Fidelity International highlights bright spots in Asia: Investment opportunities in shifting market dynamics

Marty Dropkin

A new rate cutting cycle – after the most aggressive rate hiking cycle from the U.S. Federal Reserve (Fed) in over 30 years – and fresh stimulus from policymakers in China potentially signals a new change in market dynamics.

Investors will be looking for the emerging opportunities to explore as we enter this new market environment. Fidelity International sheds light into key themes within Asia that are expected to be ‘bright spots’ for investors in the period ahead.

1. Healthy broadening trends in Asia

Asia presents a vibrant landscape for equity investment as the outlook for earnings has improved recently across a broader range of markets and sectors. Supportive policy measures announced in China to stabilise the country’s economy, along with rate cuts by the US Federal Reserve, offer a more favourable backdrop for regional markets as market breadth increases beyond a concentrated group of stocks. 

Marty Dropkin, head of equities, Asia Pacific at Fidelity International, comments: “Like the US, market leadership in Asia has become narrower since mid-2022. The Market Cap index of MSCI AC Asia ex Japan outperformed the Equal Weight index as investors focused their capital on large cap and tech driven companies while paying less attention to the sizable part of the investment universe. However, we have seen this market narrowing trend begin to reverse since September 2024 as the gap between Market Cap index and Equal Weight Index has contracted. What this means is market leadership has started to broaden, which brings with it opportunities within Asia’s vibrant and diverse investment landscape.

“In the past three months, the outlook for earnings has improved across a broader range of markets and sectors in the region. At the market level, several larger members in Asia, such as mainland China, the Philippines, Singapore, Malaysia, Thailand and Taiwan, have received positive forward earnings revisions for the next twelve months. This is being spread across a number of sectors including health care, consumer discretionary, industrials, communications services and technology.

“In addition, supportive policy measures recently announced in China to stabilise the country’s economy, along with rate cuts by the US Federal Reserve, offer a favourable backdrop for regional markets and facilitate the further expansion of market breadth as investment sentiment has improved significantly over recent months. The stage is set for foreign capital to return to the region in search of investment opportunities.” 

2. ASEAN’s multi-dimensional landscape

The Association of Southeast Asian Nations (ASEAN) has long offered a diverse and attractive investment landscape. Young demographics, a competitive labour force, rising urbanisation and a growing middle class in member countries such as Indonesia and the Philippines, underpin long-term structural demand trends which are expected to drive consumption upgrade and economic growth. However the shorter term prospects have been less convincing in recent years.

Mr Dropkin comments: “After a couple of lacklustre performance years, investor confidence towards ASEAN has significantly improved thanks to the Fed’s rate-cutting cycle, which is seen as positive for the region as a weakened dollar alleviates pressure on local currencies and creates room for ASEAN countries’ own monetary easing. On top of that, China’s policy stimulus has further boosted market sentiment as more investment capital is expected to be directed to the ASEAN region as the manufacturing base in China diversifies into the region. 

“ASEAN economies attracting significant foreign direct investment (FDI) continues to be a multi-year trend, particularly in sectors like manufacturing and technology. Companies are seeking to leverage lower-cost production bases and engage in major themes for the next decade, such as the EV supply chain, strategic materials, and data centres. Supply chain shifts towards ASEAN markets, including Malaysia and Vietnam, are further bolstered by the region’s strategic location and infrastructure development, making it an attractive hub for global trade. Some garment manufacturers, toy makers, smartphone supply chain participants, automation manufacturing and technology solutions providers, and metal miners are among noteworthy investment opportunities for the FDI and supply chain shift trend, while leading regional banks facilitate the flow of capital into and across ASEAN.

“Furthermore, several ASEAN countries are experiencing a near-term demand recovery, particularly in the tourism sector. Thailand, for example, has seen a resurgence in tourist activity nearly back to pre-pandemic levels, which is expected to boost local businesses and stimulate economic growth. Some potential investment opportunities include convenience chain stores and international medical services. Additionally, the easing of cost pressures in ASEAN countries is making them more competitive in the global market, thereby enhancing their attractiveness to investors.

“As a whole, ASEAN equities are gaining traction from global investors, backed by a combination of a positive economic outlook, stable political outlook, and currency appreciation. Moreover, relative to other parts of the Asian region, ASEAN equities remain attractively valued both on price to earning as well as price to book basis at current levels, offering an interesting investment window for long-term investors now. While well-supported by structural growth prospects, the region remains an under-researched investment universe. Collectively, these factors create a compelling case for investment in ASEAN, with its mix of short-term opportunities and long-term growth prospects.”

3. Asian High Yield: Still Attractive Despite Tightening Spreads

While it may surprise some, the past year has been exceptional for Asian fixed income, with the region’s USD and local currency credit markets and government bonds delivering robust performance across the board. Several factors contributed to this, most notably the pivot in U.S. Federal Reserve policy, easing by many Asian central banks and attractive valuations, providing a supportive backdrop for bonds. As we look ahead, a key question is whether these strong returns in Asian fixed income can be sustained. Several factors suggest that Asian bonds will continue to be a bright spot in the global investing universe.

Lei Zhu, head of Asian fixed income at Fidelity International comments: “The Fed’s policy pivot is likely to provide continued support for Asian bonds. The 50-bps rate cut in September 2024 marked the beginning of a more dovish phase for U.S. monetary policy, with further cuts expected in the coming months. This is particularly meaningful for Asian central banks, which had been constrained by a hawkish Fed in recent years. Now, with U.S. rates declining, Asian central banks have more room to ease without creating a significant interest rate gap with the U.S. market. For example, China, Korea, and Indonesia have already cut rates, indicating that regional central banks are becoming more comfortable with trimming rates, which will continue to support bond markets. 

“We believe that one of the most compelling segments of the Asian bond market is high yield. While spreads have narrowed by about 400 bps with the index delivering over a 20% return over the past year, the approximately 9% yield offered by Asian high-yield bonds, featuring a BB- average rating and an approximate 2-year duration, remains attractive. 

“According to the JACI Non-Investment Grade Index, although spreads are now about 50 bps above the 20-year average of 520 bps, Asian high yield continues to look favourable compared to global peers. Historically, Asian high-yield spreads have tightened to as low as 160 bps, suggesting there may still be room for further tightening, even if the market is not as cheap as it was a year ago. Moreover, the credit quality of Asian high yield has improved over the past two decades. The average rating has risen from B to BB over the years, reflecting stronger fundamentals across the region. This trend of rating upgrades is likely to continue, particularly in frontier Asian economies and in the BB category, where some rising stars are emerging.

“Notably, the landscape of the China high-yield property sector, which was once a source of significant risk, has also improved dramatically. The weight of the property sector in the high-yield index has dropped from over 30% to about 5%, as many distressed names have either defaulted or been removed. Many of the new China property names in the index were once investment-grade but have been downgraded due to a weak sector outlook. This has left a stronger, more resilient index with fewer default risks. In fact, the default rate for Asian high yield has fallen from over 16% two years ago to below 5% this year, further supporting the case for continued strength in this segment.

“These factors, alongside the expectation that easing monetary policy should persist through 2025, creating a favourable environment for Asian High Yield,” she says. 

4. Asian Investment Grade and Local Currency Bonds: Safe and Steady

Asia Investment Grade (IG) has proven to be a resilient asset class. The JACI Investment Grade Index has delivered over 10% returns in the past year, driven by carry, a rates rally, and credit spread tightening. According to the index, the average spread for investment-grade bonds is averaging 116 bps, with an A- average rating and around 5-year duration. By focusing on quality and exploring opportunities across various Asian markets, investors can strategically navigate an ever-changing market environment.

Ms Zhu comments: “While high-yield bonds offer the potential for higher returns, we believe that investment-grade bonds in Asia remain attractive. The supply of Asian USD investment-grade bonds has shrunk significantly, as issuers are reluctant to borrow in USD at high rates and instead prefer to opt for local currency markets. In fact, net supply has consistently been over -100bn USD per year in the past three years, compared to over +100bn USD per year between 2014 – 2021. 

“Meanwhile, demand from U.S. and European investors for Asian new issues has increased from around 21% in 2019 to over 33-40% in the past three years. With about 5% carry and stable spreads, combined with likely lower rates as the Fed continues to cut, investment-grade bonds could deliver strong returns. 

“On the local currency front, high-quality Asian government bonds are expected to continue performing well, particularly as many Asian currencies have remained stable or even appreciated slightly against the USD after the recent U.S. rate cuts. For lower yield currencies, such as JPY and CNY, the return after FX hedging could be attractive, offering 2-4% hedged gains and an additional 1-1.5% carry compared to USD-equivalent bonds..

“The total Asian local market size now exceeds USD 35 trillion. With a large market size and central bank support, especially for the high quality local currency bond markets, these strategies offer investors good liquidity and similar returns to USD Asian IG bonds, with lower volatility and hence higher Sharpe ratios if FX is hedged. We expect high single digit returns in high quality local government strategies with FX hedging and lower volatility, or FX unhedged with higher volatility due to currency fluctuations. While the 10% returns seen in local currency bonds over the past year may be hard to replicate, with inflation under control and central banks easing, we still expect to see room for solid performance.”