Nonetheless, we assume the recovery will be muted and uneven because of the depth of the systemic problems which underlie the crisis, particularly in the US and Europe. Our major concern is that the combination of the massive stimulus and quantitative easing, an outflow of US dollars, as investors relocate their money from the US, will continue to push the USD down vis a vis other currencies and the possibility of rising energy costs will lead to a resurgence in inflation which may force premature central bank tightening and may stem the pace of any recovery.
e-fundresearch: Which are the most important factors currently when you assess Asia ex Japan equities?
Sung: In the current environment, government policy has been even more important than usual so we have devoted more resources to scrutinizing stimulus packages on a country by country basis to try to determine the potential impact and the probability that they can be successfully implemented.
In particular, we’ve been paying attention to China’s RMB 4.1 trillion stimulus package and whether it would be successful in sustaining China’s economic growth. While we were confident that China had the wherewithal to quickly and effectively implement a successful program that would prevent its economy from falling into the same malaise as the developed world and sustain 8% growth, we were definitely in the minority.
However, once a host of indicators began to appear in the first quarter which provided strong evidence that China’s policies were working and that the slowdown had been stemmed, confidence began to build in China and across Asia that Chinese demand would be sufficient to drive Asia ex-Japan demand. As China’s economy grew there were some signs of stabilization in other Asian economies and Asian stock markets began to rally.
In addition to the stimulus measures and China’s economic growth, 2009 is also an important election year for Asia, so we have tried to anticipate the impact of elections on the economies and stock markets in Indonesia, India and Malaysia. However, the key election was in India in May. There was concern that a new Parliament would continue to be divided and that even if the Prime Minister Dr. Manmohan Singh was re-elected, that he would have to govern over a fragmented coalition consisting of Communists and other Left leaning parties who would oppose reform. However, the election proved to be a shocker with the governing Congress Party winning a landslide victory. Investors were jubilant as they clearly concluded that many reforms which have long been delayed could now proceed. The market responded by soaring 17% on the first trading day following the announcement of the election results.
Now, we are watching to see if the re-energized Singh government will be able to live up to expectations and will be watching to see what is included in the July Budget We are also monitoring the upcoming Presidential election in Indonesia in July and the campaigning that will be starting this year for next year’s elections in the Philippines.
e-fundresearch: Which regions and/or sectors are currently overweight or underweight in Asia ex Japan equity funds? What are the reasons for it?
Sung: There are a number of themes and trends that that are driving our sector investments in Asia. Currently, our major bets are in hard and soft commodities, energy, property, infrastructure and domestic consumption.
Commodities: We like commodities, such as copper, iron ore, and coal because the global slowdown has caused mines to cut production and in many cases to close temporarily or permanently. When a recovery occurs, it will most likely be led by Asian economies and in particular by China. We expect that demand will accelerate, capacity is likely to be constrained and prices will be driven up. We are already seeing this in anticipation of a recovery.
Gold Mining: We also have been steadily increasing our position in gold mining companies, since the middle of 2008. We believe that gold serves both as a hedge against global economic uncertainty in the short term and inflation in the medium and longer term.
Energy: Another long term theme that we have pursued is energy. Even though oil prices have fallen from $150 to $50 and have bounced back to $60, energy related stocks have been relatively resilient because most investors believe that energy prices are unsustainably low and will have to rise in order to cover increasingly costly production and to encourage more exploration. In addition to oil and gas, we have also been increasing our position in uranium. We find the argument for nuclear power to be compelling and as India, China and many other nations increasingly shift to nuclear power, demand for uranium will grow, and yet, new uranium mine capacity is likely to be severely constrained for the foreseeable future.
Soft commodities: We also like soft commodities and soft commodity related inputs, particularly in Australia, Taiwan, Malaysia and Indonesia. Soft commodities are driven by rising demand for protein in developing countries, restructuring and consolidation among the industry players as well as possible upward pressure on prices, partly due to increased medium and long term demand for soft commodities such as corn and sugar used in producing alternative fuels.
Property: We lowered our weighting in property as the global economic crisis mounted, but were among the earliest to anticipate a recovery in Chinese property stocks, and sharply increased our position in Chinese property developers since late 2008, particularly in Hong Kong and China in response to stimulus packages, low interest rates, improved sentiment and, a return of Chinese capital from the US. Taiwan is also seeing property prices move up with possible increased investment from China.
Infrastructure: We have also been increasing our position in infrastructure related stocks particularly in Hong Kong and China to take advantage of the government stimulus package.
Consumption: We are increasing our position in domestic consumption plays to take advantage of lower interest rates, stimulus packages, including cash handouts, and improved sentiment.
In developed Asia, our major underweight is in banking, particularly in Australia, due to the possibility that banks will come under increasing pressure until the global economy is on firmer footing. The rather cyclical orientation of our portfolio means we are generally underweight the more defensive sectors such as telecommunications. In emerging Asia, we are also underweight the more defensive sectors such as consumer staples.
Country Allocation
In terms of countries, we are currently overweight Greater China, including Hong Kong, China, and Taiwan. We are neutral in Singapore and Indonesia. Our underweight positions are in Australia, New Zealand, India, Korea, Malaysia, the Philippines, and Thailand.
Overweight Positions: Hong Kong, China, Taiwan
Hong Kong: While we expect volatility to continue and anticipate that a pullback is likely, we believe that Hong Kong stocks, particularly property developers, should continue to do well on low interest rates and Chinese effort to internationalize the RMB.
China: We will also remain overweight Hong Kong listed China related stocks. Even though China’s market has performed very well, we believe that continued signs that the government’s stimulus measures may be working will generate more good news for the economy, raise investor optimism, and provide some more upside to the market.
Taiwan: Although we are still cautious about the export sector as well as the domestic economy, we are encouraged by signs that relations between China and Taiwan are warming more rapidly than expected which should help our portfolio that is positioned to benefit from this development.
Neutral Positions: Singapore, Indonesia,
Singapore: We like the fact that Singapore is politically stable and well managed with solid financial institutions, but recognize that the heavily export oriented nature of economy may keep pressure on the economy and market in coming months.
Indonesia: We are reasonably optimistic about the outlook for Indonesia given demand for its resources and firm domestic consumption, but are worried about the outcome of Presidential elections.
Underweight Positions: Australia, New Zealand, India, Korea Malaysia, the Philippines, and Thailand
Australia: In Australia, we are overweight energy and resources, which we believe should perform well in response to better than expected Chinese economic results, but underweight the market as a whole because we expect that Australia’s domestic economy may experience more headwinds in coming months, and that the heavily weighted banking sector will suffer after strong performance in recent months.
New Zealand: We think that New Zealand’s economy has likely bottomed and believe that aggressive interest rate cuts should help to stimulate a sluggish recovery, but are concerned that the recovery may still take time to be realized.
India: We are slightly underweight India, but following the very good election results are hopeful that the government, with the strengthened mandate, and an aggressive stimulus plan will be able to implement long needed reforms.
Korea: We are underweight Korea because of the difficult export environment, but believe that the economy will turnaround as exports begin to improve.
Malaysia: We will consider moving closer to neutral from underweight if it appears that the new Administration under Prime Minister Najib Razak is willing to take a more proactive approach towards governing, introduce meaningful reform and follow through on stimulus measures.
Philippines: We expect the Philippines should perform reasonably but remain cautious about the prospects for continued strong inflows of overseas worker remittances.
Thailand: We will remain underweight Thailand since we are concerned about the ongoing political instability which will further damage the domestic economy and the important tourism sector.
e-fundresearch: What will be the impact of a growing Chinese domestic economy for the whole region?
Sung: China’s rapid implementation of a RMB 4.1 trillion stimulus plan has helped China to sustain rapid economic growth during the recent downturn and been critical in helping to support regional growth.
China’s stimulus plan has focused on building infrastructure, propping up the property sector and bolstering the rural sector so as to stimulate domestic consumption. As Chinese rural and urban consumers become wealthier and the government begins to provide more services, Chinese consumers will spend more on everything from cars to houses which will increase demand for a wide array of resources from copper and coal to wheat and milk. Australia, New Zealand, Indonesia and Malaysia should all benefit.
With 300 million people moving toward the middle class, regional tourism is likely to explode. Hong Kong has been a key beneficiary of Chinese tourism, but it is likely to spread to other Asian countries. Additionally, more Chinese students are likely to move abroad for education, particularly in countries such as Australia and Singapore.
Another outcome of China’s growing wealth is that the country is seeking to wield more political and economic influence regionally while reducing its massive exposure to the USD and to US financial instruments. At the same time China is beginning to promote the internationalization of its currency, the RMB, which will likely cause the RMB to appreciate.
The combination of a desire for more influence, more widespread use of the RMB and RMB appreciation should encourage Chinese companies to buy more assets, especially in Asia. Chinese companies have already been extremely active in Australian resources and have recently demonstrated a desire to move into other areas with China Mobile’s proposed 12.5% stake in Far East Tone, Taiwan’s largest telecom operator and Petrochina’s US$1 billion bid for a stake in Singapore Petroleum Corporation.
Not only Chinese companies, but also Chinese individuals are likely to invest more aggressively in Asia. Chinese citizens have been buying property in Hong Kong for many years and this pattern is likely to increase and spread to other countries.
Finally, the government is loosening its restriction on Chinese investment through the QDII scheme, which will allow Chinese individuals to invest in mutual funds that will invest internationally, but the focus is likely to remain in Asia.
e-fundresearch: What is your general market outlook for Asia ex Japan equities in the next 12 months? Where do you see opportunities and where do you see risks?
Sung: We have been consistently more positive on the outlook for Asian equities than consensus and maintain that view. Global stock markets have rallied in anticipation that the global economy may have or may be close to bottoming.
One of the key factors underlying our optimism that Asian markets will continue outperform is that Asian economies entered the crisis in far better condition than most other economies. Government balance sheets were quite healthy and better able to afford the stimulus packages than western countries. Interest rates were generally higher than in the West, so central banks had more room to cut them, helping to make investment more affordable. Plus, the precipitous decline in oil prices and inflation, and the prospects of a better more stable political climate in many Asian countries were all beneficial. Asian companies, and particularly Asian banks, had little if any exposure to toxic financial instruments and should suffer less and see their earnings recover more rapidly than in many other countries which should help to support the revival in the stock market.
Asian consumers who have a penchant for saving are also in dramatically better shape than their western counterparts and once confidence returns will be more likely to begin buying consumer goods and property. They are also likely to begin to enter the stock market more aggressively to take advantage of excellent stock market valuations and because there are fewer financial alternatives available to them. Additionally, investors are now more likely to keep their money in Asia, where economies seem safer and better managed than those in the West.
We think that international institutional investors will not be oblivious to these rather important developments and will also begin to allocate more money to Asia. This will be supported by the recent re-weighting of Asia in major indexes like the MSCI. For example, Asia ex Japan comprised 3% of the global index in May 2003, whereas it now represents 7.8%
We have long held the view that Asian market would decouple from the West. While it is too early to confirm that, there are some early indications that this might be happening. For example, emerging Asian markets have risen around 30% through May 2009, while developed Asian markets rose around 20%, whereas European and US markets are generally up around 2%.
Since our approach is to identify trends, themes and sectors at an early stage of their development and to invest in businesses rather than to trade on short term market movements, we do not expect to make major changes to our position from those outlined above. We have already positioned our portfolios based on our global and country and sector outlook for the next 12 months. What we are likely to do is to narrow and increase our concentration in areas as our investment themes and identified trends begin to mature.
Consequently, we expect to further raise our overweight in resources, energy and soft commodities to take advantage of the economic recovery and will likely add even more to pure play commodities. As noted earlier, we expect that inflation will become an important factor in the global economy and see upside to gold prices, so we may increase our fairly high weighting. In this environment we also expect soft commodity prices to rise.
We will also continue to add to asset plays, such as property. Since late 2008, we began to significantly increase our exposure to property in Hong Kong and China, which have performed very well, but are likely to move into more property in Singapore in other parts of the region as the market recovers and possibly in Australia as well as construction materials.
We currently have exposure to infrastructure, particularly in Australia, through commodity exports and in China, through engine manufacturers and commodity companies but as the infrastructure plans begin to develop throughout Asia, we anticipate that we will invest more directly and more aggressively in building materials and contractors in a growing number of countries from Malaysia to India.
We will increase our positions in retailers and tourism in anticipation of a recovery in domestic demand partly due to lower interest rates, stimulus plans and improved sentiment and will also add to our positions in banks in countries where we expect loan demand to increase and margins to rise as loan demand increases and financial systems become healthier.
In Taiwan, we positioned the Fund to take advantage of the potential for an improvement of relations with China and will continue to build on this theme. We have generally been underweight technology, and although it has already done well, we will also stay positioned in the sector.
One of the new areas that we will explore more fully are ways to benefit from the internationalization of the RMB which is likely to help stock exchanges, financial institutions and other service providers.
The risks are that stock markets may have run too hard and too fast in anticipation of an earlier and more robust economic recovery than is likely to occur. It is possible that signs of economic recovery may not be sustainable and that once the impact of the stimulus plans ease, economies will slow, sentiment will fall and markets will consolidate. While stock markets may not continue their powerful upward surge unchecked, we believe that the worst of the stock market downturn is over and that investors should feel more comfortable about returning to the market.
