To tap into Asia’s new opportunities, U.S. investors must consider the transformational power of the Asian consumer. This is Part Two of a five-part special report on Investing in Asia.

When contemplating any portfolio rebalancing, priorities and tactics will flow best from a clear-eyed assessment of opportunities and risks. When weighing up allocations to Asia, financial advisors should consider a new powerful force tipping the scales in favor of increased exposure -- but risks traditionally associated with emerging markets have not vanished completely.

“There are only two places you can go to invest in big tech stocks: the U.S. or emerging Asia.”
Aditya Kapoor
Ivy Investments
Asia’s emerging markets have changed dramatically in terms of prosperity and investability. The most visible indicator is a growing cadre of technology firms competing on a global scale, such as Samsung, Alibaba and Tencent. These firms have thrived on an unprecedented growth in consumer spending.

EM Asia now is driven by secular growth, according to Aditya Kapoor, co-portfolio manager of Ivy Investments' Emerging Markets Equity Fund. “IT and consumer stocks are making the region’s performance more sustainable. Further, there are only two places you can go to invest in big tech stocks: the U.S. or emerging Asia,” he says. “Cyclicality has not disappeared, as can be seen from China’s performance last year. But this is part of a migration from an investment- to a consumer-led economy. There are still risks, but much less so than a decade or two ago. The Chinese consumer is a force to be reckoned with.”

Combined retail spending in 11 Asia ex-Japan economies grew from $1 trillion in 2001 to $6.6 trillion in 2016, soaring past the U.S. ($3.9 trillion). Oxford Economics forecasts further growth, with disposable incomes in China expected to increase by 8.3% by 2028, outpaced by India (11.6%), Vietnam (10.1%) and the Philippines (9.3%), supporting the ‘premiumization’ of consumer sectors.

Overwhelmingly, the beneficiaries are mid-tier private enterprises. A doubling in individual spending on healthcare in China from 2004 to 2011 has already fueled an explosion in the country’s healthcare and medical supplies sector. Across the region, cyclical industrials, materials and resources giants now sit on indices alongside a swathe of firms from hyper-competitive sectors from robotics to education to financial services. Having delivered to the Asian consumer, they are increasingly accessible to the U.S. investor, with many seeking the capital to grow globally.

“U.S. investors need to ask: Where is the innovation taking place?” says veteran emerging markets investor Mark Mobius, founding partner at Mobius Capital Partners.

But Asia’s journey from emerging to developed market status is far from complete. There will be bumps for investors along the way, even though the long-term direction of travel is set.

“China is on the road to being a developed market. Valuations will reflect financial market liberalization and greater transparency.”
David Dali
Matthews Asia
Peter Williamson, a veteran investor in Asian equities and founder of Lovina Capital, is cautious about investing in stocks – in China and Asia more broadly – whose ability to deliver returns is overly exposed to policy decisions, or other hard-to-predict macro-economic factors, such as commodity prices.

“Even among fast-growing, dynamic sectors such as education, Chinese government policy will play a significant role in future growth potential. It’s a matter of understanding risks and having visibility through the cycle,” he observes.

Consumer-led growth should, over time, allay investor skepticism over Asia EM’s historical currency and rate volatility, and concerns over countries’ political models and commitment to open markets. China, in particular, is still closely associated with giant state-owned enterprises often burdened with debt and political influence. But experts argue China’s current migration to a service-led economy depends on massive international inflows, which can only be secured by reform and integration.

“Liberation of China’s financial markets is evolving at a rapid pace,” says David Dali, a portfolio strategist at Matthews Asia. “Levels of disclosure and access to management are improving. Equity and bond markets are more connected internationally. China is on the road to being a developed market. Valuations will reflect financial market liberalization and greater transparency.”

Philip Lawlor, managing director, global markets research, FTSE Russell, also expects reservations around investing in China to evaporate. “As China begins to run a current account deficit, it will take the steps necessary to maintain foreign investment inflows, improving corporate governance, transparency, auditing processes etc. And it will happen more quickly than many expect.”

But for now, the transformation of both China and Asia are a work in progress. Political, macro-economic and currency risks must be identified with a sober eye and managed accordingly. Liquidity risk can still be a factor too, as bigger funds seek new opportunities in neighboring countries as China sheds its manufacturing base. “Vietnam has a favorable outlook, for example, but liquidity thresholds can prevent managers from unearthing the next hidden gem in small markets,” observes Ivy Investments’ Kapoor.

Next: How the Wrong Exposure in the Right Asian Markets Can Doom Clients