Efficient Aussies Should Omit Non-Asian EM from Portfolios

Opportunities

• Diversification Benefits: Asian EM markets have significantly lower correlation with Australian equities compared to non-Asian EM markets, providing more effective portfolio diversification.

• Sector Complementarity: While Australian and non-Asian EM markets are heavily dominated by financial and resource sectors, Asian EM markets have a much higher exposure to technology, healthcare, and consumer sectors similar to the US market profile.

• Superior Growth Potential: Asian EM economies generally demonstrate stronger GDP growth forecasts compared to non-Asian counterparts, with countries like India, Philippines, and Indonesia outpacing most non-Asian EM economies.

• Full Development Spectrum: Asian EM provides exposure to the complete development range - from low-income countries (India at $3k GDP per capita) to middle-income (China at $14k) to high-income emerging markets (Korea at $35k, Taiwan at $38k).

• Historical Outperformance: Over the 10-year period ending 2024, Asian EM markets delivered significantly greater returns (+120%) compared to non-Asian EM markets (+43%).

Risks & Areas of Concern

• Geopolitical Tensions: Particularly China-Taiwan relations and broader US-China tensions could impact Asian EM markets, though domestic economic factors tend to be more significant drivers of returns.

• Currency Risk: Emerging market currencies can be volatile against the USD and AUD, particularly during periods of US dollar strength and rising US interest rates.

• Market Access Restrictions: Some Asian markets like Vietnam have foreign investment limits that can affect investability despite their economic potential.

• Chinese Property Market Challenges: Recent challenges in China's property sector have affected the country's economic growth, though this may create investment opportunities for long-term investors as valuations have decreased.
  

Portfolio Implications

• Adding 20% to the Platinum Asia Fund to a typical index overseas equity portfolio would

  • Reduce overall US equity exposure from 68% to 54% and Magnificent 7 (as an approximation for large US tech) by around 4.3% (of the international equity allocation).

  • According to consensus estimates it would reduce the aggregate portfolio 1 Year Forward Price/Earnings multiple from around 18x to 15.6x.

• We estimate that the long term expected return is around 2% higher than that of the broader index based on higher GDP growth rates and more favourable valuations. This allocation could increase the portfolio expected return by around 0.4% per annum.

• Emerging Markets Asia has achieved relatively poor results over the last decade in comparison to the broader international index, however, with the US market at stretched valuations and high levels of political uncertainty, EM Asian equities more recently achieved strong relative outperformance which may have much further to run.

• An addition of EM Asia to an international equity portfolio can also increase diversification, reduce volatility and drawdown of the portfolio due to valuation support.

• If you would like us to conduct similar analysis for your model, SMA or client's portfolio please contact us below.

Economic Scenario Expectations

• Continued Economic Growth

  Asian EM markets would likely benefit significantly from global economic growth, particularly companies with exposure to consumer adoption curves in autos, travel and technology in developing Asian economies.

• Mild Recession

  Quality Asian companies with strong balance sheets may demonstrate resilience, though smaller companies could face volatility. Investors should focus on companies with domestic growth drivers less dependent on global economic cycles.

• High Inflation & Rising Rates

  Companies with pricing power would be best positioned, though Asian markets generally face challenges during periods of US dollar strength. Investors should focus on companies with low debt levels and strong market positions.

• Severe Economic Downturn

  While Asian markets may initially suffer alongside global markets, the long-term growth trajectory of Asian economies could provide a faster recovery path, especially for countries with domestic consumption drivers.

Conclusion

Asian-focused EM exposure offers Australian investors greater diversification benefits and growth potential over non Asian EM, while avoiding redundant exposures to resources and financial sectors already well-represented in domestic portfolios. Despite geopolitical and currency risks, there is an arguable opportunity set across low to high-income Asian economies which could provide compelling portfolio benefits.

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