This article is part of Morningstar’s Guide to Investing in Asia where we navigate the potential risks for the chance of fantastic rewards from across the region.
Emma Wall: Hello and welcome to the Morningstar Series "Ask the Expert". I'm Emma Wall and I'm joined today by Arthur Wu, Senior Investment Analyst for Morningstar.
Hi, Arthur.
Arthur Wu: Hi.
Wall: So we are here today to talk about investing in Asia. It has been our Morningstar's Guide to Investing in Asia this week. And we've looked at the different countries, the different economies in isolation, China, Japan, India and ASEAN nations.
But of course it's all well and good looking at these stock markets in isolation. But what really matters to investors is the effect that these nations have on their portfolio. So what does investing in Asia bring to someone's portfolio?
Wu: I guess when people talk about Asia. They talk about Asia as a whole itself, but you know that different economies in Asia they do have different characteristics, they have different risk profiles. So for example if you were to invest in Thailand, you have political instability. If you were to invest in India or Indonesia there, you are heavily reliant on foreign financing.
If you were to invest in China, it’s dirigisme, which is a different problem altogether again.
So it will really depend on what is your strategy, but you should treat different economies differently in Asia by itself.
Wall: So basically what you're saying is Asia is not homogenous, it's a heterogeneous region.
Wu: Yeah.
Wall: And to that point then you've mentioned China, that's the biggest economy within Asia, so perhaps we should start there. What does investing in China bring to someone's portfolio?
Wu: I would guess, there are several aspects when you talk about it. There’s obviously the expected return and the expected risk. In terms of your expected returns per se, for overseas investors, China does have that emerging market risk premium by itself.
So if you were to add China to your portfolio prudently it will also increase your expected return of the Chinese market by itself. But do note that with higher returns comes higher risk, so there are several risks in China that we do not see in let's say the S&P 500 or the FTSE.
So an example of it is liquidity risk. China is fairly closed economy on a relative basis. Not only is liquidity is an issue, but if you were to look at the whole China market by itself, there is a very big disparity in the different regions.
So for example in the defensive sectors, the consumers sectors where the ongoing theme is your secular change, you're growing population growth frame whatever, what you see is that valuations of such equities in these regions have become very expensive.
On the flipside, you do have troubled areas such as banks and commodities. So again, picking a good active fund manager would be a very prudent choice if you were to invest in China.
Wall: So taking then an economy that's very different from China, but still lumped within this Asia region is Japan. Japan has a very different risk profile, a very different economy. What would that bring to someone's investment portfolio?
Wu: That's a good question. I guess on a macro level, if you are an investor outside China or Japan, I would say the biggest difference when you invest in the assets of these economies would be the currency.
So for example, we all know that the Japanese yen is a flight to safety currency. When there is risk off the table people flock in either U.S. dollar or Japanese yen by itself, so if you were to let's say – you are a Britain investor, an investor in Britain and you were to invest in Chinese stocks and Japanese stocks.
From a pound perspective, Japanese stocks will actually be safer, but its primarily due to the currency effect, so if you were to really to include either of these assets in your portfolio, not only you have to take into account the actual equity exposure but the currency exposure that comes with it.
Wall: So, I suppose the bottom line is when investing in Asia, make sure you understand the macro, make sure you understand the market, and make an informed decision. If I can't make an informed decision, active management comes into play.
Wu: Yes, maybe to add another point is that currency also plays a very big part, so some of the investors especially for economies like Japan, where they are buying Japanese equities, they were chose to have their equity exposure hedged to their base currency.
Wall: Arthur, thank you very much.
Wu: Thank you, Emma.
Wall: This is Emma wall for Morningstar. Thank you for watching.
