Asia has made tremendous contributions to world growth since the global financial crisis (GFC) took its toll on major advanced economies, including the United States and Europe.
Having learnt their lessons following the 1997 Asian financial crisis, Asian governments and corporations generally went into the recent economic turmoil with strong balance sheets and low debt levels.
The region weathered the GFC relatively well and has gone from strength to strength in its aftermath.
Asian economies have been climbing up the rankings, with China overtaking Germany as the world's third biggest economy in 2009 and Japan as the second largest just this year.
The International Monetary Fund projects developing Asia's gross domestic product (GDP) to power ahead 8.4 per cent this year and next.
This compares to the 2.2 per cent growth projection for advanced economies, including the US and eurozone in 2011 and 2.6 per cent next year.
Increasing interest
Banking group Standard Chartered expects China to be the world's top economy by 2020 and India to be the third largest, as rising personal incomes push billions of people into the middle class, driving consumption and economic growth.
As interest has increased from financial planners in Asia's meteoric rise, the investment industry has offered innovative ways of tapping into the theme, including regional, single country and sector-specific funds, structured products and exchange-traded funds.
"There has been a big change in the last five or so years," Treasury Asia Asset Management (TAAM) chief investment officer Peter Sartori says.
"The interest in Asia has been nowhere near as strong as it is now and that's due to the fact Asia and China are growing strongly and are so important to Australia now because of commodities demand.
"It's topical; planners can see that economic growth in the world is being driven predominantly out of Asia, so from my experience planners are much more aware of Asia than they were previously."
Better to be active
Van Eyk Research senior investment analyst Briana Lam says the firm's multi-manager Blueprint Balanced Fund, with around $450 million in funds under management, has a specific Asia allocation within the international equity component of the portfolio.
"In our international equities portfolio there is an allocation to emerging markets, and within that we recommend a strategic allocation of 20 per cent exposure to Asia, which we're currently overweight," Lam says.
"We did an Asian equities and Chinese equities review last year and we noticed not only demand for it, but also there was a lot more supply available, or accessibility to investors who wanted exposure to the region.
"The basic reason is that everyone is focused on the growth in the region, the demographics are very positive and obviously market performance has historically been very good, so there has been a lot of focus in that area."
Blueprint favours an active approach and has invested in products including the Premium China Fund and T Rowe Price Asia ex-Japan Fund.
"We do promote an active allocation to the region because we believe there are opportunities to add value by investing specifically in companies in the area," Lam says.
"It is also a less efficient market at the moment so there is a lot of opportunity to add value through stock selection."
Markets at very cheap valuations
Fidelity Asia Fund portfolio manager David Urquhart says it's the second-best time to be buying Asian equities in 10 years, given forward price-to-earnings ratios have fallen to 10 amid recent market turbulence, compared to the five-year average of about 13.
The Chinese market offers even more value at nine times earnings and is the second cheapest in the region, Urquhart says.
"Usually it's priced on about 13 to 14 times earnings and now is on about nine times earnings, and yet there is good growth potential in certain areas," he says.
"So consumer discretionary stocks are a good long-term story within China.
"You need to be somewhat selective because there are some companies really taking advantage of it and others are riding along the wave but not really getting growth above what is available there."
Staggering consumer demand
Urquhart says purchases of luxury goods are especially strong in China.
"The area that's just staggering so many people is the strength in the luxury end, so luxury cars, whether it be BMWs, Mercedes, and Swiss watches and so on," he says.
"Department store sales are probably the envy of what Australians would want to be seeing.
"You are seeing department same-store sales growth up 22 per cent year on year, which is just a staggering number and that's partly because they are repositioning the product mix, they are putting more luxury brands in."
Watch sales in some companies Fidelity tracks are soaring over 44 per cent on a same-store basis, while BMW dealerships are growing in excess of 70 per cent year on year, he says.
"If you look at the watch market at the moment, 26 per cent of all Swiss watch sales go through to China and Hong Kong, and the staggering thing at the moment here is that the growth has been phenomenal to the point where there are now shortages," he says.
"The Chinese guys pretty much say we can sell more, if there were more."
In fact, consumer demand has become such a big theme that Invesco recently decided to change its Wholesale Asian Share Fund's strategy from broad Asia investing to purchasing only those stocks that will benefit from growth in Asian consumer demand.
Effective 1 October, the fund will be renamed the Invesco Wholesale Asian Consumer Demand Fund.
"Consumer demand in the Asian ex-Japan region is set to grow strongly over the long term, underpinned by rising incomes, strong savings rates, a growing middle class and changing cultural attitudes," Invesco said in a letter to investors.
"There are an increasing array of opportunities for companies benefiting directly from strong demographic, economic and financial changes in the Asian region.
"These opportunities are growing at a faster rate than companies relying heavily on the lower-growth cycles of developed economic regions such as the US and Europe."
Attractive earnings profile
Credit Suisse Private Banking head of research for Australia David McDonald says Asia is one of the group's preferred investment themes.
"If you had a global portfolio, we would certainly be overweight Asia against the benchmark at the moment," McDonald says.
"[A] couple of reasons why include much better growth prospects than the developed world, particularly Europe and the US, and secondly it's a part of the world that doesn't have debt worries generally, which puts it in a better position."
Chinese GDP should expand over 8 per cent this year and next, he says.
Over the next two years, Credit Suisse expects Asia ex-Japan corporate earnings growth in the high single digits across the region and into the teens for China and Indonesia, in particular.
The firm favours investing in those two markets.
"We really see China as a longer-term story," McDonald says.
"It's not just things going well at the moment - we see a five to 10-year story of people getting wealthier, people moving to the cities, a move towards internal consumption rather than relying on exports.
"It's obviously not going to be a straight line, but it's something that we think to some extent is self-sustaining.
"Wages are going up in China in a way that some of the export sectors look less competitive maybe, but it helps to boost consumption and helps the market focus more on consumption and a little bit less on production and exports going forward."
Advisers slow to allocate amid fears
While there may be more interest, Premium China Funds Management associate director and head of distribution and operations Jonathan Wu reckons take up has been too slow.
"Planners are failing to act," Wu says.
"Everyone has got to the point where they really see Asia as the best investment opportunity, given the fact of what's happened globally. The Asian economies are the most secure by government and corporate balance sheets, consumer spending and disposable income.
"So while they all agree Asia is a tremendous opportunity, getting them to invest in it is incredibly difficult for some reason."
He says several concerns are holding back planners from taking the dive into China.
"A major recent worry is that China's economy could be destabilised if its banks are forced to take write-downs on around 1.7 trillion renminbi ($250 billion) worth of local government debt," he says.
But given the fact bad loan coverage has increased to 1.2 trillion renminbi ($176 billion), they have the situation covered well, he says.
"When the global economy was on the brink of collapse in 2008/09, China stimulated its economy in several ways, including by reducing lending strictness so that local governments could borrow money to fund infrastructure projects and property construction," he says.
"Essentially the issue is that several local governments could default and hence hurt the banks because some of these infrastructure assets don't generate enough revenue yet to allow the municipalities to repay the debt.
"So there is concern about default and the sustainability of these projects. In the long term, I don't have any doubt that these would have their place in their certain cities, whether it be cars on highways, trains on railways or housing establishments filled up. The Chinese have long-term planning visions not seen even in Australia due to short electoral terms."
China needs such infrastructure, but some projects would be potentially risky or unsustainable, he says.
"The Chinese government has acknowledged this issue and so they have ordered the banks to decrease loan-deposit ratios where they can, which is not necessarily decreasing the loan portion, but increase the deposit portion of it," he says.
"The second thing they are doing is ordering all banks to hold a lot more in their bad debt provisions. A potential solution if some of these defaults occur is that local governments can issue bonds instead of borrowing money from the bank.
"By no means am I saying that China doesn't have risks, but the government is well aware of the risks and is powerful enough to stem any potential risks quickly."
Price rises taken out of context
Another concern is around high inflation in the region, particularly in China and India.
Wu says inflation concerns are often taken out of context.
"In January to August for instance, much of the 5.55 per cent inflation was due to a nearly 60 per cent increase in pork prices," he says.
"Pork makes up 10 per cent of the whole CPI (consumer price index) number. Inflation will always be a problem in most Asian countries due simply to the fact they are developing and they will have some supply shortages here and there.
"Since pork has gone up, the piggeries have being upping their litters, so they have been increasing their production of pork."
He says it's not the first time inflation has been high in China due to a surge in pork prices, given the meat is part of the staple diet of the country's vast population.
"Another thing is that the Chinese government have their own reserves of pork and they have released reserves in the last few months to stem inflation," he says.
"The solutions and flexibility that China has shows how powerful its economy is in its ability to deal with these problems.
"The other part about inflation, which is actually solving itself, is the increase of the Chinese currency against the US dollar.
"So if the yuan is going higher, it means that imports for steel, foreign fertilisers, gas, oil and other resources, which are all priced in US dollars, will become cheaper, so China will be exporting its inflation to the world."
Bubble risks
Sartori says inflation and also the formation of asset bubbles are the biggest risks on a three-year horizon in Asia because interest rates and currencies are too low.
"In fact, most countries have negative real rates. If it remains like this for the next three years, it is a recipe for some bubbles forming and inflation getting out of control," he says.
For example, Singapore's economy is growing very strongly and has a small population, yet its monetary policy is very loose.
"You can get home loans for 1 per cent. You can get a mortgage for 1.5 per cent to 2 per cent. That's too low for the strength of the economy and people are not going to put money in term deposits at eight basis points," Sartori says.
"So money is going into hard assets and real estate is going to stupid prices. This is a problem across the region because central banks are keeping currencies undervalued and not letting interest rates go up as much as they should.
"Our base case is that central banks are aware of this and they will take action over the next year or so, and if they don't, that's the biggest risk for Asia on a three-year view."
Investors need to watch out
Perpetual chief executive Chris Ryan says bubbles are inevitable and investors are going to have to watch them carefully.
"Where there are strongly growing markets you are always going to get formation of bubbles and sometimes it's difficult to tell how long it's going to take for that bubble to pop, but that's your growth," Ryan says.
"I think it will increasingly be more about the sectors bubbling rather than whole markets.
"We have seen a couple of years ago we had a big spike in residential real estate prices in China and the government stepped in quickly to remove that bubble.
"Many western countries just wish they had the control over the economy that China does. Given China is such a big economy, it has amazing control over these bubbles."
He says there are bubbles forming now in some areas.
"In places like the Philippines they recently allowed mining to be re-established to the north of the country. There is a land grab going on there at the moment. A lot of mining companies are pouring money into the north of the Philippines looking for access to these resources," he says.
"There will be bubbles; we have to be aware that is going to happen."
Strategic Asia allocation warranted
Wu says that while investing in Asia is not without its risks, it's a bigger risk for planners' clients to not have a significant allocation to the region given the investment opportunities it provides.
"China is forecasting around 8 per cent GDP growth with about 15 per cent to 16 per cent profit growth in the companies we hold in our portfolios. I can't see that anywhere else across the globe," he says.
"I can't see any general strong trends in earnings per share or dividends per share growth in Australia for any industry, except probably mining, but if our Australian dollar gets stronger, that is going to eat into that growth as well."
He argues that planners should have a strategic asset allocation (SAA) to Asia in portfolios rather than view it as a tactical play. "If you're having an SAA to Australia, you've got to have a strategic allocation to Asia. Given the growth prospects of emerging markets, emerging markets should represent 100 per cent of your international exposure, with Asia being at least half of that exposure."
"If you are not going to invest in emerging markets, where are you going to invest in? Are you going to put money in the US, Europe or the United Kingdom?"
Miners and multinationals just don't cut it
Wu criticises the idea that investors get Asia exposure by investing in global large caps such as Nestle and Procter & Gamble.
"You can't just have companies operate a part of their revenue lines in Asia, while they have such big exposure to the US and Europe; it doesn't make sense and dilutes their profit anyway," he says.
"Whereas if you're investing in companies that have almost 100 per cent of their revenues coming from Asia, you are going to find a lot of growth there and not be diluted by anything else in the world."
He also questions large allocations made to Australian equities and the argument from planners and investors that BHP Billiton and Rio Tinto provide sufficient Asian exposure.
"The Australian market makes up 2 per cent of the world. It is a two-speed economy, with the good speed completely dependent on Asia," he says.
"The argument that BHP and Rio can provide Asia exposure is flawed. Those companies have got no exposure into Asia in terms of accessing the domestic growth profile.
"So you are not able to access their consumers, infrastructure plays and you are not being able to access their vast amount of disposable cash in their bank account - that's the biggest thing that they are not accessing."
Asian dividend culture emerging
While Asia may seem like a pure growth story, Sartori says there is also a misconception that Asian companies don't pay dividends.
"Following the Asian financial crisis there was a five-year period where economies and corporates restructured and then over the last eight to 10 years a real dividend story has emerged," he says.
"It is actually very easy to put a portfolio of yield stocks together and get a dividend of above 5 per cent.
"In the Australian context, 5 per cent doesn't stand out, but within Asia it's quite amazing because the yield companies pay out is higher than domestic interest rates and that should be supportive of those stock markets over the long term."
Currency bonus on the cards
TAAM's view is that investors should have fully unhedged exposure to Asia.
"We have a strong view that Asian currencies are undervalued and although timing is always difficult, we think over the next three years the Asian currencies are going to appreciate quite significantly against the Australian dollar," Sartori says.
"This is not a view of the Australian dollar versus the US dollar; this is a view that we think the Asian currencies are very much undervalued compared to the Australian dollar.
"So the message I've been telling people in Australia is that some of the absolute gains that you have lost because the Australian dollar has appreciated so much against the Asian currencies in the last couple of years you should get back in the next three years."
He says the catalyst for Asian currencies to appreciate against the Australian dollar will be countries' desire to control inflation.
"Asian central banks intervened quite aggressively to keep their currencies low and they have really done that for the historical view of maintaining a strong export-driven economic model for the last 30 years," he says.
"So we think that's changing and changing quite rapidly. The export model is becoming less relevant as they move towards more domestic-driven economies and we think what the catalyst is going to change this is inflation." «
