It is worth pointing out that there are some excellent single country fund managers in the Asian region. You wouldn’t know it to look at the pure performance numbers, which only show what a rough ride you tend to get if you hold these funds for the long term. This highlights the fundamental problem for investors wanting single country exposure. If we take Korea as a good example, the Kospi Index went from around 570 in October 2001 to 940 in April 2002. And then, while the sell-side analysts were all saying it was going up to 1100 and more, the Kospi came all the way back to 570 in October 2002. This goes a long way to explaining why regional Asian managers often take a highly active asset allocation approach. No matter how good the single country fund manager is, the fund will always be a hostage to the gyrations of the market, when a small number of stocks dominate and the movements are that extreme. Asset allocation is therefore crucial in Asian portfolios and the decisions are probably best left to regional experts.
While current valuations in Korea look attractive, the market still awaits the catalyst to drive stock prices higher.
All eyes are currently on China, which continues to benefit from huge inflows of foreign investment. Its economy is expected to outperform the rest of Asia by a wide margin in 2003, with the momentum of reform expected to remain strong after the recent change of leadership. Heavy investment in Hong Kong and China by Asia managers is a factor of the sheer size of these markets, and of their major stocks being so high profile. The only concern here is that, once again, foreign money will be flowing in just as valuations are looking stretched. However, the market is expanding fast and transparency issues are being addressed.
The momentum for change is gathering pace and mainstream fund managers will have to work harder to satisfy investor demand for consistent returns from their China portfolios. Closet Hang Seng Index huggers may find it tough going from here. There is the likelihood of further downward earnings revision in Hong Kong and with an economy so heavily dependent on external trade, and with a pegged currency, the outlook is not hugely favourable at the moment. Confidence is low, on the basis that China holds all the cards and will seek to put the interests of the mainland before those of the SAR. How long Hong Kong can remain the hub for Greater China is an open question.
Anecdotal evidence from fund managers indicates that China remains a risky place to invest for the uninitiated, but with good opportunities for the more experienced. Many of China’s listed companies are not particularly well-managed and operate in highly competitive industries, which makes careful stock selection a necessity. Fund managers are finding it necessary to look at a larger pool of companies, moving down the cap scale, in order to take advantage of the Chinese growth story. And there is still a high incidence of corruption in the Chinese securities market, which those involved accept goes with the territory. ARN’s Chris Wong has recently sold out of a major holding in China Brilliance. He says, “We have long held the stock as it is destined to be BMW’s joint venture partner in China. BMW is about to start local production with a target annual production of 30,000. Given the speed of wealth accumulation in China, there is certainly no shortage of demand across the country. What triggered our complete exit from the stock is news that a legal dispute between the ex-chairman and the provincial government could be turning more ugly.
“Reportedly, the ex-chairman has been fronting the majority shareholding on behalf of a third party. It was reported on the financial news that the provincial government could be siphoning off assets from the listed vehicle to nullify any economic reason to pursue the legal dispute. Our first response was to challenge how that can happen without contravening the Stock Exchange listing rules of Hong Kong. Our second thought was that we decided to exit. That is in keeping with our philosophy on investing in China. Our move could be wrong but we do not want to run the risk of being proved right.”
The performance of many of the funds in the Asian region has been increasingly erratic and one of the discernible trends in Hong Kong and Singapore has been the amount of fund restructuring that has gone on to try and improve this situation. There have been a number of manager changes and, of course, quite a few asset management firms have shifted their investment teams from Asia to the UK, or have consolidated in one centre rather than be present in two or three.
This is only significant if the move has served to disrupt the continuity of the fund’s management. For better or worse, at the same time as asset managers were consolidating, no one was much interested in buying into Asian markets.
Invesco’s Alfred Ho observes that a lot of global investors have lost patience with Asia as an asset class, understandably given the performance on a risk/return basis over the last ten years. However, he is of the view that liquidity is improving steadily and that the Asian markets will provide a measure of outperformance in coming years.
London based manager Sloane Robinson agrees with this. It doesn’t expect major world markets to advance significantly in the foreseeable future, but the Asian markets “are perfect for a self-funded and sustainable period of strong economic growth, resembling that of the mid-late 1980’s.” A significant de-coupling from US markets has occurred and as a net creditor to the international financial community, emerging Asia would see no adverse effects from currency devaluation. “In recent months, we have experienced the start of this de-coupling as the markets recognise the positive dynamics of certain of these economies. We believe this feature of the emerging Asian markets is sustainable,” says SR.
Since the crisis that accounted for Thailand in 1995, there has been a two or even three speed Asia. That situation is only now unwinding itself as Thailand and Malaysia in particular, regain the favour of international fund managers. The Thai market was a star performer in late 2002 early 2003, despite the temporary high risk premium after the Bali bombing. Thailand’s strong macro fundamentals, good results from banks and finance companies, a reduction in local interest rates and new rules to cap credit card charges have underpinned the market. ARN’s Chris Wong has backed his belief in Thailand’s recovery with a high exposure to Thai stocks within his fund. This is not a knee-jerk reaction but a considered response after several years during which Wong has neglected the market: “our decision is based on a wave of indication by leading banks to refinance a big chunk of their outstanding high cost capital raised at the low point of the Thai banking crises back in 1998 as a lifeline for the banks to stay solvent. The high cost capital came about by convincing depositors at that time to convert bank deposits into interest bearing note with a built-in mechanism of jacking up coupon interest once the bank starts to turn profitable. Our conclusion then was you need to look no further in deciding when banking profits will start to turn for the better. As the banking sector started to report solid meaningful profit in the fourth quarter of 2002, the marginal cost of funds for the hybrid capital is due to climb to 11% versus the prevailing lending rate of 6.75%. Hoping our decision is right, this would complete the full cycle of our call on Thai banks dating back to 1995.”
Looking forward, the China factor is going to be a major determinant for which countries run on the fast track. Singapore is playing the role of safe haven and has been able to outperform as a result. Says Ho: “The ability of the Singapore market to perform has been made easier because its currency is not pegged to the US Dollar, which permits the authorities more discretion over monetary policy”.
Having said that it’s important for a regional manager to be taking an active stance, relative exposure is an issue for the investor. One fund manager will have a natural disposition towards Thailand and Malaysia for example, while another might have as much as 50% of an Asian portfolio exposed to China and Hong Kong combined.
The region’s increased reliance on the global electronics cycle is a double-edged sword and implies greater volatility going forward, although we may at least have reached the point of maximum pain. As the producer of choice for chips, handsets and PCs, Asia should experience strong volume demand going forward. More than ever, it is crucial to look closely at the Asian specialist managers to see which ones are best positioned to make money in this most interesting and diverse of regions.
Copyright 2003 Richard Newell