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Crouching tiger

The Asia Pacific investment story is dividing opinion, with some pointing to the massive potential of China while others fear a bubble. One thing is certain, says James Smith, the region is changing the global financial landscape

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China has become a divisive issue in investment circles, with bulls highlighting the region’s massive macroeconomic potential while bears mutter about bubbles and stretched valuations.

After the recent celebrations to welcome in the Chinese New Year, it remains to be seen whether investors may be hoping for too much in the Year of the Tiger despite its association with wealth god Tsai Shen Yeh.

Asian markets in general had a very strong 2009 following the March low point, reflecting a quick recovery after overselling, easy global liquidity conditions and recognition of the region’s structural strengths.

These include largely healthy banks with sensible lending practices and no shadow system and a general lack of debt at personal, corporateand Government level.

Highlighting the positive backdrop, the average Asia Pacific ex Japan fund is up by 51.6 per cent over 12 months to February 8, with the best performer growing by more than 72 per cent.

But after such a significant bounce, there is a consensus that the general market rerating is now over and that company fundamentals will drive performance again.

Several high-profile managers are cautious on the region after a sharp rise in a short period, including First State’s Angus Tulloch.

His primary concern is the flow of money into the region and the knock-on effect of inflation. The veteran has increased allocation to gold-related stocks as a hedge against this.

Stuart Parks, head of Asian equities at Invesco Perpetual, says valuations remain reasonable despite this massive appreciation over the last year. He highlights a price-to-book ratio of around two and a price to earnings’ multiple of 14 on the basis of expected 2010 earnings.

Parks says: “Given the valuation and earnings backdrop, the fundamental basis for continued market appreciation looks intact on a two to three-year view.

But the progress of equity markets, especially in Asia, is never smooth and there are some principal risks over 2010.”

For Parks, the first of these is the dreaded bubble word and while current valuations are well away from that territory, there is a risk of markets rising in an unsustainable manner.

It remains to be seen whether investors may be hoping for too much in the Year of the Tiger despite its association with wealth god Tsai Shen Yeh

He says: “Any inflationary signs could also lead to an earlier move to tighten monetary policy. For many countries, vulnerability stems from higher food prices. These pressures are already evident in India and China, with the latter’s inflation just moving into positive territory.”

Parks says deft policy action could head off these risks and issues should also be seen in the longer-term context of emerging Asia’s growth.

Aberdeen Asset Management equity head Hugh Young, another manager who is erring on the side of caution, says Asian markets have already corrected this year, with sentiment hurt by fears over monetary tightening in China.

Over January, the MSCI China index was down by more than 8 per cent, although it bounced back in February.

Young says: “The Government told banks to set aside larger reserves and scrutinise new mortgages more stringently. Elsewhere, India hiked
lenders’ reserve ratios while Taiwan moved to curb speculative capital inflows and stem the local currency’s appreciation against the dollar.”

Looking ahead, he says sentiment appears highly sensitive to worries about sovereign defaults, the removal of fiscal stimulus and the start of monetary tightening. “Given the extent of last year’s rally, however, such a pullback would be healthy as valuations will realign with fundamentals and present buying opportunities.

“We are cautiously optimistic about the year ahead, believing markets will become more discriminating after weaker companies outperformed in 2009.”

Elsewhere, Melchior Asian opportunities manager Henrietta Luk says the region, and the whole world, has become increasingly China-centric since the start of the global financial crisis.

She sees the recent panic selldown as overdone but also feels the near-term outlook is challenging as investors worry about inflation, the deceleration of property sales and policy tightening.

“We are still positive, albeit more cautious, in a region that is in the centre of a tug-of-war between economic growth and monetary tightening,” she says. “Other markets have declined on worries as to a potential slowdown in China, with the country’s growth increasingly vital to regional production. Taiwan’s Taiex dropped by 5 per cent in January, while Korea’s Kospi index ended the month down by 4.8 per cent but, again, macro datashows improving economic strength.”

Korea continues to grow in popularity for investors, with some commentators even adding a K to the Bric acronym to highlight its current strength. Franklin Templeton’s Mark Mobius notes South Korea’s economy grew at its fastest rate in seven years during the third quarter of last year.

Mobius says: “South Korea’s trade sector also reported positive data with exports returning to growth after more than a year.”

He remains positive on Korea for 2010, believing that Asian markets are in a secular bull phase. “Although the slowdown had an impact on Asian economies, they are becoming more domestically and regionally driven. Government expenditure in areas such as infrastructure, as well as private domestic consumption, could at least partially offset declines in growth from slowing exports.” As is fitting for any review of Asian investing, the last word must go to China, and there are plenty of managers keen to extol its virtues.

Fidelity’s Anthony Bolton, for example – who has just launched a fund investing in the region – says the country’s growth will be increasingly attractive in a generally slower-growth world.

Bolton says: “China’s stockmarket is underrepresented in global terms compared to its significant economic influence. I am also attracted by the potential trajectory of economic development, similar to that experienced by countries like Taiwan, Korea and Japan 20 or 30 years ago but on a much larger scale.”

Like many advocates for China, Bolton feels that fears over the inflationary outlook and a potential asset price bubble are overstated.

HSBC manager Richard Wong – who runs one of the largest China equity portfolios in the world – also remains in the bull camp and dismisses
bubble fears. With the market trading at around 13.5 times and offering projected earnings’ growth of 20 per cent this year, Wong says the
valuation of H-shares and red chips remains attractive.

“The word bubble suggests unsustainable valuations but the market is currently on less than half the level of the 2007 peak,” says Wong. Despite China’s 60 per cent rally last year, it still lagged the other Bric nations – with 121 per cent from Brazil, 100 per cent from Russia and
101 per cent from India – and Wong sees scope to catch up.

Overall, he predicts domestic consumption will remain a key driver for the economy in the Year of the Tiger, with the Government rolling over
various subsidies from 2009.

Wong says: “Such schemes should continue to drive robust growth in domestic consumption this year. Last year, China achieved roughly 15 per cent retail sales growth and we expect this will continue.”

Roaring ahead or paper tiger?

Fund managers and IFAs consider Asia Pac prospects

Growth to go on but it won’t be smooth

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Stuart Parks, head of Asian equities, Invesco Perpetual

The rise in Asia Pacific ex Japan markets in 2009 reflected a recovery from the oversold position of early 2009, easy global liquidity conditions and a recognition of the structural strengths of the region.

Even after that rise, however, valuations are still reasonable: the price-to-book ratio is around two and the price/earnings multiple is around 14 on the basis of expected 2010 earnings (which the consensus sees as 25 per cent higher than in 2009).

Given that valuation and earnings’ backdrop, the fundamental basis for continued market appreciation looks intact on a two to three-year view but the progress of equity markets, especially in Asia, is never smooth and there are three principal risks which I see for 2010.

The first is, indeed, that a new bubble develops and some already see signs of one inflating. While we dispute that – valuations are well away from bubble territory – there is a risk of markets rising in an unsustainable manner in 2010.

Second, a stronger dollar (maybe driven by a firmer than expected US economy and an earlier rise in US interest rates) poses a risk for Asia.

Third, higher Asian inflation, leading to an earlier move to tighten monetary policy in the region. For many countries, the vulnerability to higher inflation stems from higher food prices. These pressures are already evident in India. In China, where inflation has just moved into positive territory, food prices pose the greatest future inflation risk.

However, it is certainly possible that deft policy action can head off these risks. China, for example, has recently taken measures to curb property market speculation and a resumption of renminbi appreciation against the dollar may help both to ease inflationary pressures and also affect the perception of Asian economies still being dollar-linked.

These issues should, of course, be seen in the longerterm context of the growth of China and other emerging Asian economies. China is still in the process of a multidecade period of growth which will take its GDP per head up towards the levels of those in the US, emulating the earlier successes of Japan, South Korea and Taiwan.

Overall, therefore, I think it is still right to be optimistic about the prospects for Asia on a multi-year view but, as always, it would be unrealistic to expect a smooth ride.

Theme tuning

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Gigi Chan, manager of Threadneedle China opportunities fund

The Chinese authorities are removing some of the stimulus that was put in place in 2009. They are acting sensibly and pre-emptively to sustain growth and control inflation and to rebalance growth between consumption and investment.

A balanced and sustainable Chinese economy is in the interests of all global investors. However, markets are concerned that the Chinese authorities will overtighten and that this will have a negative impact on Chinese economic growth and, by extension, China’s demand for goods and commodities produced by the rest of the world.

’Stockpicking skills will be rewarded and well managed funds will deliver strong long-term returns from investing in China’

The Chinese currency needs to appreciate and we certainly see the renminbi strengthening against the dollar this year but we do not expect a big, oneoff move. That would be highly disruptive of the labour market as it would lead many export-related factories that operate on very thin margins to close overnight. We have invested profitably in areas such as retail, luxury goods and financial services. As the consumption theme develops and matures, we continue to find good investment opportunities in these and other sectors. We invest in a variety of themes in the portfolio and at the moment we also have stocks designed to benefit from urbanisation, infrastructure spending, deregulation and the emergence of Chinese firms as true global leaders in their industries.

Given this backdrop of policy uncertainty, we may see periods of volatility this year. Last year, many funds benefited from the liquidity inflows into China.

This year, I believe, will be a year where stockpicking skills will be rewarded and well managed funds will deliver strong long-term returns from investing in China.

Asia Pacific excluding Japan best and worst-performing funds

Top five funds over three years
Fidelity Institutional South-east Asia 59.87%
CF Canlife Far East 54.21%
First State Greater China growth A 54.01%
Fidelity South-east Asia 50.36%
First State Asia Pacific leaders A 49.8%

Bottom five funds over three years
Halifax Far Eastern C 15.58%
New Star Asian dividend income Inc 12.77%
Lloyd George Asia Pacific A Acc 5.2%
Premier Alliance Trust Asia Pacific eq A 4.07%
Melchior Asian opportunities A GBP 3.01%

Sector average 29.85%

Source: Morningstar Investment from 22/02/07 to 22/02/10, based on £100,000 lump sum investment, bid to bid, basic-rate tax, income reinvested

Too many cooks boil the froth

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Alan Adam, financial consultant, Alan Steel Asset Management

Asia Pacific ex Japan has always been a sector we have been involved in but we are getting nervous about it now because everyone else is getting so upbeat about it.

We are contrarians naturally and when we see Anthony Bolton entering the sector and Martin Currie launching a China fund, we get concerned that everyone is ploughing in.

We do not think Asia Pacific ex Japan has any long-term problems but it is a hot topic and that is usually an indicator of a short-term dip.

’We are contrarians naturally and when we see Anthony Bolton entering the sector and Martin Currie launching a China fund, we get concerned that everyone is ploughing in’

We are not doing quite as much in the sector as we were doing previously but we will return once some of the frothiness has gone off the market, maybe in the summer.

We like the Angus Tulloch’s First State fund as he gets incredibly defensive when things get frothy as well. We do not get wrapped up with stocks, we like to make sure there is good quality business behind the fund. In that part of the world, accounting standards are not quite as good as the UK and you might not quite know what you are buying but Tulloch has a forensic, detail-led business assessment style so knows what to invest in.

Value in the long term

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Ben Yearsley, investment manager, Hargreaves Lansdown

For Asia Pacific ex Japan, the biggest challenge this year is sustaining the growth to achieve the high levels of valuations and to justify the market rise.

Valuations are not expensive necessarily, rather stretched slightly in the short term, but over the long term they are still good value.

In the short term, there might be a setback simply because last year’s growth was so strong. This setback might create a buying opportunity but I would be buying at this level now if I were buying for five to 10 years.

If the sector continues to receive 9 per cent growth in China and India then fine, there is no problem but if they do not, then there might be a problem but it is a huge area for long-term investment.

Fund-wise, if you are looking at China, then First State’s Greater China growth and Jupiter China and Jupiter China sustainability are good picks and First State’s in India as well. For Asia Pacific ex Japan, both Jupiter and First State are the leaders as well.

Consumers at the core

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Charlie Awdry, manager of Gartmore

China opportunities fund The economic data has been strong and the consumer is still spending.

The core of the fund continues to be consumer-related. Some of my positions are in beneficiaries of China’s rapid growth in internet usage, such as Baidu, the take-up of more varied food products by consumers, such as China Mengniu Dairy and local brands like Li Ning.

The Hang Seng China Enterprises index trades on less than 12 times this year’s earnings, which is undemanding by historical measures or compared with other major world markets.

We certainly see many areas of value and scope for unexpected earnings’ growth that support the case for investing in attractive Chinese businesses over the next 12 months.

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