The sectors that fund managers choose not to own are as important as those they do. Some of Europe’s best managers beat their peers simply by steering clear of financial stocks in 2008. Their Asian counterparts should take note.
A report from consultants McKinsey this week said banks in Asia Pacific are set for a period of marked profitability decline. Slower economic growth, rising non-performing loans and competition from new entrants will combine to dent regional banks’ $1tn profit pool. Non-performing loans are a particular worry. Interest coverage ratios in emerging markets have fallen over the past five years, leading to a pile up in bad and restructured loans. In China, stressed assets have risen by half, to nearly $250bn. In order to maintain capital adequacy ratios as loans sour, McKinsey reckons that Asian banks will need to raise between $400bn and $600bn by 2020. Meanwhile, competition could wipe as much as $400bn off banks’ revenues. Price erosion caused by new entrants will require banks to reduce their cost bases by up to a quarter to keep returns on equity steady.
There are opportunities too. Goldman Sachs estimates that Chinese technology companies will nearly quadruple the size of their financial services market by 2020, adding more than $10bn to operating profits. Alibaba affiliate Ant Financial and Tencent are especially well positioned. Both have internet banking licenses and are targeting small and medium enterprise lending, the segment expected to experience the strongest loan growth. Indian IT firms, such as Infosys and Tata Consultancy Services should also benefit from exposure to increased spending to boost banks’ digital competitiveness.