Yes, US-China geopolitical realities are already having an impact on trade and investment flows within Asia. China will remain an important destination for investor capital, but the shift in capital flows, alongside positive domestic structural developments in other parts of Asia, create investment opportunities beyond China that deserve a closer look.
Trade and financial “decoupling” between the United States and China is occurring faster than anticipated. China’s share of total US imports has fallen to levels not seen since 2005, and foreign direct investment (FDI) inflows to China declined to more than a 20-year low in first half 2023. These shifts in trade and FDI away from China appear to be more structural than cyclical. They are occurring amid the West’s renewed focus on geopolitical risks and supply-chain concentration risks in China. Meanwhile, USD fundraising activity for Chinese private equity and venture capital (PE/VC) funds has essentially frozen because of the uncertainty arising from President Biden’s August 2023 Executive Order that restricts US investment in China in the areas of advanced semiconductors, quantum computing, and artificial intelligence. Investment opportunities in Chinese PE/VC will remain, given China’s focus on technology self-sufficiency and other themes such as consumption and healthcare. However, China is unlikely to continue to receive a disproportionate amount of capital flows relative to the rest of Asia. This is a result of added geopolitical considerations and an opportunity set—particularly within Chinese venture capital (VC)—that may be constrained by US restrictions on China’s access to advanced technology.
At the same time, there are promising developments elsewhere in Asia, particularly in India, Japan, and Southeast Asia (also referred to as the Association of Southeast Asian Nations [ASEAN]). 1 ASEAN has been the biggest economic winner from shifting supply chains, gaining export share in the United States at the expense of China, and is simultaneously seeing a rise in Chinese imports and investments. India is now attracting more FDI inflows than China, while also benefitting from positive demographic changes, resilient domestic economic growth, and favorable business reforms. Although Japan has yet to see a meaningful pick-up in trade and FDI flows, structural reforms brought forth by the Tokyo Stock Exchange in 2022 and 2023 have improved the outlook for shareholder returns and led to increased foreign investor interest in Japanese equities.
The positive structural changes in these economies are likely to drive increased foreign capital flows over time, creating tailwinds for these equity markets. However, we remain neutral today on Indian and Japanese public equities, given fair to elevated valuations. Instead, we are positive on Indian VC based on improved valuations and an attractive sectoral exposure vis-à-vis public markets that focus on longer-term secular trends. In Japan, we are positive on small caps and activist strategies targeting these companies, which could better capitalize on domestic corporate reform initiatives to generate value. We also find the Japan buyouts market attractive, with managers finding increased opportunities arising from corporate succession deals and other corporate actions (take-private transactions, conglomerate divestments/spinouts). For ASEAN, the macro backdrop looks attractive, and public equities and currencies currently appear undervalued. However, the small size of local capital markets and heterogenous economies makes implementation a challenge, though this may evolve over time. As a result, for now we think investors are better served gaining exposure to ASEAN via broader Asia mandates in public and private markets rather than dedicated exposure, at least until the manager opportunity set deepens.
The geopolitical realities between the United States and China and the shift in capital flows into Asia are unlikely to change anytime soon. We believe these create Asian equity opportunities outside of China that can add value and diversification to portfolios, particularly in India, Japan, and ASEAN where there are positive developments at home today. The wider focus on Asia does not imply there are no attractive investment opportunities in China. Indeed, we recommend modest overweights to Chinese public equities relative to global equities, as depressed valuations compensate for risks. We take a more cautious and selective approach toward Chinese VC, given the shifting geopolitical dynamics and opportunity set.
Vivian Gan, Associate Investment Director, Capital Markets Research
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