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Asian economies and equity markets have been underperforming developed markets for some time (Chart 1). Historically, each outperformance/underperformance cycle lasted around five-to-seven years. In 2019 the cycle showed signs of turning around but COVID-19 derailed that progress. However, we are now seeing signs of Asian markets coming out of the COVID downturn, supported by subsiding infection rates and rising vaccination rates.

Asia is shifting to premium and discretionary spending and this is creating plenty of investment opportunities for equity investors. Over the last 20 years for instance, India has seen its consumer spending move away from being dominated by food, beverages and tobacco, to more spending on transport/communication and miscellaneous goods & services. As investors, our job is to analyze these trends and identify the companies that are best-positioned to take advantage of these changes in consumer spending.

We are very positive on Asian equities as an asset class. Asia offers a good selection of quality companies that we believe can do well in the long term. If you measure the concept of ‘quality’ by balance sheet attributes then they generally have much stronger balance sheets versus stocks in Europe and the US with high levels of cash as a percentage of assets and low levels of net debt to equity (Charts 2 & 3). In addition, valuations are relatively inexpensive. Investors are able to buy assets that are attractively-valued, not only compared to history but relative to other equity markets, especially compared to the US (Chart 4).

We think that adding a meaningful proportion of Asian small & mid cap stocks into a portfolio can offer the potential for enhancing returns in this asset class. In small & mid caps, we're looking for undiscovered gems, and we're investing in some of these stocks at a much earlier stage of their life cycle. Simply put, we're trying to spot future winners early. While that's no different in Asia compared to other markets, one of the differentiators of the Asian markets is the lack of research coverage in the region. Only 5% of the small-and-mid cap index constituents are covered by 20 or more analysts. This is important because stocks with lower levels of analyst coverage in Asia have generally tended to outperform over time, as seen in Chart 5.

Historically, there has been a rather loose correlation between the steepening of the US yield curve and the performance of the Asian equity market. Sometimes the steepening of the yield curve has signaled a downturn in the Asian equity markets and at other times it hasn’t. You have to look at the reason why the US yield curve is steepening. If it is steepening due to stronger economic growth globally, then generally this is positive for Asian equities. In addition, Asia today is much better positioned for US tapering. We do not expect a repeat of the 'taper tantrum' of 2013 as Asian economies today are broadly in better shape (see Chart 6). Then, the current account deficits of some of Asia’s major economies such as Indonesia and India were quite severe, but today their current account deficits are much improved.