NESTOR Far East - Quarterly Report 3/2020

Nestor Fernost fund is down -10.3% in Q3, against moderately up Asia-Pacific markets

Market Review
The benchmark MSCI AC Asia Pacific ex-Japan rose +3.9% during the third quarter of the year, but remains in negative territory for the calendar year.
Naturally, Covid-19 remains a significant driver of short-term economic performance.  China, Vietnam and Taiwan are leading the world, with hopes to return to a normal growth path next year, while most other countries are predicted to operate below their potential well beyond this year.  

However, at present we remain in a “90% economy” around the world, i.e. current activity levels even in recovered economies broadly remain below last year’s level, and thus equity market performance is clearly discounting stimulus and monetary policy more than anything else.

Independent of Covid-19, a weaker Dollar, and in particular the strength of the Renminbi, is medium-term positive for Asia and all other emerging markets, and should set the scene for outperformance over developed markets.  For European investors it is worth noting that due to simultaneous Euro strength against the Dollar, the Asia-Euro currency pairs remain flat.

Performance Review
The fund was not sufficiently well exposed to the dominant theme driving public market performance around the world this year, internet and technology names.  A major example would be the rally in the global semiconductor supply chain, and e-commerce, both heavily present in the benchmark.  While we own key names like Alibaba and Tencent, we did not own them in sufficient size this quarter to keep up with a very one-sided public equity market.  Performance was further impacted by a defensive positioning.
In addition, the fund’s long-term allocation to emerging Asia significantly underperformed, relative to strength in developed Asia.  This value dislocation is increasingly being recognized however and setting up a tremendous opportunity.  For example, Bloomberg recently ran an article highlighting that Asean stocks are the cheapest in ten years relative to their Asian peers, and that 2020 is an extreme year in valuation and performance divergence.  

Outlook and Strategy
We keep returning to China-US relations as this relationship is not only relevant for our region but for the entire world.  Big power competition will be the defining feature of this decade (as much as “globalization” was in the 1990s, “security/anti-terror” in the 2000s), and provide risks and opportunities.

Several countries will be enticed or forced to pick sides, as in the 5G/Huawei case.  Both China and the US will exhibit nationalism:  for example, the new US International Development Finance Corporation (formerly OPIC) with remit to help development in poor countries, was instructed to perform “domestic service” and support the re-shoring of US companies, rather than its originally core overseas development focus (which tended to support the opposite).  But even with de-globalization, supply chains in particular in technology will see duplication and intensification, leading to actually more, not less supply chain footprint, greatly favouring Southeast Asia within Asia-Pacific and Mexico and possibly Poland in broader emerging markets.

Southeast Asia’s opportunity will be to position as a “middle power” in the Pacific, carefully balancing the big powers, and selectively “selling to the highest bidder” where it makes sense.  Because Southeast Asia is China’s logical substitute in manufacturing, it remains in China’s interest to retain close ties and to not lose the region entirely to the West.  Southeast Asia countries such as Thailand or the Philippines have been able to either broker a presence of both Huawei and Nokia/Ericsson in radio access systems, or to confidently make a clear choice either way, for example Cambodia (Huawei) or Vietnam (Nokia/Ericsson).

Following a deadly border clash, India has banned 59 Chinese apps, significantly hurting China’s strategy for technology dominance in one of the key thus far open battlegrounds of global technology leaders.  Alibaba (Paytm), Tencent (Ola, Flipkart), Amazon (Future Retail) and Google & Facebook (both Jio) have invested billions.  India closing itself to China will intensify the competition for the Southeast Asia ecosystem.  Alibaba and Tencent have recently invested billions in online properties, warehouses, traditional businesses and payment systems in the region.  

Foreign direct investment (FDI) remains the best illustration of the economic opportunity, and ASEAN remains the world second largest investment destination, sourcing investment in almost equal measure from the US, Europe, China, Japan and Korea.  Japan for example has countered China’s Belt & Road Initiative (BRI) with its own infrastructure investment programme, heavily targeting all of Southeast Asia.  At the risk of repeating the obvious:  a 10% diversion of China’s $2 trillion of annual manufacturing output, would result in a 7% GDP uplift for Southeast Asia before any multiplier effects.  For perspective, it took less than $20bn between Intel and Samsung in investment to lift Vietnam onto another plain over the past two decades.  The opportunity is not only in manufacturing but also in services for example in business process outsourcing, primarily the Philippines, and also again Vietnam.  

The Southeast Asia investment case has been a long time coming, but it is no less compelling today, with globally challenging geopolitics and economic developments actually working in favour of the region.  In equities, timing remains the obvious question.

Florian Weidinger, Hansabay