Investment opportunities within Asia’s demographic demise
EPIC Oriental Focus Fund
May 2023
Global fertility rates (live births per woman) have declined dramatically over the past 50 years from well over 4 to under 2.5. Frankly, the only region holding the global fertility rate above 2.1 (the rate required to sustain a population) is Africa. While there are other influences - for example female worker participation - fertility rates have a statistically significant inverse correlation to just two variables; per capita income and urbanisation. In essence, a high fertility rate implies a lack of economic development.
Within the Fund’s investment universe, India – whose population recently exceeded that of China – can still claim the so-called ‘demographic advantage’: a situation wherein the (productive) working population will continue to climb as a percentage of the overall population for the next decade or so. This is despite the fact that Indian fertility rates have more than halved over the past four decades to 2.0. This dependency ratio is currently also advantageous to countries such as Indonesia at present but, with a fertility rate that has - roughly speaking - also halved over the past four decades to 2.2, the long-term direction of travel is clear.
China’s miserable demographic profile is often incorrectly blamed on the introduction of the one child policy in 1979. Perversely, births per 1,000 actually climbed during the 1980s from their 1979 level and true birth rates have undoubtedly been understated in that period with boy/girl birth rates heavily skewed to the former. However, from the late 1980s to 2016 the birth rate declined from circa 2.0 to just 1.3, entirely consistent with rapidly rising incomes and urbanisation. The two-child policy was introduced in 2016 but, again, the birth rate has almost halved to circa 0.7. The 2021 three child policy will prove equally ineffective. With birth rates now running constantly below death rates, China’s population peaked in 2022 and will decline inexorably henceforth. The Shanghai Academy of Social Science predicts that well before 2100 the dependant (young and old) population will exceed the working population. In particular, the dark blue section of the chart below (65+) is growing extremely fast.
It is not just China. Japan’s population peaked in 2007 and, from an investment perspective, it is very interesting to note that one in every eight residential properties in Japan are now vacant or derelict. Japan’s demographics have been well documented, but Japan is not alone. Note in the chart below that South Korea and Taiwan have experienced low fertility rates for decades. Strangely in both countries the fertility rate fell below 2.1 in the same year – 1985.
The investment implications of these highly predictable demographic profiles should not be underestimated – not least across the property sector if the recent Japanese experience cited above is the norm and not the exception.
While automation, robotics, healthcare, care homes, funeral parlours etc are obvious beneficiaries of these demographic trends, the inevitable negative economic impact on the overall level of consumption over time (be it property, autos, cosmetics, apparel etc) should not be ignored.
More immediately, with the working population falling fast, any initiative that improves employee productivity will receive the blessing of the Chinese Government. For example, industrial digitisation is a key policy objective of China’s 14th five-year plan with specific targets to raise the penetration of enterprise resource planning (ERP) from 68% to 80% and research and development digitalisation (RDD) from 71% to 85%. The digital transformation in the manufacturing sector is focussed on nine industries of which steel is the most important. Shanghai Baosight Software – which is held by the EPIC Oriental Focus Fund – is playing a key role in this consolidation by implementing the fusion of information technology with industrial operations technology. Aside from operational efficiency gains and reduced manpower, the implementation of this industrial digitalisation is key to parent Baosteel’s adoption of low-carbon technologies such as top gas recycling-oxygen blast furnaces (TGR-OBF) and hydrogen steelmaking.
More broadly, the sector that is most likely to be a long-term beneficiary of this global race to lift productivity is information technology. The Fund’s holdings in this sector are primarily hardware not software concerns, i.e. manufacturers. It is memory, capacity, size, speed and scale that is required for big data, the internet of things and artificial intelligence. We are cognizant of the old gold rush analogy – more money was made selling picks and shovels than digging for gold. Aside from Shanghai Baosight, the Fund’s holdings in TSMC, Samsung Electronics, eMemory and Digital China play directly to this. A caveat would be hardware companies overly focussed on consumer electronics which, for obvious reasons, will likely see diminishing long term growth prospects. Both our global and Asian funds are materially overweight the information technology sector while the global portfolio is also heavily overweight healthcare. The chart below says it all. It took ChatGPT just 5 days to reach one million users/subscribers!
Henry Thornton
Fund Manager, EPIC Oriental Focus Fund