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Five questions answered on… Asian equities

21 September 2022 |
Active ESG
Here, Jonathan Pines, portfolio manager of the Federated Hermes Asia ex-Japan Equity Fund, makes the case for finding opportunity in Asian equities and explains why investors should consider making an allocation as part of a broader portfolio.

Q: Why should investors consider Asia as part of their overall portfolio?

A: Asia makes up a huge part of the world, with two billion people in China and India alone. At the same time it’s diverse, comprising different sub-markets each with their own characteristics. The thing about investing in Asia is there’s inevitably one part of the region that is going to be attractive. It’s sufficiently diverse to have mainly ‘growth’ as well as mainly ‘value’ countries, regions with different political and economic systems, countries with companies that pay high dividends relative to earnings and countries that have low pay-out ratios. There are varying geopolitical considerations too. So, if one particular market happens to be expensive (because its characteristics are in favour), you tend to find another that’s attractive (because its characteristics are out of favour). For us, it means there are always investment opportunities. At the same time, it’s less efficient than most developed markets, rewarding bottom-up stock picking.

Q: What are the key risks investors need to consider when it comes to Asia?

A: There are plenty of risks and every single country in the region tends to have risks associated with it. Take China as an example where one of the key risks is tensions with the US. Then you have Korea where there are risks of tensions on the Korean peninsula. The thing to note is these risks also give way to opportunity because often the sentiment becomes so negative around certain areas that it leads to volatility. Admittedly, the risk is often ‘binary’ and, so, bad things may come to pass. However, equity valuations are often penalized too severely on a probability-adjusted basis. Right now there’s a huge amount of negativity surrounding China. While there are clear risks, in our view these have been more than priced in and have given rise to opportunities to buy attractive companies at a good price point.

Q: Do you expect volatility in Asia to remain elevated going forward?

A: Given that this region tends to be risky, volatility does tend to be higher than the rest of the world. There’s a huge amount going on in the world geopolitically that has contributed to the rise in volatility, but given that it’s so high right now I do expect it to come down short term from its elevated levels relative to its own history. For us, volatility is not a bad thing because a volatile ‘Mr Market’ provides more opportunities than a placid one.

The thing about investing in Asia is there’s inevitably one part of the region that is going to be attractive.

Q: Are you seeing opportunities within China at present?

A: Yes. We’re close to an all-time low of China’s price-to-earnings multiple relative to the rest of the world, which highlights the opportunity. Of course, within China, there are also different ways you can play it. You can invest in the Hong Kong H-share market, China A-shares – which is the mainland and where most Chinese investors tend to invest – or in US-listed ADRs. All three of these markets are cheap relative to their history and all three are attractive for slightly different reasons. The H share market is cheapest. The A share market is least efficient, least susceptible to US sanctions and most likely to attract direct Chinese government support. US-listed ADRs are down the most (of the three) – although in this market you do need to be careful to pick stocks with a HK listing.

Q: Can you describe your investment philosophy?

A: Our philosophy is to buy stocks that are cheap relative to their value – and we don’t mind buying lower quality companies. So we would be just as happy to buy a $50,000 Ferrari as we would a $5,000 Ford. Both are great ‘deals’ and we don’t mind which one of these we buy. We’re also contrarian investors. Often the stocks we buy are attractively priced because news flow has recently been negative and the companies have underperformed. One of the key things that makes a contrarian investor is the mentality that makes you prepared to second guess the crowd, always questioning what might be working and asking if people have become too pessimistic (or optimistic). Our process is designed to pick up stocks that, for whatever reason, are out of favour but which in our assessment have been ‘over penalized’. Investing in approximately 50 companies, we’d also describe the process as being high conviction with the top-10 holdings accounting for around 40% of the portfolio. We believe this is the right number and provides us with the ability to outperform, but at the same time it avoids too much concentration risk.

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