Thoughts from the Road - Asia

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I recently traveled across Asia with my colleague Frances Lim, who heads our KKR macro effort in the region. We made stops in Singapore, China, and Japan and were fortunate to spend time during our visit with leading CEOs and policy makers as well as our deal teams and limited partners in every country.

What’s our bottom line? In recent months we have typically spent time focused on what sluggish growth and heightened politics mean for China and its counterparts in the region. Those points are certainly important ones that we must all factor into consideration. Yet I actually left Asia, already my third trip of the year so far, thinking that the investment story in this region is evolving in a way that may be underappreciated by investors. In particular, there are two important viewpoints to consider:

There Is a Transformation Happening, and a New China Is Emerging to Which All Investors Should Pay Attention.

Prior to COVID, a lot of market capitalization was created in China by entrepreneurs who leveraged technology to create an improvement in the consumer experience, including online shopping, social media, and e-commerce. Today, by comparison, the new growth drivers of the Chinese economy look quite different: They are industrial digitalization and the energy and executives with whom we spoke, both of these industry segments are growing about 40% year-over- year, and each sector now represents about 10% of the Chinese economy. Importantly, China has a cost and resource advantage across both of these areas, and we think that they will look to increase their competitive advantage, especially in the EV sector. So, our base view is that – over time – investors will talk more about these drivers than they will about housing and exports, both of which we think have already peaked as a percentage of GDP, and as such, now represent actual drags on the economy. One can see the transition unfolding in Exhibit 1.


Breakdown of China GDP Growth, 2022

This is a graph showing the breakdown of China GDP growth in 2022.
Note: ‘Green economy’ based on energy transition investment as reported by BNEF. ‘Digital economy’ added value is as reported by CAICT, including added value of the information industry and added value that the information industry brings to other industries. The drag of real estate is estimated by the KKR GMAA team with an IO table and includes the real estate industry itself and the industry’s impact on upstream and downstream. Data as at December 31, 2022. Source: China National Bureau of Statistics, BNEF, CAICT, KKR Global Macro & Asset Allocation analysis.

Asia Is Much More Than Just China.

Maybe most importantly, the growth story in Asia is much bigger than China. Across the region, growth in low cost manufacturing of goods as a source of competitive advantage in the global economy has been overtaken by industrial services, including logistics, waste management, and data centers. We think that there is both internal demand and an external component to this story. Against this backdrop, the bid for infrastructure and logistics could accelerate even more meaningfully, we believe, in key markets such as India, China, Indonesia, the Philippines, Vietnam and even Japan. Not surprisingly, we left quite bullish about what this means for our Real Assets franchise.

What has not changed is our team’s conviction around two countries: Japan and India. Japan remains a ‘must own’ country, we believe. We think that Japan is exiting deflation for the first time in decades, which means it is one of the few countries in the developed world whose stock market is benefitting from our thesis about a higher resting heart rate for inflation. At the same time, Japan is having a corporate reform renaissance that may ultimately rival what investors saw during the 1980s in the United States (see below for details). Finally, while monetary policy is definitely changing, we left more confident that the long end of the curve will not compromise economic health and/or the positive trajectory of the capital markets. Importantly, Unlike the U.S., Japan is a great story that is not trading at a full price. Indeed, despite a 37% positive move upward year-to- date, valuations are still reasonable at 14.5x, and there are a lot of single stocks trading with net cash positions and/or below book value. Against this backdrop, we look for more corporate carve-outs, margin improvement stories, and public- to-private opportunities (which we think are going to accelerate on the back of more activist pressure).

Meanwhile, while we did not go to India this trip, we spent enough time with corporate executives during our visit to confirm our positive investment case for that country. Simply stated, India is booming, including accelerating domestic infrastructure investment and growing exports. These two changes – more investment and more exports – mean that the economic story is becoming more balanced and less volatile, both inputs that we believe will help support the country’s premium valuation. And with this greater and more stable growth, Asia is becoming a more diversified and balanced economic arena.

On the more cautious side, nationalism – similar to what we see in Europe, the U.S., and Latin America – is running high across parts of Asia. Almost every conversation included some discussion about geopolitical / trade tensions. Consistent with this view, we think that political considerations must be more deeply integrated into all our investment strategies. However, this reality is not code for don’t invest. We still feel quite good about KKR’s 20% balance sheet allocation to the region, particularly given its diversity across asset classes (PE, Credit, Infrastructure, and Real Estate) and countries.

Looking at the bigger picture, there is no doubt we are living in complicated times. Our trip to Asia certainly strengthened our belief that the level of fixed investment, including more specialized deal makers, capital, more technology capital expenditures and more legal/support staff, that will be required to be effective in Asia is going up, not down. This shift is a secular, not cyclical, one, in our opinion. However, we don’t support the premise that China is totally un-investable or that Asia in general is too complicated for many global investors. Regardless, it is also clear from our discussions that many global investors have already pulled back their exposures from Asia. Interestingly, though, this reduction in exposure comes just at a time when we believe deal making is poised to accelerate, which we think will lead to further gains in risk assets across the region. As such, our message is to stay the course, but still `keep it simple’ by leaning into select markets and products where competitive advantage can be built, especially in key growth areas such as decarbonization, industrial digitalization, and corporate re-positioning stories.