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back to index backASIAtalk November,  2016


Asia: Pivot Required

Beyond a rapidly changing macro outlook, the tools required to be a successful investor in Asia are changing too. As such, we think that investors may need to pivot,” adopting a new, updated approach that might require different skills than what worked in the past. Key to our thinking is that traditional consumer penetration stories are now losing growth momentum, despite full valuation in many instances. By comparison, after five years of no corporate earnings growth across Asia, many large, diversified — and underperforming in many instances — companies are ready to rethink their footprints and strategies.

This change in corporate mindset in key markets such as Japan, India, and Korea represents a new and substantial opportunity, in our view. There is also a burgeoning opportunity for leading Asian corporations that are looking to expand abroad against the backdrop of a slower Chinese economy. Finally, with GDP-per-capita still growing at high single digits or better across China, India, and Indonesia, we think that demand for value-added services, including food safety, healthcare services, and media still could have meaningful upside.

I recently joined my colleague Frances Lim, who leads the KKR Global Macro and Asset Allocation effort in Asia, on a whirlwind tour of the region. We visited a variety of cities and met with a variety of folks across both the private and public sector in an attempt to refresh our top-down view of Asia. To state the obvious, there is certainly no one” Asia, as the region includes both large developed markets like Japan, Korea, and Australia as well as large emerging economies such as India, China, and Indonesia.

Without question, our ability to compare and contrast multiple economies across Asia provided us with what we believe are an array of important macro insights. See below for more details, but our key conclusions are as follows:

• EM Equities, including Asia, may be finally bottoming relative to DM Equities after 72 months

• Larger consumer economies across EM, Indonesia in particular, are likely to see expanded valuations in the near term

• But right now in Asia, including both EM and DM markets, we are most inclined to sell simplicity, and buy complexity

• While we remain constructive on the long-term outlook for Asia, we actually concluded our trip with the somewhat surprising view that some of the most actionable near-term opportunities in the region may not actually be domiciled in Asia

• We favor Indian Credit over Equities in a solid Prime Minister Narendra Modi-driven macro environment

• Regional risks include valuations in China’s private TMT sector as well as overreach concerns surrounding the Bank of Japan

Overall, we finished our trip with increased conviction that both public and private equity are poised to do well during the next three to five years. However, the opportunity set is definitely shifting; said differently, the skill set now required to generate investment success, particularly in the private markets in Asia, will be quite different than during the last cycle. It will require a more global focus, more operational expertise, and more local industry knowledge.

In terms of fixed income opportunities, we think that performing credit is likely to outperform non-performing credit in certain parts of Asia during the next one to three years. This viewpoint on credit represents a material change in our outlook. Key to our thinking is that — while the opportunity set is still substantial in the non-performing side — many governments are still dragging their feet on forcing bad loans off banks’ balance sheets and into the hands of qualified risk evaluators, including foreign investors.

By comparison, because banks are not disposing of their non-performing loans (NPLs), they are not in a great position to provide the capital required to meet the rising GDP-per-capita stories that we have been championing for several years. As such, with the economic backdrop for EM bottoming, and demand for credit now exceeding supply, we see demand for private capital by promoters and entrepreneurs solidly increasing.

Looking at the big picture, we feel that the most important take-away from our trip is that the emerging markets as an asset class have bottomed on a relative basis, something that we have not previously indicated during our tenure at KKR. EM certainly can’t detach from DM in absolute terms if there is a major slowdown, but the macro backdrop in EM is now more favorable than it has been since the turn of the century. Indeed, real rates are higher at a time when the economic cycle appears to be stabilizing, earnings have troughed, and allocations to the asset class remain modest. To this end, we think that investors should be selectively allocating more financial and human resources to uncovering opportunities in both the equity and fixed income sides of this asset class during the next three to five years.

Section II: Details

EM Equities may be finally bottoming. After 72 months of underperformance (Exhibit 1), our base case is now that EM is in the process of bottoming. We see several factors at work. For starters, we believe that the influence of local currency trends is going from being a major negative to a modest positive. This viewpoint is significant, as currency headwinds have adversely impacted EM returns by nearly 600 basis points per year each of the last five years. One can see this in Exhibit 2. Importantly, the currency headwind was coming on top of what was an extreme period of lackluster results even for local investors (Exhibits 1 and 2).

To read entire article, please click here.

Source: KKR Global Perspectives
- GAI




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