In a disorderly decade, Asia will play a standout role for investors

The writer is chief economist at Bank of Singapore

The 2020s are proving to be a disorderly decade for investors. Frequent shocks are shortening fund managers’ horizons. But the crises are also giving rise to new longer term trends. Successful asset allocation, including diversification to Asia, is therefore likely to be markedly different from the 2000s and 2010s.

Investors have spent the past few years dealing with the pandemic, Russia’s invasion of Ukraine, a violent attempt to overturn the US elections and now war in the Middle East. In contrast, the first two decades of the century were also startling but the most significant events — the attacks of September 11 2001, the Iraq war, the global financial crisis, the eurozone debt crisis and China’s currency devaluation in 2015 — were more staggered.

Portfolio managers have thus been firefighting one shock after another. But the pandemic, war and populism are set to drive a few clear trends for the rest of the decade.

First, inflation and interest rates are likely to stay significantly higher over the 2020s. Fiscal spending is increasing sharply on healthcare, defence, energy security and climate change and to counter inequality. At the same time, companies are reshaping global supply chains, further fuelling inflationary pressures. Second, the shocks of the past few years are forcing geopolitical rivals to search for security in sectors as diverse as tech, healthcare, food, energy and metals.

Long-term asset allocation in the 2020s is thus likely to differ substantially from the past two decades. Higher interest rates will favour the equities and bonds of companies with superior balance sheets. Fears over security and inflation will benefit commodities as well as tech companies. Increased uncertainty will require globally diversified portfolios.

In this new emerging environment, Asia will play a standout role for investors. Strong companies, strategic resources and less synchronised economies are likely to induce contrarians to increase exposure rather than retreat because of tense relations between Washington and Beijing.

At the start of the century, fund managers looked at the region through a lens of “Asia ex-Japan” as the world’s second-largest economy succumbed to deflation. Two decades later, similar concerns and geopolitical tensions are making fund managers consider strategies for “Asia ex-China”. In the absence of outright military conflict, however, China’s markets will remain important for unconstrained global investors.

China’s gross domestic product growth is set to fall from current levels of 5 per cent a year to nearer 4 per cent by the end of the 2020s as debt, demographics and disputes with the US slow trend rates down. But a decade of annual growth exceeding 4 per cent would still increase the size of China’s economy by half. The renminbi is trading at its lowest levels against the dollar since the 2008 financial crisis and valuations for domestic assets are undemanding. That means fund managers seeking quality companies, exposure to sectors deemed key for long-term security, and international diversification will still look to maintain significant allocations to China.

In contrast, investors concerned about geopolitical risks may reduce or even eliminate their holdings in Asia’s largest economy. But cautious fund managers will still be able to build diversified portfolios by increasing their allocations to regional economies closely linked to China’s including Japan, South Korea, Singapore, Indonesia and Australia.

This year, Japan’s equities have reached three-decade highs as inflation finally returns, the Bank of Japan stays dovish and corporate governance improves. Strong trading links with China, close political relations with the US and the weakness of the yen have also attracted global investors. But fund managers seeking alternatives to China will consider other Asian economies too. South Korea has world-class tech companies; Singapore high quality real estate investment trusts; and Indonesia and Australia energy and metals including nickel, copper and lithium. 

Last, investors seeking to limit exposure to China and achieve lower correlations with global markets will raise their allocations to India over the 2020s. The world’s fastest growing large economy is expanding at about 6-7 per cent a year owing to favourable demographics and gathering reforms. India’s relatively closed markets are less vulnerable to external shocks.

Asia is thus likely to feature prominently despite geopolitical fears. The region’s strong companies, strategic sectors and diverse economies will enable investors to exploit the longer term trends emerging from the shocks at the start of the decade.