Asia: adapting to a new reality

The economic and political environment remains uncertain. Asia is not in the eye of this particular storm, but it cannot be immune to the vagaries of global interest rate and trade policy. Resilience is an important priority for the Aberdeen Asian Income Fund. We are adapting our portfolio as conditions change.

There is always a balance between tuning out the day-to-day drama of financial markets, while recognising that shifts in the economic environment can affect the types of companies that thrive and those that struggle. We don't want to forecast interest rates or oil prices, but we have to recognise when risks and opportunities change.

At the moment, the inflation backdrop is crucial. The war in Iran and consequent rise in energy prices is creating inflationary pressures in some Asian markets, notably India, the Philippines and Indonesia. It is also a factor for the Australian and Singaporean markets. In contrast, China is not experiencing significant inflationary pressure, while the Taiwanese and South Korea markets are more exposed to the AI trade.

We must also weigh the impact of rising government bond prices on our holdings. The US government bond yield acts as a baseline for global borrowing costs and Asian companies are not immune. We need to understand the impact of a combination of rising inflation and rising borrowing costs on the companies we hold. Importantly, the cost of capital is also a critical driver of AI demand.

This has been an important contributor to a lowering of technology exposure in the portfolio. Technology has become a ‘long duration’ sector. That means more of a technology company’s value comes from the expectation that it can generate cash flows a long way into the future. Inevitably, higher bond yields reduce the value of those cash flows and change its risk and return profile. This could pose a challenge to technology giants, such as Samsung, TSMC and SK Hynix.

This has collided with increasing volatility in the AI trade. While results from many of the Asian technology giants had been strong, expectations had become elevated. The Trust was paring back its AI-related and technology holdings before the current bout of volatility and continues to do so. These remain important companies with, in our view, a pathway of structural growth driven by AI adoption, but valuations argue for a lower weighting.

Redeployment into resilient companies

We have redeployed that capital into other areas likely to be more resilient in an environment of higher borrowing costs. The banking sector, for example, has historically been a beneficiary of higher interest rates. Higher rates give banks the flexibility to increase their ‘interest margin’ - spread on lending versus the interest paid on cash deposits.

Provided that economic growth across the Asian region doesn't start to deteriorate – and it is still buoyant for the time being – the banking sector should show strength. It helps that the sector has been very lowly valued by investors, and yields are high. Holdings include HDFC Bank, which has the largest retail banking franchise in India. We also have a number of insurance holdings, which are also likely to benefit from a higher interest rate environment, including PICC Property and Casualty and DB Insurance.

We are also looking at some industrial companies. We have tentatively started to look at healthcare which remains a difficult sector for income funds in Asia as yields remain low. Nevertheless, we see some exciting developments emerging, with healthcare a potential beneficiary of AI.

Companies pivoting

Just as we are adapting to changing conditions, we see our companies pivoting to take advantage of new markets. For example, we own Chinese company CATL, the largest battery maker in the world. Its core market has been the auto sector, but this has become an increasingly difficult area in which to operate in both China and internationally. In China, there is significant over-supply and car makers there are struggling. There are similar problems across the world.

CATL is now leaning away from its core car business and finding new opportunities in clean energy. It has made major breakthroughs in sodium-ion energy storage and is involved in multiple global grid projects. In its recent results meeting, the company said: “Global shipments of energy storage batteries increased by 71% year-on-year in the first half, with markets outside China accounting for more than half of total shipments for the first time. From Europe and the United States to emerging regions such as Latin America, Southeast Asia, and Africa, an increasing number of countries are deploying energy storage at scale.”

We also have a new position in Precision Tsugami. This is a Japanese machine tool manufacturer that makes high-precision CNC automatic lathes. These types of machines had their origins in watchmaking, but it has shifted to use cases in the auto sector, medical sector, and now the robotics and semiconductor sectors.

Robotics could present a new source of growth for many companies involved in chips and parts manufacturing. For the time being, this is mostly industrial robots such as mechanical arms that operate in factories. However, humanoid robots are a significant potential growth area. For companies, the pivot is relatively straightforward, with lots of similarities between electric vehicles and humanoid robots. In the longer term, humanoid robots could be a larger market than industrial robots, but the technology is still developing.

Asia’s diversity means it is possible to adapt Aberdeen Asian Income Fund’s portfolio to changing conditions. We continue to see real resilience and agility from Asian companies. In many cases, Asian companies have built a powerful position in their respective markets and global companies rely on them. We believe Asia remains a fertile source of opportunity and a way to swerve some of the complexities emerging in US and European markets.

Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.

 

Important information 
Risk factors you should consider prior to investing:

• The value of investments, and the income from them, can go down as well as up and investors may get back less than the amount invested.

• Past performance is not a guide to future results.

   

Other important information:

Issued by abrdn Investments Limited, registered in Scotland (No. 108419), 1 George Street, Edinburgh EH2 2LL, authorised and regulated by the Financial Conduct Authority in the UK. Aberdeen Asian Income Fund Limited has a registered office at JTC House, 28 Esplanade, St Helier, Jersey JE4 2QP, JTC Fund Solutions (Jersey) Limited acts as the administrator, and the Collective Investment Fund is regulated by the Jersey Financial Services Commission.

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