with a 9.27 per cent fall in the broader emerging markets index and a 3.04 per cent slip in the developed markets-focused MSCI World.
Of course, one of the biggest factors affecting markets in 2018 was the trade war between the US and China, while the Chinese economy has started to slow. Both of these factors have dented sentiment towards emerging Asia.
Performance of indices in 2018
Source: FE Analytics
Phadnis, who runs the UK-domiciled Fidelity Emerging Asia fund, noted that China is indeed a major driver of sentiment towards the rest of the region and has affected its markets for much of the recent past.
“After implementing a massive stimulus package in 2015, the Chinese authorities have shifted emphasis since the middle of last year and actively pursue deleveraging with a clampdown on shadow banking, curbs on property sales and significant restrictions on off-balance sheet debt in infrastructure project,” he explained.
“These measures, along with fears of an escalation in trade war, have led to a decline in corporate earnings and impacted equity markets. My view is that we are now closer to the end of this phase as China is reversing its deleveraging process and trade war concerns will potentially ease over time.
“With aggregate valuations attractive - even after discounting the current expectation for a likely slowdown in earnings growth - I see potential for strong returns once the near-term overhang of trade wars clear.”
However, the Fidelity Emerging Asia manager is also keen to point out that China isn’t the only factor that affects the direction of the region’s markets. In fact, he highlighted seven themes that could influence the long-term outlook for both good and bad.
The first is the tech hardware sector, which saw strong growth thanks to rising smartphones penetration; however, sales volumes are now starting to decline in many markets as ownership plateaus. Phadnis noted that this theme has “significant” implications for Taiwanese, Korean and Chinese companies that derive earnings from supplying components into the global supply chain.
India’s ‘twin disruptions’ – in the form of demonetisation and the goods & services tax – have caused temporary setbacks to the recovery in the country’s economic cycle. The manager believes that initiatives such as the tax are long-term positives for the Indian economy, but thinks its full recovery may be delayed by issues such as the recent liquidity crisis and the upcoming national elections.
He added that investors in emerging Asia cannot ignore the impact of reforms, which is the third theme highlighted. “Elections in India, Indonesia, Philippines, and more recently in Malaysia have highlighted public preference for a reform and growth-minded governments focused on clean governance,” he said. “Under president Xi, China has also undertaken major anti-corruption and financial system reforms.”
Performance of index over 5yrs
Source: FE Analytics
The fourth theme that Phadnis drew attention to is increased regulatory intervention, which are leading to leading to earnings uncertainty and could potentially delay corporate capital expenditure plans.
Examples include Chinese regulators intervening in areas such as peer-to-peer loans, education, gaming, content production and healthcare while the Korean government increased regulatory oversight of sectors such as banking and finance.
The manager also pointed out that the “re-wiring” of global supply chains has recently accelerated because of fears of escalating trade wars. “Global and Chinese companies alike are beginning to relocate their manufacturing chains to countries such as Vietnam, Cambodia, Bangladesh and India,” he said. “This has material implications for job creation and consumption in these countries.”
Asian companies are at the forefront of areas such as artificial intelligence and machine learning, meaning new technologies are another theme that could affect the region. This trend is clear in China, where companies likes Meituan Dianping, Tencent, Alibaba, Sensetime and Bytedance are pioneering new products and services; these can add significant value to some industries while disrupting many others.
The final theme highlighted by Phadnis is the development of China’s A-share market. “Perhaps the biggest change from an investible universe standpoint has been the gradual opening-up of the Chinese A-share market,” he said.
“Although the fund has been exposed to the A-shares for some time now via QFII [Qualified Foreign Institutional Investor] quotas, access has now become much easier with the North-South connect programme. There are some very strong businesses in China, and easier access to this market and to their management teams continues to throw up more and more attractive investment opportunities.”
Given this backdrop, Phadnis said he is seeing an “array of opportunity” in emerging Asia as a favourable valuation backdrop has combined with strong structural growth prospects and drivers such as rising consumption, urbanisation and innovation.
The manager has made recent investments in Hong Kong-based insurance company AIA (“at the cusp of a major opportunity in China”), A-share listed Guangzhou Baiyun International Airport (“will see a recovery as earnings improve from a favourable base”) and India’s Axis Bank (“gone through a dramatic clean-up of non-performing and risky loans”).
Performance of fund vs sector over 5yrs
Source: FE Analytics
Phadnis’ £88m Fidelity Emerging Asia has made a 108.21 per cent total return over the past five years, which puts it in the top quartile of the IA Asia Pacific Excluding Japan sector.
The fund has an ongoing charges figure of 0.98 per cent.