Institutional investors wary of US-Asia equities switch

Nov 23, 2017

Even though US share valuations are stretched and Asian stock markets are on a roll, Asian institutions are still reluctant to stop overweighting Wall Street in favour of Asia.

Institutional investors wary of US-Asia equities switch

Institutional investors in Asia remain wary of jumping wholesale into Asian shares by shifting funds out of the US, even though the market momentum and earnings growth nearer home is strong and shares are relatively cheaper—in some cases, much cheaper.

Taiwan Life Insurance, for one, has no plans to make the switch, according to its head of global equity investment, Kepi Lin, even though its equity investments are currently split about 60% in US, 20% in Europe, and 20% in emerging markets.

“I think emerging markets are also volatile,” Lin told AsianInvestor, “[whereas] the US still has some opportunities.”

He is not alone in thinking that. Although some institutional investor clients in recent months have pared their overweight allocations to US equities, Adeline Tan, head of investment advisory at Mercer, said it was not the end of their love affair with the US market. “There remains interest in the US economy,” Tan told AsianInvestor. “We do not see a wholesale overweight to Asia.”

Many institutional investors in Asia have been underweight on the region and broader emerging markets for a long time, Barings’ head of Asian equities, HyungJin Lee, said.

And with good reason. “Emerging markets, and within that emerging Asia, underperformed global equity markets through the post-crisis period,” Lee told AsianInvestor. “The recovery out of that dip was more pronounced in the US and other developed markets.”

This year looks like being different though, as it looks set to be the first year since the global financial crisis that emerging markets, led by Asia, will outperform developed markets, he added.

Asian momentum

The MSCI AC Asia Pacific index posted a return of 27.26% in the year to October 31, versus 18.76% in the case of the MSCI World index over the same period.

Despite this sizzling return, equity valuations in Asia are not a concern, as long as earnings growth remains solid next year, Kevin Gibson, Eastspring Investments' chief investment officer, said.

“Based on current [share price] valuations of 13 times [expected 2018 company earnings] and 1.6 times [next year's expected corporate book values],” he told AsianInvestor, “we don’t believe that Asian ex-Japan equity markets are expensive.”

“Any time Asian equity markets trade below 1.75x P/B, the chances of a rally over the next one, three, and five-year periods is pretty strong,” Gibson added, citing Eastspring analysis. “Anything below 1.75 times P/B is cheap, anything from 1.7 times to 2 times P/B is fairly valued.”

Contrast that with US equity markets, as represented by the MSCI US index, where the forward P/E ratio was 18.40 and the P/B ratio was 3.24 as of October 31.

Here, valuations are already "trading at very expensive levels" and merit caution, with US consensus earnings for 2018 expected to grow by around 11%-12% and two to three US interest rates hikes anticipated, Gibson said.

Staying power?

Relative valuations aside, the case for Asian equities is mixed.

Rising corporate profits in Asia as well as a weakening US dollar should keep the Asian equity rally going, although US tax reforms could yet have a negative impact, Matthews Asia's chief investment officer, Robert Horrocks, said.

“The overall effect of the plan would be a stronger dollar,” he told AsianInvestor. “That would put downward pressure on Asia’s P/E ratios,” he added, presumably because of the higher cost of commodity inputs and dollar debt servicing.

However, lower taxes may also result in Americans consuming more, Eastspring’s Gibson pointed out. “Key Asian exporters to the US like South Korea, Taiwan, and Singapore should benefit seeing better-than-expected earnings growth,” he said. “As a result, their equity markets can see a boost.”

Gibson still believes Asian equity valuations have room to grow, citing expected corporate earnings growth. “We could potentially see further valuation multiple expansions,” he said. “We feel Asian investors should continue to feel comfortable even if valuations go up a bit more.”

Phillipp Bärtschi, chief investment officer of Bank J. Safra Sarasin sees Asian equities continuing to grow in 2018, but it will probably slow down. “We still some upside,” he said, “probably not 30% next year, maybe more like 10% range, but this is still decent.”

However, not everyone is as bullish on Asian equities. “As I listen to clients from around the world,” Matthews Asia’s Horrocks said, “very few are confident that the rally will continue.”

This pessimism about Asia equities is shared by Bryan Goh, chief investment officer for Bordier & Cie. “Nobody is comfortable with valuations as they are now,” he told AsianInvestor. “They are buying because prices are rising, not because they see value or growth at a reasonable price.”