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Changing currents in the Pacific

The Far East has been a topic of much discussion for some time now among investors. Led by the giant stories of China and India, the region’s rapid rise upward captured attention and had started to change the way people saw investing in Asia.

The assertion that Asia has decoupled its fortunes from the US came to the fore and for some time looked to be true, until emerging markets and the Far East started to fall alongside the rest of global markets.

But with the attention that emerging markets, and Asia in particular, has received of late, the way that fund managers operate in the region is also changing.

For one, there are more competing for performance in this space. IMA figures show there are 53 Asia ex Japan funds with a five- year track record and the sector peer group has since risen to 80. And that is just the retail side. There are increasingly Asian-based hedge funds and institutional money being moved to these markets, all competing on trades and making some look a bit crowded by times, notes New Star Asian opportunities fund manager Ian Beattie.

Another dynamic shift in the Asian market of late is the components. Not only do Greater China and India now dominate many portfolios but there is also the way that other individual markets there are used.

In the past, when life got difficult in Asia, many managers sought refuge in the western market of Australia. These days, that country represents almost a reversal of that stance. Australia’s market is loaded with financials and its problems with a leveraged consumer are similar to the Western countries – its housing market is also considered to be in comparable shape with the issues being seen in the UK. Add to that the commodity-rich country has a big exposure to mining and resources, with sentiment starting to worry over a potential bubble, and Australia is not quite the defensive play for Asian portfolios it once was.

That is not to say Australia has performed that badly – so far. But sentiment on the region has meant that it is no longer being considered a bolthole when times in the Far East look tough, which many concede they now do.

Beattie says he is defensive in his portfolio but that does not mean he is looking to Australia to help out. “I do not buy that it is defensive this time. Australia has too much debt and it still has the deleveraging process to go through. It does have commodities, which is helping but its economy is almost two-tiered right now.”

James Budden of Witan notes that 18 months ago, when Witan reallocated its Far East weighting, it decided to strip out Australia from its Asia management. It put 2 per cent of its overall portfolio into an Australian-specific manager, Orbis, on the back of the belief that the Australasian market is so different (more Western) to the rest of Asia that the areas should be divided between two different managers.

Economically at the moment, Australia is facing similar issues to the UK, says Budden, pointing out that these days, companies outside that region are looking more defensive. In the longer term, regions such as China and India may seem a more defensive stance as their consumers are not as leveraged as those in the West.

The Orbis/SM Australia equity fund, which is managed with a value bias, concurs that the Australian market does appear to be more two-tiered at the moment. Its managers note that over the second quarter, the broader market performed weakly, supported only by a handful of its big resources companies.

The big five – Rio Tinto, BHP Billiton, Fortesque, Origin Energy and Woodside Petroleum – make up a collective 18.1 per cent of the Australian 300 index (ASX) leaving 81.9 per cent for the rest of the market. Yet in the quarter to June, the big five returned more than 25 per cent while the rest of the market fell by 7.6 per cent, giving the ASX 300 index an overall positive return of 1.7 per cent over that timeframe, according to Orbis.

The way that Australia, like commodities in general, is held by a fund manager can vary widely. Some portfolios in the IMA’s Asia ex Japan sector in the past have chosen to ignore the Australia component where others have historically been heavily weighted to the region. First State’s Angus Tulloch, in his Asia Pacific portfolio, has tended to have high weightings to the region and, as of July, was holding around 20 per cent of the portfolio there.

On the other hand, another well known investor in that region, Aberdeen’s Hugh Young has a slightly lower weighting in the Asia Pacific portfolio at under 10 per cent. Yet, over the three months to August 11, both managers, who are known for their stockpicking processes, are top quartile.

Looking more closely at the two portfolios and as of July 31, the £746m First State Asia Pacific fund features Woodside Petroleum and Newcrest Mining (Australia’s biggest gold producer) among its top 10 positions (with a combined 10.9 per cent position) while Aberdeen’s Asia Pacific portfolio has its third-biggest position in Rio Tinto.

So if Australia is out, just where are fund managers headed in these more volatile markets? It varies, but, in the main, many are simply seeking out higher-quality companies until some clear direction returns.

Beattie is doing just that, preferring the South-east region at the moment and bulking up on quality companies with solid cashflows. He feels that the time is not yet right to re-enter China in a big way, although he notes he is starting to look more closely at opportunities there. “This year is still about finding the right stocks, the companies that will survive,” he adds.

Matthew Vaight, co-manager of the M&G Asian fund says: “What really excites us about the region is the potential for companies to improve their capital allocation, increase their return on capital and create more value for shareholders.

“Company attitudes are changing. Management teams are increasingly aware of the need to meet shareholder demands and invest their capital with more discipline – a change that is likely to result in an upward shift in company returns.

“Improving corporate governance, we believe, will be the catalyst for greater shareholder returns.”

Investing in Asia is changing, just as the rest of the world is waking up to the opportunities present in those markets, says Beattie.

What this will mean to individual funds and how managers tackle the new dynamics there will be a matter for advisers to keep an eye on.

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