The UK’s baby boomers are retiring in large numbers at a time when the typical balanced 60/40 portfolio is being undermined by an era of ultra-low interest rates.
The combination of a series of financial crises through the 1990s and 2000s along with the deflationary forces of ageing demographics, technological innovation and globalization have allowed central banks to lower rates without fears of stoking inflation.
Developed market bonds and equities are priced for perfection while yields are beginning to rise as economies reflate out of lockdowns. As a result, allocators including Singapore’s $400bn (£288bn) sovereign wealth fund (GIC) expect real returns of just 1-2% after inflation per year over the next decade, compared to returns of 6-8% over the past 30-40 years.
Clearly, there is a major puzzle facing allocators in working out how they can generate growth, income and inflation protection for boomers heading into retirement.
Seeking out diversified sources of growth and income will be key to generating sustainable returns, and Asian Equities currently offer an attractive combination of the two. The investment case for Asian equities over the next 10 years is strong, based on three key points: Asia led the initial global response to Covid-19; that successful containment has allowed for economies to recover faster; and Asia is underpinned by long-term structural growth factors that should generate compelling returns.
Response to Covid-19
East Asia’s experience with pandemics meant that these countries were better prepared to combat Covid-19. Countries such as South Korea, China and Taiwan that implemented effective
testing, tracing and quarantine systems were early to enact social containment measures and generally kept larger parts of the economy functional during any restrictions.
Source: Our World in Data
Faster recovery and less reliance on stimulus
Although GDP growth in Asia was hit as hard as elsewhere in the world, it is forecast to bounce back faster. According to data from the IMF, the GDP of the Asia Pacific region shrunk by only 1.3% in 2020 and yet is set to grow this year by more than 7%.
By contrast, the UK economy declined by almost 10% and is expected to grow by 5.3% this year. In each of the next five years, Asia Pacific is expected to grow at a faster pace than the UK, US, Europe and Japan.
Source: IMF
Further, governments in developed markets abandoned concerns over deficits through the pandemic, with monetary and fiscal stimulus dwarfing that seen during the global financial crisis. The response in Asia has been much more restrained, either through good management or necessity depending on the positions countries were in.
Source: JP Morgan Asset Management
Better-positioned for sustainable growth
Healthier sovereign balance sheets across Asia should support more sustainable growth in the decade ahead. Economies are beginning to reflate, while corporate debt increases through the pandemic have been manageable, helped by low rates and a weaker US dollar.
Longer term there are demographic factors that will fuel growth in the region, such as a growing middle class in countries such as China and India.
One important caveat here is that Asia still faces hurdles in the short term. Progress in vaccination drives across Asia has been mixed, and fiscal and monetary policies are starting to tighten.
While Asian countries are unlikely to face the same fiscal and monetary constraints as the West in the long term, we don’t think this is a time to be throwing caution to the wind. In this environment it will pay to be selective.
Moreover, valuations in pockets of our universe looked stretched, especially in China and tech platforms, which appear vulnerable to disappointment as markets move past the pandemic.
Further, while broad thematics based around Covid-19 winners and losers have dominated the performance of Asian equities recently, this will likely be transitory.
Asia provides a rich opportunity set for dividend growth
While corporates in other regions including the UK have a more established dividend culture, there are few areas that offer Asia’s combination of income and growth.
Investment opportunities in the region offer exposure to better and more sustainable earnings growth with company balance sheets that are less levered than in developed markets. This, combined with lower payout ratios and improving dividend cultures, supports a strong case for dividend growth.
One example of the dividend growth potential in Asia is in South Korea, where pressure for corporate reform directed at the chaebols has been a catalyst for growing dividends.
Following the impeachment of former Korean president Park Geun-hye for abuse of power in 2016, current president Moon Jae-in took power on a platform of cleaning up the chaebols. In 2018, Korea’s National Pension Service (NPS), Korea’s single-biggest investor (it holds 5-12% of 90% of companies in the Kospi 200), signed up to the Stewardship Code.
In addition to this, South Korea is ageing rapidly and retiring workers are incentivised to push the NPS in promoting chaebol reform to clean up governance and increase dividend payouts. Samsung Electronics is one of the strongest examples of this shift.
Mark Williams is co-manager of the MI Somerset Asia Income fund. The views expressed above are his own and should not be taken as investment advice.