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Asia-Pacific cities in Tomorrow's World: The enhanced benefit of diversification

Asia-Pacific cities in Tomorrow

Harry Tan, Head of Research, Asia-Pacific, introduces the first article, in a series of research on Asia-Pacific cities in Tomorrow's World, which discusses the benefit of having diversification within a global portfolio.

An allocation into Asia-Pacific allows investors to not only add value to their global portfolio through intra-region growth diversification, but also to benefit from the variances across economies within the region. A top-down macro perspective, looking at real GDP growth since 1990, suggests that the enhanced diversification benefit of adding Asia-Pacific into a portfolio, that also includes the US and Europe, is highly pronounced (Fig.1). This is due to growth across Asia-Pacific, historically heavily driven by the US, and to a lesser extent Europe. However, the overriding macro dynamics have evolved substantially over the past two decades.

The rise of China has not only altered global trade patterns, but also placed China at the forefront of global capital and investment flows. China is now the world’s largest economy in purchasing power parity terms. Rising urbanisation and an expanding middle class has led to massive wealth creation and subsequently expanding consumer demand and tourism. By 2025, the number of middle income households will increase by 130 million to 373 million, more than the entire population of the US.

 

Fig.1: Growth diversification between regions

 

US

Europe

Asia-Pacific

US

1.00

0.72

0.08

Europe

1.00

0.33

Asia-Pacific

1.00

Note: Correlation of GDP growth between regions is measured between 1 and -1.

1 represents the most correlated and -1 the least correlated.

Source: Oxford Economics, 2017  

 

By virtue of geographical proximity, many regional economies have benefited closely from China’s rise, through foreign direct and portfolio investments, tourism and exports. An example is China’s one belt, one road initiative. While world demand still plays an important role in driving the region’s growth, strong domestic demand growth – buoyant corporate and household balance sheets driving business investment and lifting consumer spending – will increasingly anchor the region’s outlook in the coming years.

Rather than being led, Asia-Pacific is now driving and outpacing world growth. The more attractive secular growth prospect for the region vis-a-vis many OECD countries – lower structural unemployment rate, well-buffered fiscal and FX reserve positions, better infrastructure and transportation networks, among others – suggests Asia-Pacific can stand better alone and act as a strong diversifier to growth in the US and Europe. 

Furthermore, there are additional diversification benefits from inter-region allocation (Fig.2). For example, as the growth correlation between Hong Kong and Singapore is high – both being open economies with large financial service and export sectors – a well-balanced portfolio, while not excluding one over the other, should not include a high, equal weighting to both economies. Adding Australia into a portfolio that includes Japan, South Korea and/or Hong Kong and Singapore, may help to enhance risk-adjusted returns meaningfully.

 

Fig.2: Further diversification within the region

 

Australia

China

Hong Kong

Japan

Singapore

South Korea

Australia

1.00

0.30

-0.01

-0.18

0.12

-0.10

China

1.00

0.47

-0.10

0.44

0.14

Hong Kong

1.00

0.57

0.84

0.59

Japan

1.00

0.63

0.53

Singapore

1.00

0.65

South Korea

0.00

1.00

Note: Correlation of GDP growth between regions is measured between 1 and -1.

1 represents the most correlated and -1 the least correlated.

Source: World Urbanisation Prospects: The 2014 Revision, UNPD; based on annual GDP growth,

real terms in local currency (1990-2016)

 

A key lesson learnt from the Global Financial Crisis is while most global markets were hit by the economic downturn, the depth and breadth of the decline in values varied significantly across regions and cities, underlining the case for diversification (Fig.3). Some cities were more resilient and shielded, with little decline or no change in values. Most US cities saw a sharp and near-instant downturn, as risks intensified and scattered transactions due to market illiquidity which led to a magnified price contraction. Regardless of the magnitude of the downturn, some cities rebounded quicker than others from more resilient domestic conditions, such as Sydney, Melbourne and Seoul.  In Europe, the Sovereign Debt Crisis drove a prolonged market contraction, particularly for the PIGS (Portugal, Ireland, Greece and Spain) economies.

 

Fig.3: Global cities after the Global Financial Crisis - divergence in performance

 

Highest quartile
(-30 to -65%)

Medium quartile
(-30 to -20%)

Medium quartile
(-20 to -10%)

Lowest quartile
(-10 to 0%)

No lag (0-1 year)

Manchester

San Diego

Los Angeles

Miami

Seattle

Atlanta

Boston

San Francisco

Chicago

New York

London

Denver

Dallas

Philadelphia

Portland

Washington DC

Minneapolis

Houston

Brisbane

Sydney

Calgary

Oslo

Melbourne

Stockholm

Paris

Perth

Auckland

Montreal

Toronto

Vancouver

Lag
(2-4 years)

Dublin

Birmingham

Edinburgh

Budapest

Madrid

Porto

Tokyo

Wellington

Barcelona

Prague

Frankfurt

Berlin

Lisbon

Amsterdam

Milan

Rotterdam

Brussels

Rome

Vienna

Seoul

Antwerp

Cape Town

Geneva

Johannesburg

Munich

Zurich

Warsaw

Hamburg

Düsseldorf

Copenhagen

Source: MSCI Real Estate, 2016; decline in All Property capital values

 

Choosing a balanced and diverse portfolio, backed by economic growth cycles across Asia-Pacific, is important, as strong and resilient growth pull income and capital value higher over the long term. Equally important, the more varied differences across global and regional markets, such as investable size, transparency, liquidity, tax and currency, among others, can further help mitigate overall portfolio risk and enhance total returns.

For example, immediately post the Global Financial Crisis, the regional office market performance was quite synchronised as a result of the coordinated and massive monetary stimulus worldwide. Capital flowed strongly back into the few core office markets across the region, such as Sydney, Singapore, Hong Kong, Seoul and Tokyo, and other gateway capital cities also serving as the financial and commercial centres of the respective economies. However, in more recent years, while financial conditions remain largely robust (thus holding prices at elevated levels), the relative fundamental attractiveness of the different markets began to surface through a divergence in total returns, again suggesting strong diversification gains through a well-balanced portfolio.

 

Fig.4: Strong benefits of a diversified portfolio

 

Melbourne

Sydney

Beijing

Shanghai

Hong Kong

Osaka

Tokyo

Singapore

Seoul

Melbourne

1.00

0.83

-0.18

0.25

0.62

0.67

0.65

0.63

0.11

Sydney

1.00

-0.19

0.27

0.51

0.81

0.84

0.70

0.16

Beijing

1.00

0.24

0.06

-0.47

-0.41

0.12

-0.12

Shanghai

1.00

0.61

0.17

0.22

0.28

0.66

Hong Kong

1.00

0.29

0.34

0.75

0.69

Osaka

1.00

0.98

0.43

0.13

Tokyo

1.00

0.53

0.14

Singapore

1.00

0.17

Seoul

1.00

Note: Correlation of GDP growth between regions is measured between 1 and -1.

1 represents the most correlated and -1 the least correlated.

Source: PMA, 2017

 

Broadly speaking, scaling up a diversified portfolio of office assets (Fig.4) can be achieved through:

1) avoiding over-concentration in purely Australian and/or Japanese cities, given that cities within the same economies tend to trend in the same direction (by varying magnitude and with lags) due to similar economic or capital market conditions

2) by the same vein, limit exposure to both Hong Kong and Singapore given the high-market correlation, and

3) include Seoul and Beijing office, the former being a more localised market while the size, scale and depth of investable assets in Beijing restricts competition and transactions. 
There are lots of good reasons to invest in Asia-Pacific core real estate, and we believe that an enhanced diversification benefits is one of them.

 

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Harry Tan

Harry Tan

Head of Research, Asia-Pacific

Harry's biography