Reasons, other than China, to be cheerful

China has been the engine of global economic growth over the past couple of years, while the US and Europe have tried to kick-start their economies with a succession of cuts in interest rates.

With China’s economy growing at 8 per cent a year and the Asia-Pacific stock markets having risen 40 per cent this year, it is unsurprising that portfolio managers and private

investors have been increasing their exposure to the region.

Axel Schwarzer, managing director and European head of distribution at Deutsche Bank’s asset management house, DWS Investments, says that along with global equities, Asia- Pacific funds are currently attracting more inflows than any other

products.

This is a significant achievement given the threats that faced the region with the outbreak of the Sars virus and the conflict in Iraq earlier this year. It also demonstrates how successfully it has recovered from the Asian crisis of 1997 and 1998.

Kobus Human, managing director of Amsterdam-based private bank Insinger de Beaufort, says the medium-term fundamentals in Asia-Pacific look attractive but cautions that the 40 per cent rise this year has reduced the attractiveness of equity valuations in the region.

“Investors must be careful about investing in stock markets after the kind of run that Asia has enjoyed this year,” says Mr Human. “We have been and remain overweight, although we are not going to increase our exposure to the region. Structurally, Asia-Pacific looks good and valuations still look good.

“This is reflected in the fact that global economic growth is currently being driven by China. The benefits of this growth initially spin off closest to home, which is Japan and the rest of Asia. In the medium term, the stock market offers more attractive valuations than the US and Europe.”

Awaiting a correction

Despite steady growth of China’s gross domestic product, Mr Human is less concerned about the threat of its economy overheating than a revaluation of the currency, the renminbi.

“The growth in China is coming from a combination of a cyclical and structural upturn,” says Mr Human. “It is too early at this stage of the upturn for China to suffer from overheating. But there is mounting pressure for a currency revaluation, which would have the effect of tightening interest rates.

“The other problem with retail investors putting money into China now is that the potential of the country is not a secret. It is probably better for retail investors to invest in Asia-Pacific rather than just China.

“Given the rise in the stock markets this year, however, it might be worth waiting to see if there is a correction before investing.”

Insinger uses four Asia-Pacific funds in its fund of funds portfolios – First State Asia-Pacific, APS Far East Growth, Aberdeen Asia-Pacific and the Invesco Equity Core fund. Given that First State has raised the initial charge on its Asia-Pacific fund to 4 per cent to deter new inflows, Insinger says it will consider the asset manager’s new Asia-Pacific Leaders fund or investing in an alternative fund.

Mr Human says that Asia-Pacific stock markets have traditionally suffered when the US tightens monetary policy by raising interest rates. But fund managers argue that through strong domestic demand and corporate restructuring in the region, Asia-Pacific is less reliant on exports to the US and elsewhere.

Western outsourcing

Mark Mobius, manager of the Templeton Asian Growth fund, says the relative out-performance of the region’s stock markets can be put down to factors including strong domestic demand and economic development as well as the growth in western companies outsourcing manufacturing and services to Asia, particularly to China and India. He has used his knowledge to outperform the MSCI Pacific ex-Japan index over one, three and five years.

‘Money is flowing into Asian equities due to relatively poor performance of stock markets elsewhere in the world’

Mark Mobius, Templeton

This expansion in domestic demand and intra-regional trade is demonstrated, says Mr Mobius, by the fact that the value of Korea’s exports to China now equal those to the US and Taiwan’s exports to China are rising rapidly. He argues that the strong growth in consumer demand in China is reducing Asia’s correlation to the US economy.

The main beneficiaries of this growth, are what Mr Mobius calls the three Cs – consumer products, cellphones and commodities.

“Asia could ride out a fall in the US stock market,” he says. “In 1997, the Indian stock market actually went up when the US was going down. Money is flowing into Asian equities because of the relatively poor performance of stock markets elsewhere in the world, money is coming out of fixed income as a result of low interest rates and the

fact that stocks are yielding 3, 4 or 5 per cent.”

‘We think the story in China is too hot. Everybody is talking about China as if it is the only story around’

Angelo Corbetta, Pioneer

Mr Mobius does not believe the Chinese economy is showing signs of overheating, particularly as there has been no significant rise in inflation. While Angelo Corbetta, head of portfolio management Asia at Pioneer Investments, agrees that the economy may not be overheating and valuations still look reasonable, he argues the stock market has overheated for technical reasons. “We think the story in China is too hot. Everybody is talking about China as if it is the only story around,” says Mr Corbetta. “We have taken some profits in China recently.”

Country specialists

Korea, he adds, has benefited from the recent decision to de-peg its currency from the yen. This has led to a 10 per cent devaluation of the Korean won against the yen and consequently boosted the former’s export companies. The Pioneer Pacific ex Japan Equity fund, which holds 130 stocks, has been overweight in Korea and invests 2.3 per cent of its portfolio in Kookman Bank. But performance has been behind the benchmark over one and three years.

While Mr Corbetta says valuations of technology stocks in Taiwan are probably stretched, he believes banks are set to boom: “The consumer credit sector will start enjoying double digit growth.” Cathay Financial in Taiwan, for example, comprises 2.5 per cent of the Pioneer fund while 1 per cent is invested in Fuban Financial Corporation.

The outlook in the Philippines is improving, according to Mr Corbetta, but the country still relies on money sent from its citizens working abroad to meet its debts.

‘Asian stocks are at about fair value at the moment but growth prospects look good for next year’

Adam Matthews, JP Morgan

Adam Matthews, client portfolio manager of the JF Asia Equity fund, says that when investing in Asia it is still important to have country specialists on the team. He argues that with a few notable exceptions, particularly in the technology sector, there are no global companies based in the region.

He says: “If you are analysing a retailer in Korea, it does not matter what is happening to Hong Kong or Taiwanese retailers.” This approach has led to a healthy 104.7 per cent five-year return, well ahead of the index.

JP Morgan Fleming Asset Management is still overweight in Asia-Pacific, says Mr Matthews, although he adds that stocks in the region are not as cheap as they were at the start of the year: “Asian stocks are at about fair value at the moment but growth prospects look good for next year.”

Mr Matthews believes China and Asia will benefit from a technical development as well over the next year. “China’s share of global GDP is about 4 per cent, compared with 27 per cent for Asia. China still comprises a small part of the MSCI World Index, however, with just 0.3 per cent. It is under-represented and indices are likely to play catch up over the next year or two, which will lead to money flowing into Chinese stocks.”

Chinese flexibility

The Chinese government, says Mr Matthews, has sufficient flexibility at the moment to avoid over or under-heating of the economy. “When China suffered from the Sars outbreak, the government was able to step in and spend money. It has enormous infrastructure expenditure planned for the next five years which it can reduce if necessary.”

‘Thailand’s market still attractive as it provides interesting domestic-driven investment opportunities’

Allan Liu, Fidelity

Allan Liu, manager of the Fidelity Funds South East Asia fund, which lags behind the benchmark over all three periods, says the management track record is one of the key stock selection criteria he uses because “this is crucial in helping me understand the management’s capability in growing company profits and shareholders’ value. More importantly, this helps me to judge the trustworthiness of the management.

“When evaluating the valuation of a company, I tend to look at cash flow and earnings growth prospects rather than at asset value.

“I believe that earnings and cash flow are better determinants of which companies will demonstrate more attractive long-term growth prospects.”

He adds that he has recently favoured stock markets in north Asia “because of the availability of companies with solid management track records and healthy fundamentals.

“Quality companies listed in these markets tend to show a strong competitive edge, better corporate transparency and sound financial positions. I am less keen on smaller markets in the region due to concerns over liquidity and company quality.

“However, I still find Thailand relatively attractive as the market provides interesting domestic-driven investment opportunities. Thailand is also expected to benefit from the easing interest rate trend.”