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T Rowe Price positive on Hong Kong

Low valuations, strong free cash flow and selective sectors can support a continued rally in Asia-Pacific markets, despite short-term uncertainty and further volatility, according to T Rowe Price strategists.

“At least in the near term, the large money impulse from both fiscal and monetary stimulus will remain a strong tailwind to risky assets. On the other side of this ‘great lockdown’ crisis, Asia’s importance in portfolios will be even greater,” said Thomas Poullaouec, head of multi-asset solutions for Apac at T Rowe Price on Tuesday, when he discussed the firm’s mid-year strategic outlook.

“Fueled by its unique characteristics of demographics, innovation and capital, we believe Asian assets will attract both domestic and foreign investments. Indeed, Asian assets provide valuable characteristics compared to other regions, such as sound fiscal balances, attractive income levels, fair valuations and diversification benefits,” he said in a media briefing.

Poullaouec advised equity investors to focus on companies with abundant free cash flow, rather than future (but vulnerable) earnings expectations. He also warned credit investors to avoid taking duration risk to enhance yield, but instead to look for opportunities among BB-rated, short-dated issues and so-called “fallen angels”, which have slipped below investment grade due to temporary  balance sheet weakness caused by the Covid-19 pandemic.

Eric Moffett, manager of the $155m T Rowe Price Asia Opportunities Equity Fundy, sees the best potential opportunities in Hong Kong, a market that has suffered from the disruptions caused by the civil unrest in 2019 as well as the effects of the coronavirus pandemic.

“Within the region, we are most constructive on Hong Kong equities,” said Moffett. The fund has a 13.3% weighting to the territory, 4.5 percentage points more than its benchmark MSCI AC Asia ex-Japan index, according to its most recent factsheet.

“The next 12 months are likely to be much more stable than last year, while Hong Kong stocks are selling at cheap valuations and also offer investors attractive income, with dividend yields about 2% higher than 10-year US Treasury bond yields,” he said.

The fund, which is available to accredited investor in Singapore, has generated a 22.22% cumulative three-year return, outperforming its benchmark (11.09%) and its sector average (4.44%), according to FE Fundinfo data.

Its high 18.86% annualised volatility over the same period is similar to both its benchmark and peers, largely caused by what Poullaouec described as the “unprecedented volatility” that has afflicted most financial markets since March.

China recovery

In China, Moffett thinks the A-share market has held up relatively well, and pointed to two main areas where the tailwinds have strengthened.

“The first is consolidating industries dominated by a few big players among many competitors. Whether that is in property development, retail, or certain industrials, consolidation should accelerate, creating attractive opportunities. In industrial technology, for example, there are many good Chinese companies serving the domestic market — including factory automation, industrial motors, or components used in electric vehicles — that could become global competitors,” Moffett said.

“The other area is import substitution. As a result of the trade war with the US last year, many Chinese companies wanted to avoid dependence on US suppliers, so there was a move toward import substitution and less reliance on global supply chains. That trend is accelerating this year. Many of these companies are focused on the domestic market, but could become competitive global players over time,” Moffett added.

Moreover, negative real deposit rates in China should continue to encourage savers to invest in domestic equities, he said.

Moffett is less convinced by Southeast Asia and India, despite historically attractive valuations.

“Whereas, North Asia has effectively extinguished the virus, governments in South and Southeast Asia generally lack the resources to compensate workers should they enforce lockdowns. Instead, they are likely to rely on ‘herd immunity’ to develop over time,” he said, which will make corporate earnings vulnerable as well risking individual lives.

Technology and healthcare boost

Overall, however, the extreme dislocations in the financial markets present both risks and opportunities in equities, especially Asia-Pacific stocks, according to Poullaouec.

The firm is finding compelling opportunities in the technology, healthcare, and energy sectors and in Asia ex-Japan companies. In particular, the pandemic has accelerated the shift to the digital economy.

“As a result, the longstanding trends toward mobility, e-commerce, and cloud computing have become further cemented in people’s lives. This has further strengthened the position of the big technology platforms and other companies that are on the right side of change,” he said.

In healthcare, the pandemic could lead to investors putting an even greater premium on innovation and new drug platforms.

“The importance of drug development is likely to change public perceptions about the trade-off between innovation and drug pricing. If the regulatory overhang diminishes, valuations in the sector are likely to benefit,” said Poullaouec.

The main threats to a sustained recovery in risk assets are a second wave of coronavirus cases that prompt further lockdowns which would lead to weak global demand, a worsening of the Sino-US trade dispute and instability caused by geopolitics, notably the US presidential election, he said .

T. Rowe Price Asian Opportunities Equity Fund: Relative Allocations

Source: Fund factsheet, 31 May 2020

Source: Fund factsheet, 31 May 2020

T. Rowe Price Asian Opportunities Equity Fund vs sector average and MSCI AC Asia ex-Japan index

Source: FE Fundinfo. Three-year cumulative returns in US dollars.

Part of the Mark Allen Group.