Allocating to Asia February 2016

Transcription

1 Allocting to Asi Februry 2016 Introduction A key element of investment success is long-term perspective. With it, investors cn ssess the long-term impct on their portfolios of fundmentl, economic nd demogrphic chnges. They cn then llocte their portfolios more effectively, focusing on incresing returns over n extended time horizon. This pper is designed for those long-term investors, nd seeks to help them understnd nd evlute the benefits of mking meningful lloction to Asin investments. Mrkets in Asi cn be voltile. But for investors who see the potentil in estblishing strtegic lloctions to Asi, periods of short-term price voltility cn provide n excellent opportunity to estblish or increse positions. The globl investment environment currently shows cler differences between regions, highlighting the growing importnce of Allocting to Asi : The United Sttes economy hs returned to growth, rising employment nd much-improved investor sentiment. But this recovery hs turned on ultr-low interest rtes nd quntittive esing. As this support is removed nd rtes begin to rise, there is some uncertinty s to the implictions for the economy. Europe continues to suffer from lckluster growth nd persistent high levels of unemployment. Menwhile, quntittive esing by the Europen Centrl Bnk continues with the im of improving the region s wek economic outlook. Mny emerging mrkets ex-asi re sddled with debt (often denominted in U.S. dollrs), nd struggling with flling commodity prices nd softening export demnd in Europe, Jpn nd Chin. Brzil nd Russi mong the world s lrgest emerging economies nd the non-asin components of the BRICs re in recession nd burdened with hrd currency debts incurred when commodity prices were robust in the hlf-decde fter the finncil crisis. Asi stnds prt, with 2015 regionl economic growth of 5.5%, ccounting for 35% of globl output. Notwithstnding the impct of the finncil crisis, Asi tody is hrvesting the fruits of genertion of improving fiscl indictors, robust economic growth nd rising stndrds of living. Despite the voltile strt to 2016 nd concerns round the generl helth of the globl economy, from reltive stndpoint Asi s economic fundmentls remin ttrctive. While it continues to represent sizble prt of the globl economy it remins very smll prt of n investor s portfolio. This pper ims to explin why portfolios re typiclly underweight nd show how investors cn most effectively consider incresing their lloction. It begins by setting out the economic nd fundmentl cse for Asi, looking t some of the key indictors tht highlight the region s growing role on the world stge. This is followed by discussion on how benchmrks typiclly under-represent the region nd how this cn led to n underweight portfolio lloction. Finlly, the pper looks t the pproches investors cn tke when dding n Asi-focused strtegy to their portfolio nd the importnce of tking n ctive mngement pproch. Given Asi s rising economic importnce nd growing equity nd fixed income mrkets, we believe investors now need to tke this into considertion in globlly diversified portfolio. In future white ppers, we will exmine these importnt spects further nd tke deeper look t portfolio construction, risk nd the benefits of ctive mngement. For Investment Professionl Use Only

2 ALLOCATING TO ASIA A Brod Opportunity Set Asi encompsses hlf the world s popultion nd, ccording to the Economist Intelligence Unit, will ccount for hlf of globl GDP by 2050 (Figure 1). Asi is lso expected to ccount for two-thirds of middle clss spending globlly by The region is highly diverse, rnging from mture economies like Jpn to the emerging gint, Chin. There re other lrge emerging economies (Indi nd Indonesi) plus those still t erly stges of globl enggement (Philippines, Bngldesh, Los, Sri Lnk, Cmbodi, Mynmr). FIGURE 1. THE RISE OF ASIA CONTINUES Regionl shre of globl GDP 100% 80% 60% 40% 20% 0% Source: The Economist Intelligence Unit Estimted Asi-Pcific Americs Europe Middle Est nd Afric For mny yers, investment strtegies hve treted Asin investments s tcticl, levered ply on globl growth, dding counter-cycliclity nd diversifiction for investors whose lloctions re primrily concentrted in North Americ nd Europe. But investment mrkets re chnging. As the globl economy shifts to the est, forwrd-thinking welth mngers understnd tht crefully selected Asin investments my be the best wy to cpitlize on primry theme for the globl economy in coming decdes: the rise of the Asin middle clss. And it is worth noting tht this is theme tht pplies in Asi more brodly thn in other emerging mrkets. When ssessing wht mkes n ttrctive investment destintion, investors should consider rnge of fctors. From top-down perspective, these include economic, socil nd politicl fctors. From the bottom-up, the focus is more on compnies, their growth potentil nd ttitudes towrd minority shreholders. In our view, Asi scores highly cross ll these fctors. SAVINGS, PRODUCTIVITY AND STRUCTURAL CHANGE Mny Asin economies hve experienced fster rtes of per cpit GDP growth thn other emerging mrket economies (Figure 2). This drmtic economic lift-off hs been driven by three key fctors: high svings rtes, totl fctor productivity nd structurl economic chnges. While ech is significnt, it is the combintion of these fctors, together with other supporting elements, tht ccount for the region s more rpid reltive growth. Economic growth does not necessrily imply outperformnce of ny individul sset clss or mrket. The chrcteristics of Asi s mny regionl equity mrkets rnge from highly mture in Jpn, to emerging in Chin nd mny ASEAN sttes. Bond mrkets re similrly heterogeneous in chrcter nd composition. But long-term investors should lign themselves with brod themes tht trnscend shortterm mrket voltility. We believe ctive mngement of investments cross sset clsses nd in different ntionl mrkets is the best wy to lign investment gols with regionl growth. FIGURE 2. GDP PER CAPITA Over the pst three decdes, mny Asin economies hve generted higher rte of chnge in GDP per cpit thn the United Sttes, s shown by plots bove the digonl blue line tht represents the sme GDP growth per cpit s the United Sttes. GDP per cpit reltive to the U.S. (2010) Singpore Hong Kong U.S. 0.8 Tiwn 0.6 South Kore Jpn Chin Thilnd Indi Mlysi GDP per cpit reltive to the U.S. (1980) 1.2 Europe U.S. nd Cnd Ltin Americ Asi Middle Est nd Afric Sources: Angus Mddison, MICM 2 ALLOCATING TO ASIA

3 Mtthews Asi High Svings Rtes: Asi s bility to sve nd invest efficiently in its economy nd its high svings rte s compred with other developed nd emerging economies drives much of its ppel s n investment destintion. The region s svings rte (Figure 3) hs fr reching implictions for its economic growth, socil stbility nd productivity. Domestic svings re n inherently more stble investment source thn re foreign-sourced investment flows tht vry with economic cycles. Domestic svings re prticulrly vluble source of investment for long-term projects in infrstructure nd eduction. Asi hs been uniquely successful in this regrd, generting robust svings for investment nd providing the region with investment cpitl for future growth. With the exception of mjor oil exporters with smll popultions, the world s leding ntionl svings rtes, mesured s percentge of GDP, re in Asi. For exmple, ccording to IMF estimtes, Chin s ntionl svings rte of nerly 50% of its GDP is more thn double the world verge of 25%, or Germny s t 24% nd nerly triple the U.S. rte of 17.3%. And Asi s svings rtes re mrkedly higher thn other emerging mrkets. For exmple, developing Asi countries like Thilnd nd Indonesi hve svings rte of 30.2% nd 29.9%, respectively, s compred with 23.2% in Russi nd 13.5% in Brzil. FIGURE 3. GROSS NATIONAL SAVINGS AS % OF GDP Chin Singpore Kore Switzerlnd Tiwn Mlysi Indonesi Indi Thilnd Netherlnds Hong Kong Sweden Denmrk Germny Austrli Russi Jpn Peru Philippines Colombi Frnce Chile Finlnd Mexico Belgium Itly Spin U.S. Argentin Brzil U.K. 0% 10% 20% 30% 40% 50% Source: Interntionl Monetry Funds 2014 estimtes, Switzerlnd is 2014 CIA estimte Totl Fctor Productivity (TFP): Often seen s the true driver of productivity gins, resource use nd long-term economic growth, totl fctor productivity cptures ll the contributors to n economy beyond the trditionl mesures of lbor nd investment. Exmples of TFP in contemporry Asi include shift from mnul industril production to robotics, incresed use of informtion technology, nd the migrtion of workers from rurl res to cities where their lbor contributes more to GDP nd where their children hve the opportunity to become better educted. Another fctor in country such s Chin is the migrtion of economic ctivity from the lbor-intensive stte-owned enterprises tht becuse of their size dominte Chin s stnding in investment benchmrks, towrd more productive privte enterprises tht re the country s min source of economic nd employment growth. Long-term svings rtes re prticulrly criticl element in totl fctor productivity nd Asi hs some of the highest svings rtes in the world. Mny economists believe tht TFP my be the single biggest fctor driving GDP growth. And TFP growth is notbly high in Asi, influenced by supply-side reforms, mrket friendly policies, entrepreneuril environments, technology nd eduction. The combintion of these fctors hs contributed to the region s remrkble economic success reltive to other mrkets, in prticulr Ltin Americn countries (Figure 4). FIGURE 4. AVERAGE TFP GROWTH, Tiwn South Kore Indi Chin Hong Kong Philippines Indonesi U.S. Thilnd Jpn Singpore Peru Sweden Germny Colombi Mlysi Denmrk Switzerlnd Spin Frnce Itly Chile Brzil Argentin Netherlnds Belgium Austrli U.K. Mexico Finlnd -2.0% -1.0% 0.0% 1.0% 2.0% Sources: Asin Productivity Orgnizion Dtbook, Orgniztion for Economic Co-opertion Development mtthewssi.com 3

4 ALLOCATING TO ASIA TOTAL FACTOR PRODUCTIVITY IN CHINA In brodly held misconception, it is often ssumed tht Chin s remrkble economic success hs been driven by lrge nd growing pool of chep lbor. In fct, lbor force growth hs been very smll contributor to productivity. Fr more importnt hs been totl fctor productivity (TFP). Bsed on the numbers published by the Asin Productivity Orgniztion, during the period from 2000 to 2010, Chin hs hd one of the fstest nnul rtes of TFP growth t 4.1%. Chin s vst nd ccumultive investment in reserch nd development, ttrction of lrge mounts of foreign direct investment nd its deepening of industriliztion re some of the resons behind the outstnding TFP growth rte during the decde. Even more importnt, in the cse of Chin, hs been the cretivity nd efficiency with which cpitl nd lbor hve been combined. In the pst few yers, s regionl economies hve mtured, TFP growth in Chin nd the ASEAN sttes hs begun to plteu. Economic plnners see ccelerting TFP s key to rekindling economic growth. To do this, they re focusing on more sophisticted goods nd services tht tend to move ctivity up the vlue-dded chin, incresing TFP nd, eventully, overll economic growth. Services will be criticl fctor, given the ever-incresing criticlity of ICT (informtion nd communictions technologies). Modern services exports nd export diversifiction generlly bodes well for Indi, Philippines, Singpore, Thilnd nd especilly Chin. Chin Seprting Fct from Fiction, Mtthews Asi Perspectives, December 2014 Structurl Chnges: Asi s economies re in continul chnge. Rising personl welth nd consumption, combined with grdul economic liberliztion nd the spred of technology, hve trnsformed Asi s economies nd mrkets. The region s economies re evolving rpidly through shift from low-productivity ctivities such s griculture nd mining towrd consumption nd sophisticted services tht will help businesses generte profits nd mke greter contribution to economic growth. Tody s economies re focused more on domestic demnd nd this should be just the beginning of sustined growth in the kinds of businesses tht will help generte profits from revolutionry chnge in lifestyles tht now include consumer brnds, resturnts, leisure, medi, insurnce, property, consumer bnking nd welth mngement. By incorporting new technologies, together with physicl nd humn cpitl, Asi will continue this move up the vlue chin towrd higher vlue-dded industries. GREATER PURCHASING POWER AMONG ASIAN HOUSEHOLDS In ddition to productivity gins, fctors including rising wges, personl welth nd urbniztion re driving Asi s consumption of physicl goods, such s utomobiles nd property. At the sme time, the region is ccelerting the build-out of socil infrstructure like helth cre nd insurnce. This should continue in coming yers s Asi s middle clss continues to expnd. According to 2010 Brookings report, in 2009, Asi ccounted for 28% of the world s totl middle clss popultion; this is expected to increse to 54% by 2020 when Asi could bost more thn 1.7 billion middle clss citizens, ccounting for 42% of totl middle clss consumption. FIGURE 5. GROWTH OF AVERAGE REAL WAGES IN ASIA-PACIFIC AND THE WORLD, % 7.3% 2006 Globl 3.1% 7.7% 2007 Asi 1.2% 5.1% % 6.5% % 6.3% % 5.4% % 5.9% % 6.0% 2013 Source: Interntionl Lbour Orgniztion: Globl Wge Dtbse 2014/15, bsed on ntionl sttistics The tendency to see Asi s economic model s one bsed on low wges is too simplistic given the diversity of economic development from mture economies to ones emerging in the region. For the pst five yers, the Asi-Pcific region hs experienced wge growth roughly three times higher thn the rest of the world. This sets the region prt from lrge developed economies, where rel wges hve stgnted since the Globl Finncil Crisis of According to the Interntionl Lbor Orgniztion, wges in Asi Pcific hve risen by lmost 250% since This much wge growth for the region s more thn 700 million wge erners nd their fmilies trnsltes directly into economic dynmism, higher living stndrds nd incresed spending. These higher-erning middle clss workers should shift economic ctivity towrd sophisticted goods nd services, including enggement with technology, improved helth cre nd finncil services, underscoring the theme of rising Asin middle clss. 4 ALLOCATING TO ASIA

5 Mtthews Asi FIGURE 6. CUMULATIVE REAL WAGE GROWTH IN ASIA PACIFIC AND THE WORLD, (INDEX: 1999 = 100) World Developed economies Asi Est Asi Southest Asi nd the Pcific South Asi Source: ILO: Globl Wge Dtbse 2014/15, bsed on ntionl sttistics FIGURE 7. RISING WAGES AND PRODUCTIVITY BEHIND ASIA S RISING SHARE OF CONSUMPTION Globl middle clss consumption ( )* 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% In the coming decdes, middle clss spending in Asi is expected to outpce tht of North Americ, Europe, Afric nd the Middle Est combined. Increses in Asin wges re lifting regionl stndrds of living towrd Europen nd North Americn levels, further expnding n emerging consumer group tht is becoming pillr of globl consumption. REFORMS BENEFIT DIVERSIFIED ECONOMIES Middle Est nd Northern Afric Sub-Shrn Afric Asi Pcific Centrl nd South Americ North Americ Europe 0% *Dt represented beyond November 2011 re estimtes only. Notes: Globl middle clss consumption is defined here s household consumption between USD 10 nd USD 100 Purchsing Power Prity (PPP)/dy. Projections hold most recent distribution constnt (from PovclNet dtbse) nd ssume consumption equls income growth (projected by Cobb-Dougls production function, model of Rel Exchnge Rte (RER) convergence bsed on the Blss-Smuelson model, nd UN popultion projections). Source: Orgnistion for Economic Co-opertion nd Development (OECD) 2011, Perspectives on Globl Development 2012: Socil Cohesion in Shifting World; Dt s of November 2011 Economic reforms cross Asi re supporting rising wges cross the region. Chin, Indi, Jpn nd Indonesi ll hve reltively new prime ministers focused on reform. But wht distinguishes the region from the West is tht economic reforms re trgeting the economy t its foundtion t the corporte nd consumer level, designed to both deepen the mrkets nd broden their prticipnt bse. Asi continues to embrk on supply-side reform nd institutionl improvements, such s refocusing on corporte governnce nd driving economic efficiency. In Indi, Prime Minister Nrendr Modi is wrestling n mbitious pro-growth reform gend (including lnd reform) pst vested interests. Reserve Bnk of Indi Governor Rghurm Rjn, previously highly regrded cdemic t the University of Chicgo, is mong the few centrl bnkers globlly who is ctully recognized expert in globl monetry policy. In Chin, the Qulified Foreign Institutionl Investor (QFII) progrm now llows select globl institutionl investors to invest in its renminbi-denominted cpitl mrkets. Simultneously, the Shnghi-Hong Kong Stock Connect progrm is llowing greter cpitl flows from Minlnd Chin to Hong Kong from locl Chinese investors. In ddition, through Stock Connect, foreign investors cn ccess the A-shre mrket directly without the need for QFII license. In South Kore, policymkers hve encourged corporte reforms such s the distribution of dividends, improved use of csh nd refined ownership structures within conglomertes. Mynmr frontier mrket long considered beyond the rech of interntionl investors lunched its first officil stock exchnge s the ntion opens its economy fter decdes of isoltion. Investors re expressing rising interest in Asi s frontier mrkets, such s Pkistn nd Bngldesh the ltest exmple of cpitl mrket expnsion cross the region tht is expected to offer new investment opportunities for interntionl investors. Beyond the Benchmrks While Asi s growing economic importnce is well known, investors continue to be typiclly under-llocted to the region. One problem turns on benchmrk construction specificlly lg between the rpidly chnging economic nd finncil lndscpe nd mrket indices nd other metrics tht re slow to evolve nd bckwrd looking. Finncil indices for equities nd fixed income re n expression of where mrkets re here nd now nd where they hve been. There re no investment indices tht re representtive of the sectors, industries nd compnies tht my be successful in the future. So if investors re llocting in ccordnce with the finncil mp of the present nd the ner pst, they my miss emerging trends nd opportunities. Most investors prefer highly developed securities mrkets in economies with world-stndrd ccounting nd trnsprent, imprtilly pplied regultion. This leds to structurl mtthewssi.com 5

6 ALLOCATING TO ASIA EMERGING ASIA S RISING PRODUCTIVITY Productivity is the key to emerging opportunities in Asi. Productivity growth cretes economic growth, rises living stndrds nd improves opportunities for business profits nd investment. From the perspective of productivity, it is esy to be optimistic bout Asi. Notwithstnding genertion of high growth, Asi is still reltively unproductive prt of the world. While city sttes like Singpore nd Hong Kong hve per cpit GDP comprble to the United Sttes, productivity per hour of their workforce is still 20% to 30% lower thn the United Sttes. This suggests tht there is incresed room for greter productivity in the region, which could led to higher per cpit GDP. Over the pst decde, per cpit GDP in Chin hs tripled in purchsing power prity (PPP) terms, nd yet Chinese workers still hve their most productive yers hed of them. Since the globl finncil crisis, consumption in Asi hs incresed by more thn third, even s the West hs lnguished. A sense of optimism pervdes Asi optimism tht lives re chnging nd tht the future is going to be welthier thn the pst. Emerging Asi s Rising Productivity, Mtthews Asi Insight, November 2012 over-lloction to North Americ nd Europe, where cpitl mrkets hve long history. For their prt, Asin mrkets hve been mking significnt progress with reforms nd improving ccountncy stndrds. Asi s equity mrkets hve lso grown significntly to represent lmost 40% of the world s totl stock mrket vlue (s represented by the World Federtion of Exchnge Members in Figure 8). Another benchmrk issue results from the fct tht widely used indices do not include Chin A-shres (renminbidenominted stocks in minlnd-bsed compnies, trded on Chinese exchnges nd generlly vilble for purchse only by minlnd citizens). If A-shres were to be included, by some estimtes, Chin s proportion of globl equity mrket cp would expnd significntly. FIGURE 8. WHILE ASIA S GROWING ECONOMIC IMPORTANCE IS GAINING RECOGNITION, INVESTORS CONTINUE TO BE TYPICALLY UNDER-ALLOCATED TO THE REGION MSCI ALL COUNTRY WORLD INDEX Cnd 3% U.S. 53% Mid Est/Afric 1% Europe 23% Ltin Americ 1% ASIA Chin/Hong Kong 4% Indi 1% Jpn 8% Other Asi 6% 19% Indices lso tend to not include vst blocks of shre cross holdings (when publicly trded compnies own blocks of ech others stocks). By filing to ccount for these substntil portions of Asin mrket cp, it could be rgued tht the widely used indices effectively under-stte the mrket cp of Asin exchnges. WORLD STOCK MARKET VALUE Cnd 3% U.S. 40% ASIA Chin/Hong Kong 18% Indi 2% Jpn 8% Other Asi 9% 37% Brod emerging mrket indices, becuse they include ll regions nd fctor in mss commodity exporters mny of whom re not locted in Asi chroniclly underweight Asi nd fil to reflect the region s growth potentil. Not ll emerging mrkets re creted equl. While most emerging mrkets hve experienced historic expnsion of the middle clss, this expnsion hs been most pronounced in Asi. A benchmrk-only pproch to Asi mens investors my not hve ny exposure, not enough exposure, or the wrong kinds of exposure to the region s dynmic growth potentil. TOO LITTLE ASIA CONTRIBUTION TO GDP Mid Est/ Afric 3% Mid Est/ Afric 6% Ltin Americ 7% Cnd 2% U.S. 24% Europe 15% Ltin Americ 2% Europe 26% ASIA Chin/Hong Kong 16% Indi 3% Jpn 6% Other Asi 10% 35% The MSCI EAFE Index of developed mrkets in Europe, Austrlsi nd the Fr Est (excluding the U.S. nd Cnd) is populr benchmrk for U.S. investors seeking Sources: MSCI, Interntionl Monetry Fund nd World Federtion of Exchnge Members IMF GDP dt s of December 2015; MSCI All Country World Index nd Stock Mrket Vlue dt s of 12/31/15 6 ALLOCATING TO ASIA

7 Mtthews Asi interntionl equity exposure (Figure 9). The MSCI EAFE Index is mrket-cpitliztion weighted, which mens tht it mesures its securities mrket cpitliztions tody. With stock nd bond mrket-to-gdp rtios in Asi significntly lower thn in the U.S., this cp weighting demonstrtes Asi s undersized securities mrkets rther thn the growth potentil of the continent s expnding economies. In ddition, it should be borne in mind tht the deep mrket liquidity nd reltively fmilir mrket stndrds nd prctices of North Americ nd Europe contribute to the systemic home country preference on the prt of mny investors. FIGURE 9. UNDERWEIGHT ASIA Interntionl indices cn underweight Asi, creting missed opportunity for benchmrk-driven investors Europe 65% compnies, the Asi of the future should look more like Western economies, with focus on consumer goods, helth, leisure, trvel nd technology. These ssumptions led to very different lloction thn tht found in benchmrks. How Portfolios Underweight Asi Historiclly, mny professionl investors hve constructed globl portfolios using combintion of developed nd emerging mrket strtegies. Within listed equities, we find common pproch is to chieve the trgeted interntionl weightings by using combintion of MSCI EAFE-bsed developed interntionl mrket strtegies nd MSCI emerging mrkets-bsed strtegies. Let s ssume n equity portfolio invested roughly 30% interntionlly, with 75% of this lloction in the MSCI EAFE Index nd 25% invested in the MSCI EM Index. Using these two indices, the investor s totl exposure to Asi ex-jpn would be bout 8% of their totl equity holdings (Figure 10), despite the fct tht the region ccounts for 27% of globl GDP nd expected n economic growth rte of 5.5% over twice the globl growth rte of 2.5%. Other Asi 8% Jpn 23% Mid Est/Afric 1% Chin/Hong Kong 3% FIGURE 10. PORTFOLIO ALLOCATION BY REGION % Equity Alloction Mrket Cp (USD billions) Expected GDP Growth Rte 2016 Jpn 5% 4, Asi ex-jpn 8% 17, Europe 15% 15, United Sttes 72% 26, MSCI EAFE Index Sources: MSCI, FctSet Reserch Systems; Dt s of December 31, 2015 THE WRONG KIND OF ASIA If globl benchmrks tht systemticlly underweight Asi, led to too little Asi, Asin regionl benchmrks, when compred to GDP nd GDP growth, illustrte how investors cn end up with the wrong kind of Asi. Asin economies re expected to grow fster thn those of Europe nd North Americ in coming decdes. And their securities mrkets re expected to grow even fster s combintion of economic development nd reform deepen mrkets nd broden out the insurnce nd finncil services sectors. This process of moderniztion nd rpid chnge is often cptured lte in benchmrks. For investors, it s importnt to understnd the res of Asi s economy tht will potentilly benefit. The consumer is likely to become the dominnt driver of the region s economy. When thinking bout compnies tht will benefit from rising welth cross the region, the Asi of the next decde tends to look very different from current benchmrk sector weightings. Rther thn focus on lrge bnks, petrochemicl nd industril Sources: World Federtion of Exchnges, Interntionl Monetry Fund, FctSet Reserch Systems, MSCI nd Mtthews Asi; Equity Alloction dt s of December 31, 2015; Mrket Cp Dt s of Jnury 2015; GDP Growth Rte for 2016 Dt s of April 2015 Let s leve side for the moment the sizble lloction to the United Sttes, which is derived in prt by home-country bis mong dollr-holding investors, the desirbility of U.S. dollr-denominted ssets nd the unrivled depth nd liquidity of U.S. stock nd bond securities mrkets. By lmost ny mesure, under-lloction to Asi seems egregious. Europe s equity mrket cp, t US$15.5 trillion, is mrginlly smller thn tht of Asi ex-jpn (US$17.5 trillion) but Europe receives lmost twice the equity lloction 15% to Asi ex-jpn s 8%. Perhps the gretest lloction shortfll, in terms of cpitlizing on future economic growth, is tht Asi ex-jpn receives less thn hlf the equity lloction of Europe despite the fct tht its projected GDP growth of 5.5% is nerly triple the 1.8% foreseen in Europe. Whether mesuring by mrket cp, GDP or GDP growth, the most commonly used investment indices seem considerbly off trget with respect to Asi, nd more generlly for investors seeking to cpture future economic growth. For exmple, investors relying on the MSCI EAFE Index for the mtthewssi.com 7

8 ALLOCATING TO TO ASIA Mtthews Asi mjority of their Asi exposure would be overweight Jpn while hving only sliver of exposure to Asi s fstestgrowing economies notbly Chin. Becuse of this benchmrk distortion, investment in Asi clls for n ctive, hnds-on pproch to lloction tht is flexible nd ttuned to economic cycles nd investor behvior. Active mngers must mke educted ssessments regrding prospects for economic growth nd investment mrket pprecition rther thn relying on pssive lloctions predicted on bckwrd-looking indices. Closing the Gp: New Approches to Asi Given the systemtic under-lloction to Asi, resonble question to sk is how to bridge the gp? Once investors begin to look beyond the widely used benchmrk lloctions nd towrd more nunced pproch to investing, there re number of wys to improve their process of llocting to Asi. Before this cn hppen, there needs to be considertion of how best to dd Asi to n investor s portfolio. This could be complementing existing exposure or replcing n existing pproch. There lso needs to be decision on the type of Asi exposure n investor is looking to dd to their portfolio. For instnce, Asi cn be llocted geogrphiclly though regionl nd country strtegies tht include the region s developed, emerging nd frontier economies. This is one pproch tht hs been gining more ttention with investors globlly. Investors cn lso focus by style, concentrting on dividends or growth strtegies tht my be more ligned to their overll portfolio objectives. Irrespective of the pproch nd strtegy tken, clerly one of the key objectives is to improve the overll risk-djusted returns on the portfolio. INVESTING GLOBALLY BY REGION Investors could consider splitting the world into three min blocs U.S., Europe nd Asi Pcific. A simple brekdown into thirds brings the portfolio close to the world brekdown by GDP. It lso brings it more in line with how the world is represented from n equity mrket cpitliztion perspective (Figure 11). Investors cn refine this strtegy by using ctive mngers to select investment trgets in prticulr regions, while being creful to reblnce regionl lloctions to the preferred strtegic lloction. Others use Asi to represent their entire emerging mrkets lloction, dropping the use of emerging mrket benchmrks ltogether, with the understnding tht Asi is expected to generte the lion s shre of the growth mong emerging mrket countries. INVESTING GLOBALLY BY STRATEGY Rther thn treting region like Asi s n investment destintion within n interntionl lloction, investors could enhnce their existing investment strtegy with exposure to specific Asin strtegies. For instnce, income-oriented investors in the U.S. could double the universe of dividend pying stocks vilble to them by mking n lloction to n Asin dividend-pying strtegy. The growth rte nd stbility of dividends in Asi my be higher thn those in the U.S., while investing by strtegy potentilly helps to cpture overlooked investment opportunities globlly. Aprt from dividends, other strtegies re now vilble to investors given the extent to which Asi s finncil mrkets hve deepened. Investors cn now dd dedicted exposure to strtegies tht focus on single countries, smll compnies, or frontier nd emerging Asin economies to meet specific strtegic objectives. FIGURE 11. WORLD MAP BY EQUITY MARKET CAP (IN US$BN) Cnd 1,156 United Sttes 19,731 Mexico Colombi Peru Brzil United Kingdom 2,691 Irelnd Frnce 1,313 Norwy Sweden Finlnd South Kore Denmrk Russi Chin 889 Netherlnds Polnd Germny 1,194 Indi Tiwn Belgium Switzerlnd Hong Kong 1,275 Jpn 3,006 Thilnd Turkey Spin Itly Mlysi Singpore Philippines Indonesi Austrli Chile Sources: Mpping Worlds, Bloomberg, July 2015 South Afric 8 ALLOCATING TO ASIA

9 Mtthews Asi ASIA AS A COMPLEMENT TO CORE INTERNATIONAL STRATEGIES Depending on the core interntionl funds used, incresing portfolio s existing Asi weight might involve dding Asi Pcific s whole, Asi ex-jpn or just Chin nd Indi the countries tht tend to be most under-represented reltive to their economic size. The decision to dd country strtegies rests in prt with how comfortble n investor is in mking lloction decisions in order to crete more customized portfolios with specific country risk exposures. Investors looking for even greter diversifiction opportunities my wnt to consider Asi fixed income, in ddition to Asi equities. A multi-currency portfolio of Asi fixed income investments hs different nd more diverse drivers of return thn single currency fixed income portfolio. For exmple, U.S. government bond returns re driven primrily by chnges in interest rtes. In contrst, returns for multi-currency fixed income portfolio, such s diversified Asi fixed income portfolio, re driven by three distinct elements credit, currencies nd interest rtes. The diversity of these risk nd return drivers results in low correltions with minstrem fixed income segments, s well s with U.S. nd Europen equities. The potentil benefits of globl diversifiction from n investment stndpoint re cler. But it is importnt to understnd the growth nd risk exposure offered by vrious pproches. Most brod-bsed interntionl nd emerging mrket mndtes leve investors under-llocted to Indi nd Chin, s well s other Asin mrkets poised to benefit from future economic trends. Asi offers investment trgets from spectrum of mturity, from frontier to emerging nd developed. And with the vrious stges of economic development cross the region, greter diversity mens there re greter numbers of investment trgets, offering wider rnge of risk nd return scenrios. The Essentil Role of Active Mngement In our view, pssive investment lloctions using bckwrd-looking benchmrks llocte more to Asi s pst thn to its future, with outsized weightings in the griculturl or commodity sectors tht hve historiclly ccounted for much of Asin GDP, nd undersized lloctions to the urbn consumption nd service industries tht will define the region s future. We believe there is no substitute for informed ctive mngement to identify the compnies nd securities poised ASIAN BONDS AND PORTFOLIO EFFICIENCY Asi fixed income offers investors ttrctive totl return potentil nd distinct investment chrcteristics tht cn help improve the overll risk/return profiles of fixed income holdings. For U.S. investors whose fixed income portfolios re predominntly exposed to the U.S fixed income mrkets, Asi fixed income provides currency diversifiction, the potentil for yield enhncement nd exposure to mrkets tht follow different economic nd credit cycles. Treting Asi fixed income s distinct sset clss offers investors cler benefits tht include low correltion to U.S., Europen nd globl fixed income mrkets, exposure to ttrctive regionl fundmentls nd ttrctive historicl performnce compred to other high-yielding fixed income sectors. As the U.S. begins to consider tightening monetry policy while lrge prts of the developed nd developing world re heding in the opposite direction, the potentil impct on bond mrkets could be pronounced. It seems prudent, therefore, for investors to ssess the composition of their fixed income portfolio nd look deeper t the underlying risk/return chrcteristics. Asi fixed income comprises reltively smll lloction within globl bond indices (19%) nd emerging mrket bond indices (21%). This systemtic underrepresenttion is ccounted for by the fct tht Asin countries hve less debt thn do other regions. With Asi fixed income being systemticlly underweighted in both globl nd emerging mrket benchmrks, investors could benefit from treting Asi fixed income s distinct lloction within their broder fixed income portfolios. Creting More Efficient Fixed Income Portfolio with Asi Bonds Mtthews Asi White Pper, July 2015 ASIA FIXED INCOME WELL-POSITIONED ALONG THE RISK/RETURN CONTINUUM Annulized Return 10% 9% 8% 7% 6% 5% 0% 2% 4% 6% 8% 10% 12% Annulized Voltility U.S. Bond Locl Currency U.S. High Yield Bond Emerging Mrket Denominted Asi Bond Bond Globl Bond USD Denominted Asi Bond 12/31/ /31/2014 Dt shown from 12/31/2001 since returns for Locl Currency Denominted Asi Bond (HSBC Asin Locl Bond Index ALBI), USD Denominted Asi Bond (J.P. Morgn Asi Credit Index JACI), U.S. Bond (Brclys U.S. Aggregte), Emerging Mrket Bond (J.P. Morgn Emerging Mrkets Bond Index Globl), Euro Bond (Brclys Euro Aggregte), Euro High Yield Bond (Brclys Pn-Europen High Yield), U.S. High Yield (BofA Merrill Lynch U.S. High Yield Mster II) nd Globl Bond (Brclys Globl Aggregte) re ll vilble from this dte. Performnce for ll indices is in USD terms, except for Brclys Euro Aggregte nd Euro High Yield, which re in euro terms. Pst performnce is no gurntee of future results. Source: Bloomberg Euro Bond Euro High Yield Bond mtthewssi.com 9

10 ALLOCATING TO ASIA to benefit from the world s fstest-growing, fstest-chnging economies. Pssive investment cn set investors on wywrd course tht doesn t come close to cpturing Asi s true opportunity set. We believe ctive mngement is essentil for investors to nvigte the future of Asi s economies nd to void the permnent loss of cpitl tht could result from investment in the wrong sectors nd countries. Successful investing in Asi does not come from pssively following mrket indices, mcro regionl trends or hot countries. Rther, it requires ctively identifying individul compnies tht stnd to benefit from Asi s rising welth nd chnging consumption ptterns. In fst-growing economies, ctive mngement cn ply key role in helping investors mnge risks nd generte ttrctive, sustinble long-term growth. GOOD CORPORATE GOVERNANCE ENHANCES RETURNS Corporte governnce cn be defined by mny inputs, rnging from metrics such s ownership structures, interest lignment, historic cpitl lloction, trnsprency nd independence, ll of which provide vluble insights into the wy business is mnged. According to 2000 McKinsey & Compny survey, over 75% of investors would py more for well-governed compny nd over time, compnies tht score well in terms of corporte governnce cn potentilly benefit from governnce premium in their vlution. Within Asi, corporte governnce remins work in progress nd while overll there hs been some progress, in mny countries it hs been mixed (Figure 12). Given how widely corporte governnce vries cross the region, this is nother fctor tht underscores the importnce of ctive mngement. From FIGURE 12. CORPORATE GOVERNANCE STANDARDS ARE GENERALLY IMPROVING Country Corporte Governnce Wtch Mrket Scores Points Chnge = Hong Kong = Singpore (3) 3 Jpn = Thilnd = Mlysi Tiwn Indi South Kore Chin (4) 10 = Philippines = Indonesi (1) evluting corporte governnce to the bsic fundmen tls of compny s blnce sheet nd compny s competitive position within its own industry, skilled ctive mnger cn potentilly dd significnt vlue to investors. The choice of ctive versus pssive is n importnt decision for investors considering llo cting to Asi. INVESTING IN QUALITY Pssive strtegies in Asi hve n implicit bis towrd lrger-cpitliztion stocks thereby fvoring populr nd expensive stocks tht hve enjoyed successful runs over mny yers. Investors ccept these strtegies becuse they understnd tht it is difficult for ctive mngers to produce excess returns in more efficient mrkets such s Europe nd the United Sttes. But in Asi, where compe tition is less intense nd mrkets re less efficient, ctive mngement cn still uncover potentil opportunities for profit. Through n ctive mngement strtegy, investors cn put long-run opportunities front nd center nd focus on the underlying businesses bility to survive disloctions in growth nd economic structure. This llows investors to gin exposure to qulity, s expressed by returns on cpitl, mrgins, csh ernings, dividend growth nd the sustinbility of competitive dvntge nd mngement expertise. This implies focus not on the pce of growth but on its sustinbility expressed either s csh ernings or dividends. This leds ctive mngers to scrutinize the survivbility of businesses by ssessing the strength of the blnce sheet nd the competitive position of the business frnchise over longer-term time horizons. LOOKING AT ASIA IN A NEW LIGHT Asi will be mjor contributor to globl growth nd consumption over the next severl decdes. With combintion of lrge popultions, reltively high economic growth, rising wges nd productivity, shift towrd sophisticted services nd consumption nd deepening cpitl mrkets, the region should continue to crete new nd ttrctive investment opportunities for investors. In this dynmic region, the future will look different thn the pst, so investors should not rely on bckwrd-looking benchmrks lone to clculte their lloctions. Rther, they might tke fresh look t Asi using brod rnge of investment indictors in collbortion with experienced ctive mngers in pursuit of reduced risk nd more sustinble long-term results. Source: Asin Corporte Governnce Assocition (ACGA; CG Wtch 2014 Mrket Rnkings ) 10 ALLOCATING TO ASIA

11 Mtthews Asi mtthewssi.com 11

12 Wht Differentites Mtthews Asi? At Mtthews Asi, we believe in the long-term growth of Asi. For 25 yers, through ll types of mrket environments, we hve styed committed to our distinct philosophy for hrnessing Asi s growth. To help mnge risk nd enhnce long-term performnce, we conduct extensive proprietry reserch, conducting over 2,500 meetings yer with compnies, suppliers nd customers in Asi. We hve successfully mnged client portfolios through the Asi finncil crisis of 1997, the SARS outbrek of 2002 nd the globl finncil crisis of As n independent, privtely owned firm, Mtthews is the lrgest dedicted Asi-only investment specilist in the United Sttes. We employ fundmentl, reserch-driven investment philosophy with shrp focus on Asi s future. Serving both individul nd institutionl investors globlly, our strtegies rnge from country-specific to pn-regionl solutions tht provide diverse exposure cross sectors, themes nd mrket cpitliztions. As ctive, bottom-up investors, we re prticulrly focused on uncovering smller-cp nd smller-mrket opportunities for diversifiction nd growth potentil. As result of our stock selection nd ctive mngement style, the composition of our portfolios tends to be very different thn tht of Asi indices, emerging mrket benchmrks nd other ctive emerging mrket mngers who tend to tilt those portfolios to lrger cp lloctions becuse the geogrphy is so brod. When thinking bout compnies tht will benefit from rising welth cross the region nd the Asi of the next decde, we tend to choose sector lloctions tht typiclly look very different from current benchmrk sector weightings. For exmple, rther thn focus on lrge bnks, petrochemicl nd industril compnies, we think the Asi of the future will look more like western consumer mrkets, with focus on consumer goods, leisure, trvel, eduction nd helthcre. Finlly, we re stedfst in mintining long-term focus. A key tenet of our investing, right from our founding to tody, hs been to sk two questions when investing in n Asin compny: Will it be round in 10 yers? And if so, how big will it be? When you think longer term, you sk different, more strtegic questions, resulting in different investments. Why Choose Mtthews Asi? Focus nd Speciliztion: Mtthews Asi is focused exclusively on investment in the greter Asi Pcific region. Investing in Asi hs been our focus for 25 yers nd this dediction nd commitment to the region permetes our compny from the investment tem through ll of the deprtments involved in mnging nd servicing our clients ssets. Being focused enbles us to shrpen our investment expertise nd to deliver consistent nd distinctive vlue proposition to our clients nd prtners. Independence: Mtthews Asi is independent nd is privtely held. This cretes supportive environment for the long-term investment horizon tht we pply to stock selection nd portfolio construction. Our portfolio mngers re ligned with clients when they think bout the best long-term interests of our portfolios. Loction: Our hedqurters in Sn Frncisco fosters n independent, objective nd distinctive perspective on compnies nd business models. While we strongly believe in the importnce of trveling to Asi in order to meet with compnies nd conduct our on-the-ground reserch, we view Sn Frncisco s being supportive loction to mke our investment decisions. Experience: Senior portfolio mngers t Mtthews Asi hve extensive investment mngement tenure within the firm nd deep investment experience within Asin mrkets. During our first 20 yers, we hve mnged through multiple mrket cycles nd periods of voltility, including the Asin finncil crisis, the technology bubble, the SARS crisis nd the globl finncil crisis. Our firm nd our portfolios re tried nd tested, nd we understnd first-hnd the risks inherent with investing in Asi. Blnce of Temwork nd Accountbility: Our Sn Frncisco bsed investment tem sits together on one open floor nd constntly shre ides formlly nd informlly. This orgniztionl design leverges the intellectul cpitl of the entire tem for the benefit of our clients portfolios. At the sme time, ech portfolio hs Led Mnger clerly ccountble to our clients for performnce of the portfolios. For Investment Professionl Use Only The views nd informtion discussed in this report re s of the dte of publiction, re subject to chnge nd my not reflect the writer s current views. The views expressed represent n ssessment of mrket conditions t specific point in time, re opinions only nd should not be relied upon s investment dvice regrding prticulr investment or mrkets in generl. Such informtion does not constitute recommendtion to buy or sell specific securities or investment vehicles. Investing in interntionl nd emerging mrkets my involve dditionl risks, such s socil nd politicl instbility, mrket illiquidity, exchnge-rte fluctutions, high level of voltility nd limited regultion. The subject mtter contined herein hs been derived from severl sources believed to be relible nd ccurte t the time of compiltion, but no representtion or wrrnty (express or implied) is mde s to the ccurcy or completeness of ny of this informtion.mtthews Interntionl Cpitl Mngement, LLC ( Mtthews Asi ) does not ccept ny libility for losses either direct or consequentil cused by the use of this informtion Mtthews Interntionl Cpitl Mngement, LLC VA012