Why investors shouldn’t overlook Southeast Asia

Southeast Asia started this decade as the next hot emerging-market growth story. Investors were let down by weak growth and bad politics, but it’s getting cheap enough to be interesting again, says Cris Sholto Heaton.

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It was just over ten years ago that investors began rediscovering their enthusiasm for Southeast Asia. After shunning the region in favour of China, India and other countries, such as Brazil, many suddenly became aware that it had just as many points in its favour as more fashionable emerging markets.

A young workforce, especially in countries such as Indonesia, the Philippines and Vietnam. The promise of soaring foreign direct investment as companies shifted manufacturing away from China. An expanding middle class and rising consumer spending. A huge opportunity to reach new customers in sectors such as financial services. Steady progress in cutting trade barriers and improving the flow of goods and services via the Association of Southeast East Asian Nations (Asean) trade bloc. Abundant optimism that countries could raise already strong growth further by investing in infrastructure and introducing economic reforms. The list was long and the story was compelling.

While Southeast Asia never became a blockbuster investment theme in the way that the Brics (Brazil, Russia, India, China and South Africa) did in the previous decade, the potential for an area with a combined population of more than 600 million to create an economic powerhouse still attracted plenty of attention. I remember many fund managers who had no interest at all in any of these countries in 2009, but were very keen to talk about what they were buying there a few years later. 

And so between the bottom of the global financial crisis in 2009 and the beginning of 2013, the MSCI Asean index – which includes the emerging markets of Indonesia, Malaysia, the Philippines and Thailand, plus the developed but closely connected market of Singapore – returned almost 170% in US dollar terms, compared with around 100% for the MSCI Emerging Markets. The MSCI Philippines, MSCI Indonesia and MSCI Thailand indexes all gained 200%-250%.  

Not just a Covid-19 meltdown

Fast forward to today. The MSCI Asean is down by more than 17% this year in US dollar terms, compared with a loss of just 1.5% for the MSCI Emerging Markets. Fears about the impact of Covid-19 on the economy have played a part in that. Some countries, such as Thailand, are especially dependent on tourism; others, such as Indonesia and the Philippines, have inadequate healthcare systems that have struggled to cope. But in reality, this is just the endgame for a trend that’s been in place for several years.

The MSCI Asean peaked as long ago as the beginning of 2018, but it had been struggling to make consistent headway since those stellar returns ended around 2013. Gains over the last five years averaged just 0.3% per year; the equivalent figure for MSCI Emerging Markets is 6.5%, even after the recent sell-off. And this weakness is broad-based; the best performer over five years is Thailand (3.25% per year), the worst is the Philippines (-5.2% per year). 

This is definitely not the kind of performance that investors were promised when they decided to forgive and forget Southeast Asia’s last cycle of boom and bust in the mid 1990s. That era culminated in the Asian crisis of 1997-1998, International Monetary Fund bailouts for Indonesia and Thailand, and a trail of economic wreckage and social upheaval across the region. The damage this time is nowhere near as bad. The disillusionment is more muted. But make no mistake, Southeast Asia is out in the cold again. 

The region is a diverse set of countries, so one can’t pin this depressing record on a single factor. Some economies are quite geared to the commodity cycle, so the 2010s have been much less helpful to them than the 2000s; others are not and should have benefited from lower commodity prices. But there are two broad trends that probably explain much of the problem.

Too much money chasing too few returns

One is simply the glut of investment. In the first half of the past decade, as investors got increasingly excited about the region and piled back into local markets, valuations rose to a point where there was no margin for error if expectations weren’t met. Several countries were trading at price/earnings (p/e) ratios above 20 at their peaks. If economic growth had accelerated and corporate profits done likewise, that could have been justified. But they didn’t: even before Covid-19 upended the world, most of Southeast Asia was going the wrong way. Indonesia began the decade with GDP rising by more than 6% per year and aspired to lift that to 7% or more; by the end of last year, it was struggling to hit 5%. The Philippines started at 7%, last year it posted 6%. This may sound okay – but it’s not enough given their young and growing populations. 

Profits in some cases peaked as long ago as 2013-2014 and suffered years of declines; smaller firms were especially affected. The exact reasons vary between sectors and countries, but in many cases it’s due to rising competition and increased investment, creating capacity that wasn’t matched by higher demand. 

Not all of this is Southeast Asia’s fault. Growth has been disappointing in most of the world since the global financial crisis; the winners have typically only been winners in relative rather than absolute terms. But the inability to take advantage of what growth there is – and to use the global glut of cheap money to invest in and improve its economic potential – is self-inflicted. The perennial millstone for most of the region is a set of political systems that range from the merely bad to the stupefyingly dysfunctional. At the start of the decade, it felt like the trends in most of these were finally moving in the right direction; as we reach the end, they have slipped backwards.

An endless series of dreadful elections

Most notably, the Philippines elected the authoritarian yet incompetent Rodrigo Duterte as president. His six-year term will at best end up undoing the limited amount of political and economic progress that was made under his predecessor Benigno Aquino III; more likely, his assaults on his opponents and rampant cronyism will leave an already corrupt political system and flimsy rule of law in far worse shape. Unlike fellow incompetent populists such as Donald Trump in the US and Jair Bolsonaro in Brazil, Duterte continues to enjoy very high public approval ratings, which testifies to how low the standards in Philippines politics are. The best hope for the country is that this does not translate into the ability to hand the presidency to a relative or an aide when his term ends. 

Duterte is the most horrendous example. But in Indonesia, Joko Widodo has been a growing disappointment as president. Although he came to power in 2014 on a platform of cleaning up the country, reforms have been limited and anti-corruption forces have been weakened. In his second term he has cosied up to Islamists, choosing a cleric as his vice president, and to key figures from Indonesia’s era of dictatorship. Jokowi, as he’s popularly known, is promising sweeping reforms and more investment in infrastructure, some of which may yet come to fruition; he is by no means an outright disaster like Duterte. Still, so far Indonesia has not taken major strides forward under his tenure.   

Elsewhere, the ongoing schism between the electorate of Thailand and the ruling elite shows no signs of ending. Voters would like to pick a government that they believe represents their interests, but the elite dislike the leaders that the majority chooses and quickly evict them from office through coups or legal chicanery. After the last coup in 2014, the military junta rigged the electoral system in their favour to ensure the 2019 elections produced an elite-approved government headed by former junta leader Prayuth Chan-ocha. The erosion of even the veneer of democracy wouldn’t necessarily be a disaster if the government had the competence to follow the policies Thailand needs. So far, they’ve shown no signs that they do, which is no surprise – if the elite knew how to improve the lives of the majority of their people, perhaps they’d be able to win a fair election.   

And then there’s Malaysia, which offered the sole glimmer of political progress last time I wrote about the region in MoneyWeek a couple of years ago. Back then, voters had surprisingly kicked out the corrupt and increasingly hopeless United Malays National Organisation (Umno) party that had ruled the country since independence. The replacement was an unruly coalition headed by Mahathir Mohamad, a former Umno leader who is deeply flawed but still one of the best leaders Malaysia has had and a good deal better than his successors. Unfortunately, predictable infighting in the coalition led to the collapse of the new government. Now Umno is back in power under new leadership and showing no signs that it has learned any lessons during its spell out of office.

Vietnam, of course, remains stable under its nominally communist one-party state. Wealthy Singapore is still governed by the People’s Action Party (PAP), which – like Umno – has been in power since independence, but – unlike Umno – has at least some idea how to make a country richer. But overall politics in Southeast Asia has been a vast disappointment in the past decade, which goes a long way to explaining why the progress that investors hoped for – and, crucially, paid up for – has not materialised.  

When pessimism is an investor’s friend

At this point, it probably sounds like there are no good reasons to invest in Southeast Asia – and the more this sentiment takes hold among investors, the better. That’s because all the positive points about the region – demographics, foreign direct investment, the evolution of consumption and so on – haven’t vanished. The problem is that they’ve been outweighed by high valuations, poor growth and bad governance. Valuations are now being corrected and growth goes in cycles; sooner or later, good times will return to these markets. Whether investors will then want to hold these countries for the long term or just until the cycle peaks again will depend on whether politics improves and that remains impossible to say.

Let’s be clear: Southeast Asia will not lead the emerging market recovery from Covid-19; the trend suggests that the East Asian economies of China, Korea and Taiwan will take that role. But opportunities are emerging for patient investors to capitalise on when the global recovery is under way.

Best of all, there’s Vietnam. It is unique in Asia – possibly even in the world – in having a clear path to following the kind of development model so successfully embraced by Korea, Taiwan and China: a focus on export manufacturing in which companies consistently strive to move up the value chain. Demographics, education, location, low labour costs, foreign investment – all are helpful. There is no certainty that it will succeed. The government made major mistakes in the past: it squandered billions trying to make inefficient state-owned conglomerates into national champions instead of concentrating on helping private businesses. But the ingredients are there that could lift Vietnam to at least middle-income status and hopefully beyond. Like most frontier markets, Vietnamese stocks have a frustrating record of boom and bust, but on a p/e of less than 16, it is an attractive if risky bet for the next decade.

Both Indonesia and the Philippines now look better value (on p/e ratios of 14.5 and 13.5 respectively). The coming year will be dreadful for earnings due to Covid-19 and if the political headaches on the previous page don’t worry you, they should. But at these prices, there is a better balance between potential and risk than there was when they traded at over 20 times earnings. Singapore offers decent value on a p/e of 11 (its economy won’t grow fast, but many of its companies benefit from regional growth). Malaysia and Thailand still look expensive, on valuations of 20 and 19. 

Finally, because the Covid-19 crisis followed years of poor returns, investors who were still bothering with the region were already favouring larger companies whose valuations have held up better in recent years. That means that opportunities in small stocks are likely to be even greater. Bold investors – and there is probably little appeal to investing in a region like this at present unless you feel bold about its prospects – should look beyond the obvious. That’s why my main picks below include trusts for small caps and Vietnam, and also include a few smaller stocks, rather than the banks, telecoms and so on that dominate the index. 

How to invest in Southeast Asia

The best way to invest in Southeast Asia now is through an investment trust. Investing in an out-of-favour region requires patient, permanent capital. Otherwise the impact of fellow investors giving up and pulling out their money can be too hard to manage. Just this month, Waverton said that it is closing its Southeast Asia fund after assets shrunk too far. This is an unfortunate loss: I wrote about this fund several times in MoneyWeek and still think it had the right long-term strategy for markets like these. It demonstrates only too well the difficulty of running open-end funds in situations like these and also shows the extent to which investors have turned against the region. 

As far as I know, there are no dedicated regional funds left for UK investors, so my pick is Aberdeen Standard Asia Focus (LSE: AAS). This is an Asian small-cap fund, but like many Aberdeen funds, it is more heavily invested in Southeast Asia than its peers. Slightly under half of the portfolio is in the region. That weighting has been a drag on performance: its net asset value has gained just 32% over five years, against a 69% gain for the MSCI Asia Pacific ex Japan index. But if you believe Southeast Asia will recover, that shortfall is exactly why you’d consider investing. The trust had ongoing charges of 1.16% last year and is on a discount to net asset value (NAV) of 13.6%.

Vietnam is at most a tiny holding in any broad Asia or Southeast Asia fund, so if you are keen on its long-term potential, you need one that invests only in the country. There are two main ones listed on the London Stock Exchange: Dragon Capital’s Vietnam Enterprise Investments (LSE: VEIL) and VinaCapital’s Vietnam Opportunity Fund (LSE: VOF). The former invests mostly in listed stocks, while the latter has around 57% in listed stocks and most of the rest of the portfolio in unlisted stocks and private equity. Five-year returns are similar: Vietnam Enterprise Investments has grown its NAV by 63% in US dollar terms over five years, compared with 47% for the VN index benchmark, while Vietnam Opportunity Fund has returned 61%. VEIL had ongoing charges of 2.16% and is on a discount to NAV of 10%, while VOF had ongoing charge of 1.7% and is on a discount of 19% (funds with unlisted assets tend to trade at a larger discount due to greater uncertainty over their value).

Investors who prefer to buy stocks directly may want to start in Singapore, where plenty of companies look quite cheap if you are optimistic about a recovery. Jardine Cycle & Carriage (Singapore: C07), part of the Jardine Matheson group, mostly operates in the motor trade in Indonesia. The trailing p/e ratio is just 6.4, although this year’s earnings will be much worse. Silverlake Axis (Singapore: 5CP) is a Malaysian firm that supplies software to several major regional banks. It’s on a trailing p/e of 11. Thai Beverage (Singapore: Y92), one of the region’s largest beer and spirits firms is trading on around 15 times last year’s earnings. Delfi (Singapore: P34) is the leader in confectionary in Indonesia; it’s suffered from rising competition, but a trailing p/e of 11 prices in a lot of bad news. Haw Par (Singapore: H02) makes the iconic Tiger Balm liniment and owns other assets, including a stake in a major Singapore bank (UOB). 

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