The worldÆs portfolio investors have long understood that there are substantial opportunities in the Asia-Pacific region. Portfolio investment from Europe and North America into Japan surged from around $1,200 billion at the end of 2002 to nearly $3,000 billion at the end of 2005. The 31% annual growth is partly the result of the strong recovery in JapanÆs stock market and partly the result of capital flows.
The strong growth in portfolio investment from Europe and North America into the rest of the Asia-Pacific region has also increased significantly, growing from $500 billion to over $1,000 billion, or by 25% per annum. In part, this has been because investors have needed to diversify their portfolios. In part, it has been because superior GDP growth rates have led to growth in corporate earnings. Various governments have also taken steps to promote inwards investment. The case for investment in the Asia-Pacific, which was very widely accepted from the mid-1980s to the mid-1990s, has been embraced once again.
The worldÆs portfolio investors will likely continue to show massive enthusiasm for the stocks and bonds in the region û even if the growth of investment into Japan slows.
Drivers of investment into the Asia-Pacific region
The surge of new money into major equity mutual funds that focus on the Asia-Pacific region outside Japan is one indication of much more bullish sentiment on the part of portfolio investors. Net inflows to such mutual funds grew from $5.6 billion in 2004 to $8.4 billion in 2005. Net inflows in the first eight months of 2006 amounted to $10.6 billion. Of course, mutual funds account for only part of the new portfolio investment into the region.
However, some of the factors that are driving the growth of inward investment into the Asia-Pacific region have been around a long time.
Superior GDP growth. CitigroupÆs economists expect that regional GDP growth will accelerate to 7% per annum between 2006 and 2010, while the developed world should grow by 2-3% per annum. Essentially, what is already a major part of the global economy is becoming more important. GDP growth should result in superior stock market performance.
Diversification potential. The drivers of growth vary markedly from country to country. It is partly for this reason that investors can achieve the benefits of diversification through investment across the Asia-Pacific region. For instance, the economic growth of China has been driven substantially by exports of manufactured goods, while the economic growth of India has tended to be driven by the development of that countryÆs services sector.
Under-developed markets. Among developed nations, stock markets typically have capitalisations that are 1.5 û 2.0 times the GDP of the countries with which they are associated. Among regional emerging markets such as China, India, Indonesia, and the Philippines, the equivalent figure is about 0.6 times. As Asian economies expand, activity within their capital markets will surge. This should result in rapid expansion in the capitalisations of their stock markets.
Favourable regulatory changes. In part because of the regional financial crises of 1997/98, the governments of many countries have introduced changes to promote inwards investment. China, India and Vietnam, for instance, have all increased foreign ownership limits in stock markets. Securities lending has been introduced or extended in many countries. Standards of corporate governance, and transparency within companiesÆ financial statements, have been improved.
Lower risk. The improvement to regulatory regimes is one reason why risk levels are lower now than they were in the early 1990s. In addition, the regional economies are no longer nearly so dependent on the fortunes of the US economy as they used to be: Taiwan and Korea, for instance, export more to China than to the USA. The stock of savings that has been accumulated in the Asia-Pacific is now vastly larger than it was a decade ago. Regional stock markets no longer depend to anything like the same extent on inwards flows of portfolio capital.
Portfolio investors in the Asia-Pacific region discover the world
Increasingly, portfolio investors in the Asia-Pacific region are looking for cross-border opportunities. International investment by Japanese investors grew from just under $1,500 billion at the end of 2002, to over $2,000 billion by the end of 2005, or by 15% per annum.
Cross-border investment by investors in other parts of the region grew from a lower base û or below $500 billion û but at a faster pace (27% per annum) to reach around $800 million.
This trend is not going to end any time soon. Savings rates remain high across the region. Pension funds and mutual funds are developing quickly as demographics û and economics û mean that the number of middle-aged and middle-class savers grow. Many investors û both individual and institutional û will seek the benefits of diversification.
Often, investors in the Asia-Pacific have looked for opportunities within the region:
The shift away from cash could be enormous
It is possible that the movement of portfolio capital into or out of the Asia-Pacific region will be dwarfed by a shift of a different kind: the movement of savings from bank deposits into local portfolio investments.
During calendar 2005, bank deposits in the Asia-Pacific grew by 10% to $11,166 billion. They are, therefore, already significantly larger û and faster growing û than bank deposits in either the USA or the 12 nation Euro zone. Bank deposits in China alone exceed $2,500 billion.
To a certain extent, the massive bank deposits are the result of high savings rates. In most countries in the region, they also reflect the lack of attractive opportunities within local financial markets. As stock markets and fixed income markets develop, the absolute sums that could potentially be moved out of bank deposits across the Asia-Pacific region are enormous. Indeed, the rise in cross-border investment into and outwards from China could be one of the central features of global capital markets over the next decade.
In India, where financial markets are also developing rapidly, 4.9% of household savings made its way to equities in the year to March 2006. In the year to March 2005, the corresponding figure had been just 1.1%. However, India also stands out as example of a country where regulators and securities services providers are working together to strengthen market infrastructure.
Six major trends to watch out for
Exactly how the financial markets of the Asia-Pacific region develop will likely be influenced by six major trends:
1. Economic growth and emerging middle classes. Strong economic fundamentals across much of the region will fuel portfolio investment both into and out of the region. Emerging middle classes in markets such as India and China will have ever increasing demands for increasingly sophisticated investment products.
2. Deregulation of investment. In both China and India, as in other countries in the region, the authorities have taken steps to promote inwards investment. Increasingly, investors in the Asia-Pacific region will focus on cross-border opportunities.
3. New distribution opportunities. Japan's Postal Savings system is progressively enabling promoters of mutual funds and other savings products to reach retail investors via its distribution network" Opening up the distribution channel is not dependent on privatisation occurring. The sophistication of products that are distributed should increase. Similar trends should be visible in other countries where the financial liberalisation is taking place.
4. Growth and change of pension plans. The countries of the Asia-Pacific vary markedly in terms of the size and sophistication of their pension plans. However there is a general, and strong, trend towards greater assets and greater sophistication. As is the case in other parts of the world, there is movement away from Defined Benefit plans towards Defined Contribution plans. The products and services demanded by pension plans are becoming ever more complex.
5. Further development of offshore mutual funds. Investment managers and other distributors of mutual funds have had great success in distributing Dublin- and Luxembourg- domiciled SICAV funds in Hong Kong. Hong Kong investors are estimated to hold around $400 billion in such offshore funds. Offshore funds could continue to grow in popularity, both in Hong Kong and elsewhere. However, an offshore fund boom will represent an opportunity for securities services providers outside the Asia-Pacific region.
6. The hedge fund phenomenon. Hedge funds have become an important wealth management tool for High Net Worth Individuals. Both groups are growing in number û and overall wealth û throughout the Asia-Pacific. As investors in the region increasingly seek the benefits that hedge funds offer, hedge fund managers will play an increasingly important role in the financial markets of the Asia-Pacific.
7. Promotion of alternative investments other than hedge funds. Increasingly sophisticated investors in the Asia-Pacific are always seeking tax-effective investment opportunities that combine superior income with the probability of preservation of real capital. The regional boom in Initial Public Offerings (IPOs) likely has some way to run. So too does the development of Real Estate Investment Trusts (REITs).
Summary û What it all means for providers of securities services
The local investor base will continue to develop throughout Asia-Pacific. There are compelling reasons why foreign investors will continue to increase their commitment to the region. These trends will, in turn, naturally drive demand for a broader range of increasingly sophisticated financial products and customised services.
These products and services will likely include insurance, asset management, pension funds, transfer agency and funds administration. There are opportunities for domestic fund managers and broker/dealers. However, there will also be substantial opportunities for foreign groups.
The major global securities services providers will have an important role to play.
The growing need for stronger infrastructure is the natural consequence of the further development of pension systems in the Asia-Pacific. By working with governments and local banks, the global securities services groups will encourage the development of indigenous custodians and other service providers. They will also help to ensure that official initiatives embrace world best practice.
As investors in the region become more sophisticated so too will the need for services tailored for markets and client segments. The growth of outwards portfolio investment, which is already substantial, will mean that local custodians will need increasingly to work with partners who not only have the scale and skills to provide them with the specialist services that they need but the local market knowledge and expertise. Global custodians may tend to move from country-specific relationships with sub-custodians to relationships with regional custodians.
In part because of moves by governments in the Asia-Pacific to liberalise capital markets, conditions are changing rapidly. Portfolio investors who are moving funds into or out from the Asia-Pacific need easy access to particular markets. They may well need training on local market practices, and guidance as to regulations. Global securities services providers can assist with this.
Access to liquidity
The financial markets of the Asia-Pacific are growing quickly, however some markets have regulated funds flows and currency convertibility. There is also the issue of trapped liquidity. Securities Services provides knowledge of local market regulations and can help investors navigate through the intricacies of doing business in Asia-Pacific and can provide innovative liquidity and funding solutions that meet local regulatory requirements.
Growing demand for hedge funds and other alternative investments is consistent with an increasing requirement for creative solutions from service providers. Global securities groups are also well placed to facilitate securities lending and borrowing and to support sophisticated and leveraged trading strategies.
Value added services
Financial liberalisation is consistent with a boom in the quantity and variety of financial products that are distributed to individual and institutional savers. Different segments of the investment industry require comprehensive solutions that are specific to their needs ûwhether fund accounting, administration, transfer agency or other activities.
The trends and patterns in the Asia-Pacific region are such that it is becoming increasingly important for securities services providers to demonstrate:
ò Financial strength (which allows easier access to liquidity)
ò Scale (to lower per unit costs and clientsÆ expenses of entering new markets)
ò Strong local market teams within a global network (to develop key relationships with regulators and with local clients)
ò Ongoing investment in technology (to support a greater range of financial instruments and to be able to offer a full suite of solutions and services)
ò Versatility (to meet growing demand from an increasingly sophisticated clientele for cash and funding solutions, foreign exchange management solutions and other services that add value).
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