A roundtable hosted by Professional Planner and sponsored by AMP Capital examined the opportunities for investors in Asian equities.
Hoyle : When we talk about “Asia”, what are we actually talking about in terms of the economies that make up the region, different stages of development and so forth?
Wilson : I think of Asia in three parts. There are the Asian giants – China, India and I’d even include Indonesia in there – which have massive domestic populations and which have the potential to have growth in their own right. They’re not as interdependent on the rest of the world. And then countries like Thailand and the Philippines and so on are beneficiaries of those giants, and their economies are very inter-related in trade and so on. So economies like the Philippines, for example, export domestic workers to these regions and that drives that economy. Then there are the city-states, the financial centres of Hong Kong and Singapore.
So they really don’t have economies. A lot of the economic numbers don’t make sense for them because they’re just three million and six million people. They’re financial centres for the rest of the region. So they’re quite unique in that sense. And then there are the externally-based economies like Taiwan and Korea, which have built up fantastic industries undercutting the Japanese and supplying the rest of the world. But now they find themselves somewhat sandwiched between the Japanese at the very high end and China chasing up on the value-added curve. It’s quite an interesting space for those economies at this point in time.
Chee : The countries in terms of GDP and the GDP purchasing power is a lot different than what you look at in terms of the capitalisation index. If you look at China, their market cap is maybe only 1.5 per cent [of the MSCI World Index], but their GDP purchasing power is a lot higher. But be a bit careful when you look at Asia. If you look at how people take their focus now it’s mainly to say, “I’m investing in Asia”, and they automatically assume they’re investing in China. They’ve kind of missed out a lot of the other countries. So our focus is very much looking at the value that managers can bring, but also look at what the growth stories are within these countries, rather than saying that we just have to invest in a particular country.
Murphy : We’ve done a fair bit of research in emerging markets. I wrote a paper back in 2003 about emerging market dynamics. And one of the things in 2003, when we started to say to clients, you’ve got to be overweight the emerging sphere, was that the relative growth of the region was obviously going to produce profitability that was above its developed-market counterparts. That’s obvious. What wasn’t so obvious then, though, was that the capital accumulation in Asia was going to ultimately far exceed that of Latin America and Eastern Europe. And in the period since 1997, we’ve seen Asian countries and Asian companies clean up their balance sheets massively. And the ability of countries like Indonesia and Malaysia to correct their ills to a surprising degree after the April 1997 collapse was quite impressive, in the sense that they allowed their currencies to collapse relative to the US dollar.
They allowed their current accounts to follow through with what had happened to the currencies. And ultimately, in fact within two years, we had a situation where their current accounts had turned around, and their trade position was starting to improve. A lesson was learned then; and you only have to compare today what’s happening in Latvia to what’s happening in a country like Korea, which is arguably not an emerging country anyway. If you look beneath the surface, it’s quite clear that what is happening is that the Asian bloc is saving, accumulating and lending. I think they learned the lesson that in a globalised environment, currencies trade freely. And if your currency is allowed to trade freely it will correct, if allowed to do so, some of the economic ills that had occurred previously – over-gearing being the greatest one. So we in Asia were very lucky that this happened in ’97, because what happened in 2008 affected everyone else, [but not] Asia to the same extent.
O’Malley : They were already trying to slow their economies down. And then they had this massive credit crunch that sort of stopped trade. And being export-based, it had that double-wham- my effect on their economies. But I think, as Tom was pointing out, their financial systems seem to be a lot more robust. Obviously going through the ’97 crunch they realised that leverage or over-leverage was obviously a very bad thing. And I think that with China being a bit of a powerhouse and being more of an ordered economy, obviously they can push that. Having their massive current account surplus that they can now spend internally, they’ve been able to generate this massive amount of stimulus that actually seems to be rushing through the economy. And it seems to be doing a very good job of it at the moment.
Hoyle : Which of the economies in the countries around China are really dependent on China firing in order for their own economies to grow and prosper? Which would be good investment stories in their own right regardless of whether China pulls out of this very strongly?
Wilson : I think Indonesia’s looking very interesting at the moment. We’re about to have a presidential election which looks like it’s going to be a landslide [to] someone who’s a real reformer and is very economically proactive [and] is encouraging open trade. Indonesia, just because of its demographics and [because] it’s quite resource rich, has a lot of potential without being that interrelated with China, [and] is probably one of the few very strong economies that isn’t interrelated with China. And India is in that same basket. India has a slightly different situation. The Budget was announced [recently]. Again, the politics have improved dramatically in India. We talk about a centrally-commanded economy in China; well, India is the complete opposite.
They call India a “highly-participatory democracy”, which means it has way too many parties that have to be appeased on their coalitions. But they have one of the strongest coalitions they’ve had for a while recently. And there’s great hope that they will be able to push for reform and help India reach its economic potential, which is sometimes held back by its democracy, because of the bureaucracy and actually making things happen and getting the infrastructure happening. But India’s quite independent of the other markets in Asia as well. I think the more independent countries are countries like Korea, which does a lot of industrial machinery that’s supplied into China. So it’s sort of a love/hate relationship there. We visited China’s state ship-building [business] last week. We had someone in Beijing, and they said that they were going to be able to build every type of supertanker by 2015 – they’ll be able to do everything the Koreans do and they’ll do it cheaper.
So on the one hand they’re undercutting the Koreans and on the other hand at the moment they can’t make turbines and they can’t make driveshafts and all those things that they need. And Korea is the supplier of that. So if you look at the trade numbers there, they’re quite dependent. And Taiwan is the most topical one in terms of the capital links theory. Taiwan is effectively Chinese, but it’s cut off from China. The opportunity for Taiwan to open up into China is sort of the growth story there. But again there’s a love/hate relationship. They’re a democracy. They want their freedom, but the economic attraction of being more closely linked to China is very compelling. So it’s quite a dilemma for them also.
Hoyle : How big a potential fly in the ointment is North Korea in this story? How much is it a genuine threat to stability in the region?
de Pourbaix : Interestingly, you’ve had China step in a little bit more than they have historically and try to settle things down with North Korea, which I think is a big step for the region; that you have one of the big powerhouses actually [engaged], whereas historically they’ve been a bit stand-offish.
Hoyle : Is that suggesting that they’re saying that this is a real problem and stability is something we need to work at?
de Pourbaix : I don’t think it’s just that. It’s also the national standing of China. They’re realising that they are an important player in world politics. And that’s part of it I think.
O’Connor : When we’re looking for managers who participate in the region, we do look for some sort of top-down influence in their investment process. And that’s not just to be blinded by the fundamentals when you’re looking at stocks, but [also] to have some level of overlay. Whether that top down analysis is included in the fundamental research, or whether it’s a pure separate overlay, I think it’s just one of those extraneous issues, geopolitical risks that you’ve just got to be aware of as an investor in the region.
Hoyle : When you approach the region from the outside as an investor, how do you start your assessment process?
O’Connor : I guess for five years now or so, we’ve had a very encouraging view on emerging markets, full stop, purely based off the premise of GDP growth potential for the region as opposed to the developed economies. And that’s prior to the GFC [global financial crisis]. So I guess from that then, looking at the various constituents of emerging markets, we’ve probably now for three years had the view that we see Asia as a lower-risk subset of emerging markets. We would look at using an emerging markettype [fund manager] capability.
But for some clients, given that they have such an overweight to Australian equities – Australian equities has a natural link to the region through its resources – that’s where we can actually carve out, and for some clients give, an exposure just to a pure Asian region exposure through a manager or two in a portfolio. Typically we won’t drill any deeper than that. We will want to try and find a manager that can have, I guess, the wherewithal to invest across all of the region of Asia without trying to take on and make the calls ourselves. So typically then it’s played out in a portfolio through emerging markets or through dedicated Asian equity managers.
McLaren : I think that’s fair to say – I know a lot of work that traditionally St George has done with S&P has been around that region-specific [approach], not countryspecific. I don’t think there’s been that demand for China or India funds specifically, or even drilling down into Taiwan. It’s been much more of a regional level.
de Pourbaix : Obviously there’s been an increase in the number of funds with specific Asian mandates in the market. For a high growth portfolio, for example, the maximum exposure to emerging markets is roughly around 15 per cent of [the equities] exposure. Interestingly, the way we’ve tended to gain exposure to those markets is via active international equity managers, because on a look-through basis, and you look at a lot of those portfolios, you are actually getting a fair bit of Asian exposure in a lot of those mandates because a lot of what you have seen increasingly over the years is that a lot of the managers are becoming increasingly index aware.
So in the MSCI World index, Asia makes up approximately 1.6 per cent, around that mark of the index – a lot of these managers are quite overweight particularly Asia. I think the last time we looked at the portfolio on a look-through basis, about 10 per cent of international equity portfolios was invested in Asia. I think one thing an investor should be cognisant of is what exposure they are getting through some of their broad international mandates.
Mac Lachlan : You can look at Asia internally and say, which are the countries that are going to do well, but you can also look at it globally and say, what are the sectors that are going to do well from Asia’s growth? That’s one of the reasons why we’re still positive on the energy materials global sector, because if you look at someone like China, they’re still the largest consumer of copper, lead, zinc, nickel, rice, wheat, rubber. Pretty much you name it, they’re the largest consumer. And we’ve talked a bit around the table about the global fiscal stimuluses, which have been around 5 per cent of global GDP. A lot of that is going to be infrastructure-heavy. So we continue to think that’s a sector that’s going to benefit. It’s not clear, for example, if China in and of itself is going to lift the global economy out of recession. I mean, they’ll have a big impact, but they can’t do it alone. But certainly China alone can have a big impact on certain sectors, like materials.
Hoyle : It seems like the common theme here is a bottom-up approach.
McLaren : And what I think Graham touched on right at the beginning: liquidity. And how to access that.
Chee : I think there are more people that think that they can probably invest into a business in China. It’s okay to invest in the business in China, but it’s very hard to get your money out of China, just through the monetary requirements. So I think that the definition of what you want to invest in is one of the hardest things to get people to understand. Like, it’s either a commodity play, an international play. You’ve got real estate.
Hoyle : What are some of the things you need to be conscious of or cognisant of when putting money in, and also trying to get your money back out, of the region?
de Pourbaix : I think it’s more a regulatory, a broader issue when investing. Not in every Asian country, but certainly in China. Yes, they’ve got a high growth rate, and no doubt they’ll make that happen, because in order to keep the peace they have to have a good growth rate. But as an investor, making money in the Chinese market isn’t that easy and the regulatory environment can change quite quickly; and unless you’re in the know, then if you’re a bottom-up analyst, that can really throw your assumptions. For example, labour reform. China was bringing in labour reforms and they made a back flip on that in order to stop the labour costs, to keep the economy kicking along. But it just shows how if you are investing in that region you’ve got to be on top of [it]. It is dynamic, from a regulatory point of view. It is a dynamic beast.
McLaren : It’s really the same for any emerg- ing market isn’t it, that opacity?
de Pourbaix : Well that’s right, yes, certainly. And it’s one thing to have the “story”, but it’s another thing to actually make money out of it.
Hoyle : So how do we link the “story” to actual, specific, on-the-ground investment opportunities?
Wilson : Your access point is interesting because China has the A sharemarket, which is the third-biggest market in the world, at $US3 trillion dollars, and that’s not accessible to foreigners generally. You have to have a FII [Foreign Institutional Investor] licence. I think [there are] about 70 licences around the world. And then you have Hong Kong…and it’s probably 20 to 30 per cent the size of the A sharemarket. So there’s this massive, massive market for China that really can’t be accessed by foreigners to a large extent, except through people who have licences, and the licences issued are [for] less than $10 billion dollars in a $3 trillion market. So it’s very, very small. And that works in reverse. The Chinese investors can’t get their money out.
Their investment opportunities are very limited. They can basically buy a property or they can invest in the Chinese sharemarket, which means that there’s a real disconnect, even from companies that are dual listed. If people want liquidity, they really have to invest through Hong Kong, or they can get limited liquidity investing in Asia funds, like AMP Capital has a China A-Share fund. But it’s only half a billion dollars. There’s a lot of money around the world. And there’s only about half a dozen funds like ours. India’s very similar. You need an FII if you want to invest in India – there’s probably 3000 FIIs in the world. So it’s more accessible.
Sivanesarajah : At the moment you have this bizarre situation where the same shares [are] listed in Hong Kong as well as the mainland. They have the same share of economic profits, but they trade at two different valuations.
Hoyle : Lukasz, you mentioned, if I got it correctly, that roughly 15 per cent of your equities exposure is to emerging markets.
de Pourbaix : For a high-growth [investor]. I think the important thing which we have to talk about is the risk. From a consultancy perspective, we model for long inflation, long-term growth and so forth. But we also model for risk. You could say emerging markets more broadly have been a lot more volatile than developed markets. So when we look at modelling portfolios across our various risk profiles, which range from very conservative-type clients right up to your high-growth – and highgrowth is where you’re pretty much 100 per cent invested in equities – there are different tolerances to risk. So provided that the right client’s in the right product for their risk tolerance – and in our range it’s up to 15 per cent. It’s not a 15 per cent target. Would you put a conservative client in an Asian equity fund? My answer would be no, because for their risk tolerance it’s not appropriate.
O’Malley : It depends on what you define as risk. Is drastic under-performance in western markets a bigger risk than some of the volatility you get in the emerging markets? If you look at the US, obviously [growth is] starting to come through, but if you think there’s going to be extremely low growth there for four, five, six years, even longer, you may be thinking to yourself…it’s going to be lower volatility for sure, but it’s going to be very, very poor returns. So I suppose sometimes you’ve got to look at risk from not just the volatility side, but [also] the trade-off between the various sub-asset classes within equities.
McLaren : I guess it comes down to your client base as well doesn’t it? Tom’s clients are going to look a bit different to a bank planner channel, for example.
de Pourbaix : And timeframe. I mean it is a long-term story. If someone’s got a conservative client and their timeframe is three years to four years, you’re getting in at the wrong time. It might be three years of pain.
Hoyle : When you take an industry or a sector view of the world, what controls or balances or checks do you have to have in place so you don’t end up with an over-exposure to a particular economy or a particular region?
Mac Lachlan : Are you bottom-up or topdown? And to an extent, if you’re looking at it from a sector perspective, you have to be a little bit of both. So the bottom-up portion of your portfolio, you’ve got stock pickers or commodity pickers, as the case may be, who are picking individual companies who say they like companies because of the management, the quality of the asset base and growth profile. So they pick a range of companies. And then you get that portfolio mix and then that’s where you may have to overlay some of the top-down. So we do – at least in our resources fund – we do a little bit of both. We overlay some top- down where we might take some macro, ETF or ETC positions to balance out the bottom-up portfolio. So we do look at both.
Hoyle : Does one take precedence here? If you have a clash in the view of what’s coming from the bottom up and a view that’s being generated from the top down, how do you reconcile [that]?
Mac Lachlan : Well that’s just one of portfolio balance. Trying to get the right mix. You’re not trying to completely offset what the bottom-up guys are doing. But then again the natural weighting of the delivered portfolio may not be appropriate for your investor base. It’s just finding that right balance.
Hoyle : What do you look for in terms of resources, capabilities, experience, track record, the works, when you’re assessing whether a manager is a suitable candidate for investment?
O’Connor : We look for a combination of both bottom-up and top-down involvement, because we think that emerging markets as a whole are witness to such large amounts of capital inflows, out-flows. So there are global thematic issues at play with that movement of money in and out. And we like to see that I guess incorporated from the top-down view into constructing a portfolio. We like to see on-the-ground presence, whether that’s just in the proximity of the region. I’m fully a proponent of the active approach to manage in the region, given the volatility of the markets, and hence the opportunity to add value. We certainly don’t consider passive exposure to the region there. As large a team as possible. My personal view is I like to see the team together, rather than in different locations, because I think that makes the whole collegiate and communicative part of the investment management process very difficult.
Hoyle : What about track record?
O’Connor : The one thing you do want to see with track record is being true to label. So understanding the investment style of the manager and then understanding the nature of the markets, and how [the market has] performed compared to how the manager’s performed. So I guess you see some more defensive managers in emerging markets that are non-benchmark aware, focused on the quality issue in companies, and some of those managers have stood up well over the last 18 months to two years.
de Pourbaix : You want to ensure the right people are there. People that are familiar with the relevant markets they’re investing in. The tendency sometimes from product issuers is that a product is launched without actually thinking about, do they have the building blocks to execute the strategy sufficiently. If someone says there’s an Asian product, we want people to have experience in relative regions, in investing in markets, and obviously you want a clearly-defined process. But the way you can really, I suppose, check that they’re adhering to that is to look at some physical portfolios and run some analysis over time. You want to see strong risk management as well. It is a volatile market. If you get portfolios comprised of two stocks running the whole portfolio then that’s not something you probably want in this type of market.
Track record is an important part of it as well, in terms of gauging how their portfolio tracks in different markets, because obviously depending on their style, concentration, which market they may invest in, that will drive how a portfolio will perform. And commitment to the strategy because I remember emerging markets years ago, this is from a retail point of view, there’s quick money in but quick money out. So a lot of these product providers went on the bandwagon and everyone had an emerging markets fund. Then in the early 2000s, suddenly [managers] in the retail space said, well, we’re not offering it any more – because it’s exciting, but the reality is, on a retail level, not a lot of money goes into it, of a total portfolio. So commitment to the space – someone that’s been in the space for a while and is committed, and it’s not just because it’s popular. So they’re some of the things to think about.
O’Connor : The other thing I was going to say was we prefer currency unhedged.
O’Malley : You like to make sure of the track record and that the process looks like it’s repeatable and all those sorts of things. And doing the back testing on the portfolio, making sure it sits with their process. One of the issues that we’ve come up with with managers recently is the fee structures. Obviously performance fees – with some of the smaller funds there tends to be a base fee plus a nice chunky performance fee. I suppose we’re quite happy to pay a performance fee in the space so long as the base fee comes right back. So you’re not paying almost double fees. Some of these markets have obviously got quite high beta. So I want to pay for alpha, as opposed to the beta.
McLaren : The top ones would be the risk management piece. Ability to recreate the success. And from our perspective, when we look at the dealer groups that are looking at these types of funds, it’s the currency hedging piece [and being unhedged] that has a degree of popularity.
de Pourbaix : I think the key point for financial planners is, yes, Asian equities is a growth story. But be cognisant of the issue with higher return prospects. There is high risk associated with that. So be sure you have the right clients in the right product. And also another point is, if you already have exposure to global equities, know what your exposure is to Asian equities within that framework because you may be doubling up.
Murphy : I think the most important point for the retail investor is that the investment in Asian equities needs to not be taken over a threeto five-year time frame, but on a seven- to ten-year time frame. And if the investor would even consider withdrawing all of his money upon a 50 per cent fall in the value of that part of the portfolio, the investor does not belong in the emerging markets at all. And I think it is the pointy end of equity exposure; and even though the standard deviation of returns, or the volatility, will be closer to that of developed markets going forward, than it has been in the past, it will still be higher.
So it is a higher-volatility component of the portfolio. It is an alternative asset for the retail investor. I believe on a seven- to ten-year time frame it will be one of the best, if not the best performing asset class; and as I said before, we invest in emerging markets almost solely in Asia, with one exception in Latin American, and no exceptions in Eastern European. All the emerging market exposure in our company is in Asia because of the growth characteristics and the balance sheet strength of the region. And I don’t expect that to change.
O’Connor : When we talk about having an Asian exposure in a portfolio, first of all, why do you have it? And you have it for the growth potential. Why does that growth potential exist? Well, if you look at developed nations, the GDP growth over the last 10 to 15 years, probably 70 per cent of it has been filled by the consumer, by consumption. With the consumer now deleveraging to such an extent in the developed nations, we have a mediumto long-term outlook for GDP growth being far more restrained looking forward over the next ten years to looking backwards over the last, say, 10 to 15 years. So purely on a GDP growth potential we like Asia over developed nations. So we believe if you do want to generate alpha, generate growth in the portfolios, you need to have some level of exposure, pending your risk. But be clear first and foremost why you were there, and it’s back to that growth story.
Mac Lachlan : From our perspective, Asia remains a real generational play. This is a longterm play and is going to play positively over the long term. It’s actually not going to be all in one direction. And similarly, we’ve got all our emerging market exposure in Asia as well. There are different ways, though, to play Asia: country perspectives or regional perspectives or sector perspectives, as we talked about. And also, as Graham mentioned, I think particularly in Asia, because a lot of the managers are newish, you really do need to do your due diligence when you’re going into Asia. Make sure you’ve got the right product and the right managers.
Wilson : Think aggressively about your asset allocation. Think about investing into Asia because of both the growth and leadership potential of these markets. The growth potential is well documented. China and India are expected to be the first- and second-biggest economies in the world by 2050. And the leadership potential is becoming more self-evident: we used to invest in the US to get exposure to the world’s best auto industry, to get exposure to extensive telecom networks, to get exposure to progressive technology. But these days…Silicon Valley companies are investing in Taiwan expertise. Indian telecom companies are producing mobile frequency at the cheapest rate globally and the most profitable rate globally. So these companies are the potential future leaders of the world, and this is a great opportunity to get in early.
O’Malley : We’re moving to a higher allocation into Asia. We think obviously the growth story’s there. Just be [conscious] of the risk. Make sure you do your due diligence. But when you’re weighing it up against not just other equity classes, but other asset classes particularly, just make sure you understand what the risk is, what the return is; and sometimes the more risky asset you’re in may not be the lowest-volatility asset. It may be the one that gives you those very boring returns. It could be lower than inflation and very serious. So keep a very close eye on asset allocation, and obviously this is probably one of the better ways to get some of the growth in industrialisation that we’re probably going to see; that’s going to take long periods of time. And you can also probably get a little bit of that through your Aussie equities.
McLaren : I’m coming from a slightly different angle, coming from a platform or an investor supermarket angle. I think it’s been a tough time for financial planners. And I guess my main message would be to hang in there, and just comment on the things we’ve been saying which is very much that demand for liquidity. Liquidity is key, and again across that regional, as opposed to country-specific, demand.
Sivanesarajah : One of the things coming into the GFC, especially, I think is not well understood in Asia is gearing. In western markets everyone speaks about gearing. Asia has de-geared, in a big way, and it’s not just in one sector. On the country level, on the company level, on the government level. I think on the consumer level, it’s pretty well spoken about how high savings rates are. But on a company level, we’re finishing 2008 with a net debt-to-equity [ratio] in Asia ex-Japan region of about 10 per cent. A number of these companies are not just under-geared, but have excess cash on their balance sheets. I don’t think that’s very well understood. And probably the second thing is GDP rates versus index [weightings]; Asia is not well represented in the world [indices] as yet.
And all you need to do is look at a chart where GDP is going to be for the biggest countries, not just in 2050 where China will dominate, but in 2020, which is only ten years away. From that perspective Asia is under-represented because of foreign institutional restrictions and the security they keep around their markets. That’s changing. It’s changed in the last five years, and it’s going to change going forward.
Chee : They have to understand whether they want growth within Asia or growth from Asia. [Investors] really need to understand where their growth is going to come from. And you may have the Australian equities company that is getting growth from within Asia. Take BHP and Rio. If they didn’t have any growth from Asia they would be very low. If you look at it from the perspective of a global company, that is where everybody is trying to enter into, and I think it’s how well those international companies actually participate in the Asian growth story. If you believe that they have the right structure and they can operate within Asia, then they may be a company that you’re more comfortable with…than you would be investing in an Asian company.
ROUNDTABLE PARTICIPANTS Graham Chee – managing director, MyMoney Group Simon Hoyle – editor, Professional Planner Marnie McLaren – national manager, fund manager governance, BT Financial Group Alex MacLachlan – managing director, funds management, Dixon Advisory Thomas Murphy – managing director, Family Office & Research Management Shaun O’Malley – senior research analyst, Australian Wealth Management Paul O’Connor – director, fund services, Standard & Poor’s Lukasz de Pourbaix – investment consultant, Lonsec Ragu Sivanesarajah – senior portfolio manager, Asian equities, AMP Capital Investors Karma Wilson – head of Asian equities, AMP Capital Investors
