The world's cutting edge
Japan is undergoing the most dramatic evolution in its corporate governance for at least the past half century. China is in the midst of its own significant, and painful, set of policy changes overlaying a slowing economy. South Korean policymakers are absorbing lessons from Japan while keeping an eye on Chinese developments. The world is discovering the importance of Taiwan – and its geopolitical significance. South-East Asia’s economies have moved to where China was 20 years ago. India might finally be living up to its promise. Australia remains the storehouse of raw materials essential to global growth.
Throw into the mix favourable demographics and an urge to develop national human capital, and it’s easy to see why Asia is the world’s most dynamic region. Within its extensive borders, there are companies operating at the cutting edge of technological innovation, others are giants in maturing industries, still others are rapidly expanding alongside their home economies – which count among the fastest growing in the world. At the same time, different domestic dynamics mean there’s considerable dispersion across the region’s markets.
Relative to the US and Europe, corporate Asia is under-researched and under-analysed and often cheap as a consequence (see Figure 1). For most global investors it remains the Wild East. As a result, the region’s at times bewildering state of flux creates a wealth of opportunities for investors focused on corporate events – such as mergers and acquisitions, initial public offerings and other major capital raising – particularly those agnostic to market direction.
Average price-to-earnings ratios between 31.12.2017 and 31.12.2023, measured biannually
Source: Bloomberg. Data as at 31.12.2023.
Eyes on total returns
In this environment, investors should consider a market neutral strategy focused on excess returns which do not rely on market direction but are driven by corporate activity and regional reform. They should seek out strategies that can take advantage of the unique regional tailwinds without being exposed to the noise of macroeconomic effects. So while a volatile macro environment fuels corporate events, investors don't necessarily want to be exposed to those global trends themselves.
Asia offers the perfect intersection of growth, reform and opportunity for investors looking to deploy capital in this way. The nature and variety of corporate activity is legion. Mergers and acquisitions; restructurings and asset sales; initial public offerings and capital raising; buybacks; wholesale industry change. All present an attractive set of opportunities for investors seeking to take advantage of the structural shifts in a risk controlled way, independent of market movements.
Categories of opportunity
Within Pictet's Lotus strategy, we divide corporate events and special situations into three categories.
The first is a set of defined catalysts. Here, the triggering event, or catalyst, is known but the market has not yet given it a value. The less liquid or covered the market – as is the case in much of Asia – the longer and more inefficient this pricing process can be, which creates opportunities for fast moving and well informed investors. These defined catalysts include all equity capital markets trades, such as initial public offerings, block trades or secondary share issues. Regulatory developments can also trigger profound changes in a corporation's prospects, as can special situations such as dual listings, restructurings or spin-offs. Indices rebalancing their constituents also represent an investment opportunity – stocks exiting the index will be sold by index-tracking funds and traditional long-only investors, while those entering will be bought. The variety and geographic spread of these catalysing events and the fact that they occur frequently across markets makes them a diversified source of excess returns.
The second category of corporate events is mergers and acquisitions (M&A), which provides consistent, uncorrelated and low volatility returns. That’s because although these involve a change of company control – unlike in the case of other defined catalysts – their successful conclusion is purely a legal and regulatory process rather than anything to do with market movements.
Asia offers the perfect intersection of growth, reform and opportunity for investors.
Finally, there are what we call “pre-events”. These are more volatile sources of excess returns because they involve anticipating significant corporate events through close analysis and familiarity with sectors and markets. But the risk to a portfolio here is mitigated by a systematic risk management process and a disciplined approach to position sizing as well as simultaneous investments in the previous two categories of corporate events.
Combining all three approaches can thus convert cyclical opportunities into an all-weather strategy, like Lotus.
Asian M&A as % of world total
Source: Bloomberg. Data as at 31.12.2023.
A rich Asian landscape
It’s hard to overstate the diversity of the economies and scope of opportunity across the region.
Asia looks set to continue to be the global growth engine over the coming years. Pictet Asset Management’s economists forecast an annual growth rate of 4.6 per cent, after stripping out inflation, for the coming five years for Asia excluding Japan, compared to just 1.8 per cent for the rest of the world combined.
Although countries across Asia are undergoing profound changes, developments in Japan and China have significance that stretches well beyond their own borders, affecting both policy and the economic landscape in neighbouring countries. These in turn are shaping corporate actions across the region, including driving M&A activity (see Figure 2).
Japan's governance revolution
Japan’s post-World War II reconstruction was enormously successful in part because of the close ties that developed between government, banks and companies. Cross-shareholdings and mutual support allowed corporate management to focus on the long run. By 1985, some 70 per cent of all outstanding capital in the country was owned either by banks or corporations.
Unfortunately, it also led to a corporate over-reliance on debt as a source of new capital. This debt became a millstone when the bubble burst at the start of the 1990s, forcing massive government bailouts and an era of deflation. Subsequently, the cross shareholdings engendered a sort of sclerosis across the corporate sector, with decades of market declines and shareholder underperformance.
Shinzo Abe, Japan’s then-prime minister, launched major reforms of both the economy and corporate governance. Simultaneously tackling deflation and the structure of cross-shareholdings – including pushing for more independent directors and a primacy of shareholder value – the changes hit a crescendo by 2023 (see Figure 3). The country emerged from deflation while its equities started to take off.
Corporate activist campaigns in Japan
Source: Bloomberg. Data as at 31.12.2023.
Despite the stock market’s gains, it remains under-owned by the Japanese public, who continue to prefer cash and short-term deposits, resulting in a discount to other major markets. Tax incentives, however, are likely to draw Japanese investors back into equities. This will reinforce a virtuous cycle that’s already started, where company management aims to improve returns though divesting cross-shareholdings while also seeking mergers and other corporate activity. Since Abe’s initial reforms, Japanese M&A deal count has doubled, as has return on equity. But there’s a long way to go. Cross shareholdings still account for more than 16 per cent of market capitalisation of Japanese firms. Offloading these would be a big boost to return on equity. Not only that, it would shave corporate Japan’s valuation discount – Japanese companies trade on a price to book ratio of less than 1, half of corporate Europe and a mere third of the S&P 500. Meanwhile, still low Japanese interest rates makes for cheap M&A funding.
The Chinese conundrum
Across the Yellow Sea, conditions are less auspicious. Chinese equities have struggled under the burden of a macro slowdown, aging demographics and a trade war with the West, targeting products in which China has a powerful competitive advantage. US and European politicians have turned their sights on Chinese electric vehicles – US President Joe Biden recently announced a 100 per cent tariff – and photovoltaic cells. Meanwhile, Beijing has been trying to reform the country’s struggling property sector, while instigating other policy measures to shore up a flagging economy.
All of these factors are forcing China’s corporate sector to be nimble. For instance, ferocious competition in EVs, plus tariffs, is bound to drive consolidation in the industry. At the same time, Chinese firms are looking to shift some of their manufacturing capability to other countries in the region which are not subject to the same trade protectionism. That could prompt cross-border M&A.
Changes bring opportunities
While the side-effects of China’s circumstances are rippling through the region, so too are Japan’s, albeit in a slightly different way. For instance, South Korean politicians and regulators have been closely monitoring the effects of Japan’s corporate governance revolution and concluded that something similar would be good for their economy too.
In resource-rich Australia, resources critical to the energy transition – lithium, nickel, copper, gas – are drawing significant investment, with many new discoveries being made as a result of renewed exploration interest.
And India – now custodian to the world’s largest population – may at long last start living up to its promise. That’s not least thanks to extensive regulatory reforms, which mean investors are starting to benefit from an increasingly transparent and efficient market.
A market-neutral, event-driven strategy like Lotus can generate stable and attractive returns.
These structural factors, unique to the region, have and will continue to give rise to corporate events regardless of what direction markets take.
Asia represents an ever greater proportion of global M&A, rising from 2 per cent of the total in 1998 to 21 per cent in 2023, making it ideal for an event driven strategy.
Indeed, a plethora of factors make Asia an excellent hunting ground for investors focused on corporate events. Strong and growing economies make for strong and growing companies, hungry for capital and eager to expand through M&A. At the same time, regulatory and macroeconomic upheaval mean that the overall positive trend is characterised by considerable turbulence. Many investors are wary of this sort of uncertainty – but by avoiding taking macroeconomic and currency bets, using detailed corporate analysis and close control of risk, a market neutral, event-driven strategy like Lotus can generate stable and attractive returns in this environment.
About Lotus
To take advantage of corporate Asia’s growing opportunities, it is essential for portfolio managers to have local knowledge and presence – as Lotus does. Unlike the US, or, to a lesser degree Europe, Asia is a mosaic of regulatory and currency regimes, languages and cultures. Markets each have their own rules backed by different legal regimes. Cultural differences abound – unwritten rules of business conduct can make or break deals. But it’s not just understanding Asian markets that matters. As Asia becomes increasingly important to the world economy, companies based outside of the region are becoming ever more closely tied to its fortunes. Understanding Asia helps to develop an understanding of these firms, and turns them into investment opportunities, too.
The region’s complexity necessitates a careful approach to risk management, especially in today’s world where geopolitical tensions run high. A wide spread of currencies makes it important to hedge out foreign exchange risk in deals. Although macroeconomic forces can help foster corporate actions, they can also muddle the pursuit of company-specific returns and thus have to be hedged away.
With its main staff in Singapore, and leveraging Pictet resources in Japan, Hong Kong and Mainland China, Pictet’s Lotus team capitalises on over 40 years of combined investment experience and eight years of live track record in the region by sharply focusing on the sources of returns across the corporate event spectrum and by closely monitoring sources of risk. Pictet’s Lotus strategy continues to be exceptionally well placed to extract returns from the vibrant and expanding Asian investment landscape.