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East beats West

Uncertainty in China may be giving investors a few headaches, says James Smith, but Asian equities as a whole continue to outperform those in the West

Asian equities have continued to outperform their Western counterparts in recent years, with the region’s governments, corporates and individuals largely free of corrosive debt.

China remains the major investment dilemma – with an obvious disconnect between exceptional macroeconomics and market performance – and exposure to the country is a key call across the top-performing funds in the sector.

Familiar names head the peer group over one and three years to January 31, most of whom have remained fairly cautious on the region and largely avoided mainland China.

First State, for example, has three of the sector’s top 10 portfolios for three and five-year periods – Asia Pacific, Asia Pacific Leaders and Asia Pacific Sustainability – and team head Angus Tulloch attributes this success to a focus on well financed above-average companies.

The veteran has also been concerned about flows into Asia since markets turned in 2009, adding to gold-related stocks as a hedge against inflation.

Heading into 2010, First State’s portfolios were overweight in areas such as consumer staples, industrials and telecom services, although Tulloch says that consumer stocks – expected to offer a defensive growth profile – were becoming too fashionable with investors.

At regional level, the portfolios are overweight in South-east Asia and South Korea and underweight in Greater China, Australasia and the Indian sub-continent, with India and China both looking priced for “near perfection”, according to the manager.

“Current optimistic expectations and attendant rich valuations make us wary and we continue to adopt a defensive stance,” says Tulloch.

“However, strong liquidity, underpinned by highly accommodative monetary policy in the West, should support Asia Pacific markets until the need to return to a real interest rate regime is recognised.”

He believes it is difficult to see how China can maintain a situation with inflation running at 3 to 5 per cent and interest rates at current lows, with further concerns about lowering lending standards.

“Our focus on soundly financed and above-average quality companies, overweighting defensive sectors and gold exposure should all help mitigate negative macro influences,” says Tulloch.

Another long-term Asian investor, Aberdeen’s Hugh Young, has broadly similar views, with his Asia Pacific fund sitting seventh out of 64 peers over three years.

After a very strong 2010 for the region’s markets and economies, Young is reluctant to be too bullish and also voices concerns about excessive inflows and increasingly stretched valuations.

He has also been a consistent sceptic on Chinese equities, recently getting into a media war of words with Fidelity’s Anthony Bolton on opportunities in the region.

Overall, he feels the strength of balance sheets at government, company and consumer level offer comfort in what is likely to be a volatile year for investors.

“Asian companies are in good health due to financial discipline and good management and earnings are forecast to grow by around 15 per cent this year,” he says.
“We hope excess cash will continue to be returned to shareholders rather than used to diversify businesses into non-core operations – a strategy that has proved problematic in the past.”

Aberdeen’s strategy has remained unchanged throughout various upheavals in the region, looking to identify quality companies with robust balance sheets and strong franchises. This fundamental approach tends to mean relatively low stock turnover, with Young himself owning certain holdings since the late 1980s.

Overall, 2009 saw minimal activity on the portfolios, although Young did add some more aggressive positions early in the year on growing confidence before paring these back. Last year was also steady in terms of activity, with the few additions including AIA – the Asian arm of AIG at IPO.

Caution on China has hit other defensive-minded Asian managers but Young has benefited from his decent weighting in India and large sector positions in financials, for example.

“Many Chinese companies remain largely state-controlled and we have struggled to find professionally run private firms on the mainland with a track record of looking after shareholders,” he says.

Aberdeen’s team has continued to use market weakness as an opportunity to top up long-term positions and portfolios remain skewed towards companies exposed to domestic growth stories, such as retailers and banks.

Young says his process could also withstand any pick-up in inflation and interest rates, with the goal of building a portfolio of diverse industries that can prosper throughout a cycle.

Schroders Asian Alpha Plus heads the sector over three years, with manager Matthew Dobbs also highlighting the benefits of holding better-quality companies.

His portfolio outperformed strongly throughout much of last year, largely due to stock selection in the industrials and materials sectors.

He says: “Our focus on quality names with strong exposure to the burgeoning domestic market also proved beneficial as these were at the forefront of outperformance.

“Jardine Strategic Holdings, for example, which has interests in the region’s hotel, property and real estate sectors, benefited strongly from the robust regional recovery. Elsewhere within the sector, our positions in SembCorp Marine, the world’s second-biggest oil rig maker, and Filipino construction firm DMCI Holdings contributed to returns.”

Highlighting the region’s growing dividend culture, Newton Asian income is among the top performers over three years and manager Jason Pidcock also boasts a second top-quartile offering with the Oriental fund.

Like many peers, Pidcock highlights healthy corporate balance sheets across Asia – with much lower borrowing than Western counterparts – encouraging companies to distribute surplus cash to shareholders.

Pidcock says several of Newton’s global investment themes support investment in Asia, primarily ongoing rural to urban migration and the domestic demand this unleashes. As with Newton’s other income offerings, the Asian portfolio has a strict yield discipline but Pidcock says this still allows plenty of flexibility to access themes.

He says: “To play consumerism, for example, we hold many Chinese toll-road companies, such as Hopewell Highway and Jiangsu Expressway, which benefit from the increased ownership of cars and propensity to travel.”

As expected on a yield-focused fund, telecoms and Reits – as well as toll roads – are major sector positions but there is also meaningful exposure to the oil and gas sector and to IT.

At country level, Pidcock’s biggest exposure is to Singapore, reflecting Reit exposure, while China, India and Indonesia are all underweights due to lack of companies with sufficient yield.

“Within the portfolio of around 45 stocks, our preference is for high-yielders, as many of these have good business models, strong balance sheets and predictable cashflows,” he says.

“This means they can still maintain growing dividend policies, even if their net income is growing slowly.”

Over recent years, the fund’s naturally cautious bent proved beneficial in 2008 but Pidcock also outperformed in the cyclical rally the following year, with stockpicking in oil and gas and industrials offsetting any defensive drag.

He also outperformed in 2010, with holdings in oil and gas, financials and IT, plus overweights Thailand and Singapore all positive.

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