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14 Jul 2016

PROSPECTS IN THE ASIAN FINANCIAL SECTOR

Economic commentators have for some time predicted a doomsday scenario for the Chinese economy as its once prodigious growth rates slow. The clamour intensified last year after the Chinese markets dramatically seesawed. KAVITHA MENON explains why we continue to favour Asian financial stocks.

The Chinese authorities are purposefully steering that economy from an investment- to a services-driven model, the hallmark of all developed economies. The transition cannot unfold smoothly and the changing composition and pace of economic growth is creating uncertainty and stock market volatility, coupled as it is with fears of excessive credit expansion.

China’s GDP is expected to grow at 6–6.5% per annum over the next three years, down from its double-digit growth in the past decade but well above the global growth rate of only 3–3.5%. Contrary to the doomsayers, we do not anticipate a hard landing, but expect a slow and managed unwinding of China’s excess leverage. Unlike most emerging market economies, China’s huge foreign exchange reserve stockpile (approximately US$3 trillion) provides a strong buffer against currency and other financial shocks and acts as a margin of safety for investors.

The general pessimism for emerging markets provides opportunities to buy Chinese and Southeast Asian companies with strong earnings growth prospects at attractive valuations and high dividend yields. We like the financial sector, which is driven by a combination of structural and cyclical factors, including low retail credit penetration, strong demographics, rising incomes and supportive monetary policy.

The insurance industry in developing Asia is an underpenetrated market with attractive growth prospects. Insurance premiums as a percentage of regional GDP languishes at 3%, compared to 11% in the more developed Japanese and South Korean markets. Structural economic and demographic trends, rapid urbanisation, increasing wealth and low coverage offered by government sponsored programmes should drive demand for self-provisioning in developing Asian countries including China.

In the property and casualty insurance segment (referred to as “short-term insurance” in South Africa), we are invested in PICC Property & Casualty (PICC). With a 33% market share, the state-controlled PICC dominates the immature Chinese non-life insurance market and could be described as the Santam of China. PICC’s low-cost model, surplus capital and strong underwriting capabilities position it to benefit from rising Chinese living standards. We anticipate an increase in insurance premiums, despite the low-growth environment and potential lag in vehicle sales.

In the life insurance segment, we invest in AIA Group, which is a diversified life insurer with a presence in 18 Asia-Pacific countries. A strong balance sheet, agency-driven business model, best-in-class management and sustainable earnings momentum underpin our positive view on AIA.

Rising corporate leverage and resultant asset quality issues have affected sentiment towards Chinese banks. But well-capitalised balance sheets and attractive profit generation mean that Chinese banks can absorb higher loan impairments. Moreover, the sector would benefit from government financial support in the event of systemic stress, given the state’s substantial participation in the sector.

Accommodative monetary policy, regulatory onslaught on shadow banking, proactive measures to address non-performing loans and a gradual lending shift towards better-quality sectors are tailwinds for the banking sector. It also benefits from the ongoing transition to a services-driven economy and we believe current valuations provide a great opportunity for long-term investors.

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