The importance of strategic moats, something that holds off the competition and lets a company generate long-term returns, isn’t lost on any fundamental investor. But identifying moats isn’t a straightforward process in familiar situations, let alone when analyzing foreign companies.
“The history and width of economic moats in Asia is open to even greater deliberation in many cases given ownership structures, a historical lack of standardized accounting, crony capitalism, protectionist policies and weak transparency in subsidy and tax regimes,” writes Matthews Asia portfolio manager Kenneth Lowe.
Cronyism, protectionism can distort a company’s actual competitive edge
The first pitfall that Lowe warns investors to watch out for is the distorting effect of cronyism. If a company has been getting ahead because it’s favored by the current government, a change of government or loss of favor could cause its profits to tumble quickly. While a change of regime might be the more dramatic version, anytime elections happen in countries with lots of cronyism investors have to wonder how a new ruling party will impact profits. There’s also the possibility that reform sweeps out the old elites and much of their ill-gotten gains.
Next up are protectionist policies including trade restrictions and subsidies (which aren’t always well documented). There’s an argument that these policies encourage domestic growth, but whether that’s true isn’t necessarily relevant for investors. If the policies change as governments gradually liberalize their markets, China being a clear example, companies will have to face their competition on an even playing field for the first time.
Asia hasn’t focused on intangibles: Lowe
“Compounding these challenges is also a mentality that has pervaded in many parts of Asia for decades,” writes Lowe. “That is, the model of being a manufacturing center focused on tangible assets and ignoring the building out of intangible assets through research and development and advertising.”
Lowe argues that companies that have relied on advantages such as protectionist policies often haven’t spent time developing their brand. In some cases, scandals have left consumers with a bad impression of national champions that gives foreign companies an immediate in once they are able to bring their products to market. This does seem to be changing, Asia accounts for a larger percentage of global R&D than it did in the 1990s, but it remains to be seen if that will translate to lasting brand loyalty as artificial competitive advantages fade.